Academic journal article Entrepreneurial Executive

College Education Funding: Maximizing Family Tax Savings and Financial Aid

Academic journal article Entrepreneurial Executive

College Education Funding: Maximizing Family Tax Savings and Financial Aid

Article excerpt


With the average cost of a college education at public and private institutions estimated to rise to $60,000 and $200,000, respectively, by the year 2007, the need for financial planning for college is more critical than ever. While changes and additions to the Internal Revenue Code have fulfilled Congress' intention to "maximize tax benefits for education and provide greater choices for taxpayers in determining which tax benefits are most appropriate for them" (H.R. Conference Report), "the mere number and perplexing intricacies of these benefits make it extremely difficult for taxpayers to choose and interpret the ideal option" (June 2004 testimony of former IRS Commissioner Fred Goldberg).

Further complicating the overall planning process is the impact of various funding alternatives and tax incentives on eligibility for federal financial aid. Last year a record $90 billion in financial aid, an increase of more than 11.5 percent from the prior year, was awarded to students at both private and public institutions. Thus, a basic understanding of the financial aid process is an essential component to effective planning for the college years. All of the pieces of this complex puzzle will be explored in the paragraphs that follow.


Despite the ever-growing cost of a college education, reports that although families are saving for college, they aren't saving enough. Specifically, between two-thirds and three-fourths of families say they are currently saving for their children's college education. However, of those, one-third have saved less that $5,000. Further, these savings tend to be in taxable accounts, especially low-risk (but also low-yield) investments. Savings accounts are the most popular savings vehicle with three-fifths of families using them, a quarter using CDs, and half using stocks and mutual funds. About a quarter of families use UGMA (Uniform Gift to Minors Act) accounts, a third use savings bonds, a sixth using Coverdell education savings accounts, and a sixth are using section 529 accounts.

In the current climate of ever-increasing college costs and ever-decreasing federal income tax rates, most financial planners agree that the starting point for evaluating all college funding alternatives is the effect that the financing alternative will have on available financial aid. Generally, those who qualify for federal financial aid (grants, loans, and work-study programs) should attempt to maximize those benefits first, while those that don't qualify will have a more simple plan--to maximize tax benefits. As a basic rule of thumb, those who earn less than $70,000 and up to $120,000 to $125,000 a year will probably qualify for aid with chances increasing with more than one child in college. Because tuition is growing at a faster rate than income (about three to four times the yearly inflation rate), those who qualify now for financial aid will probably continue to qualify in the future.


To fully understand the impact of financial aid on tax incentives, a basic understanding of the financial aid process is necessary. Two formulas are used to determine a student's eligibility for financial aid-the Federal Methodology Formula (FM), established by Congress and used by every accredited college in the United States, and the Institutional Methodology (IM) used by many colleges and private scholarship programs. Although the specific items considered in each formula may vary, both formulas measure a particular family's ability to pay against other families' ability to pay. The information used for FM analysis is collected on the Free Application for Federal Student Aid (FAFSA) which may be found at while the IM information is collected on the CSS/Financial Aid PROFILE in addition to the FAFSA. It is possible to estimate eligibility for financial aid with financial aid calculators which may be found at www. …

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