FP511 Module 7 (Education Planning)

Question 1

Expected Family Contribution (EFC)

Answer 1

an index number that colleges use to determine the amount of family-paid annual college costs.

Ultimately, the EFC is subtracted from the total annual cost of attendance to determine the amount of financial aid that students will receive.

The term is used on the Free Application for Federal Student Aid (FAFSA), which is an application that students file for federal student aid.

([22%–47% parent income + 5%–5.64% parent assets] + [50% student Income + 20% student assets]) = EFC
Overall, a higher percentage of assets and income included increases the EFC and reduces the available financial aid.
Parental assets and income are assigned a lower weighting in the EFC calculation than are student assets and income.

Question 2

4 Federal Grants for College

Answer 2

Federal Pell Grants

Federal Supplemental Educational Opportunity Grants (FSEOG)

Teacher Education Assistance for College and Higher Education (TEACH) Grants

Iraq and Afghanistan Service Grants

Question 3

Federal Grant Eligibility

Answer 3

Be a citizen or eligible noncitizen of the United States

Have a valid Social Security number

Have a high school diploma or a General Education Development (GED) certificate, or have completed homeschooling

Be enrolled in an eligible program as a regular student seeking a degree or certificate

Maintain satisfactory academic progress

Not owe a refund on a federal student grant or be in default on a federal student loan

Register (or already be registered) with the Selective Service System (if the student is a male and not currently on active duty in the U.S. Armed Forces)

Not having a conviction for the possession or sale of illegal drugs for an offense that occurred while receiving federal student aid (such as grants, work study, or loans) – Students who have such a conviction must complete the Student Aid Eligibility Worksheet to determine their eligibility for aid.

Question 4

Stafford loans

Answer 4

also known as William D. Ford Direct Stafford loans) are a common type of educational loan. Both direct subsidized and direct unsubsidized loans are offered through the Stafford loan program. Only undergraduates qualify for subsidized Stafford loans.

Federal student loan interest rates are tied to financial markets

Normal repayment period is 10 years but extensions and options are available

Question 5

Parent Loans for Undergraduate Students (PLUS loans)

Answer 5

parents may borrow funds for their children’s undergraduate studies. The amount that can be borrowed is unlimited, except the total of all aid received cannot be higher than the total cost of schooling.

These loans are not need-based

Fixed interest rate (2023 = 7.54%)

Repayment begins within 60 days of disbursement, and although repayment may be delayed until the student is out of school, the interest on the loan continues to build during this time.

Question 6

Direct Consolidation Loans

Answer 6

This program allows for the combination of multiple student loans into one loan. A parent loan cannot be consolidated with student loans and become the student’s responsibility to repay.

Currently, for Direct Consolidation Loans, the interest rate remains the weighted average of the interest rates on the loans included in the consolidation, rounded to the next highest one-eighth of 1%.

Question 7

Perkins Loans

Answer 7

Ended in September 2017 but people still have outstanding loans

Perkins loans were low interest rate loans funded by the federal government but administered by individual schools.

These loans were available both to undergraduate and graduate students.

They were need-based and were available to students who were attending on at least a half-time basis and who had an exceptional financial need.

5% interest rate which would not change as the individual was a student

Not charged interest until done with school

Question 8

Federal Grants

Answer 8

Federal grants are gifts by the federal government to a student to be applied toward education funding.

The student is not required to pay back the government-provided grants.

Like loans, grants are either disbursed directly to the student by the federal government or by the institution (campus-based aid)

Question 9

Pell Grants

Answer 9

Pell Grants are available to undergraduate students only and are distributed on the basis of substantial financial need

Needs based

The maximum amount available may change year by year but will seldom (if ever) be enough to completely pay tuition expenses (maximum for the 2022–2023 award year is $6,895).

Available for part time, half time and full time undergraduate students.

Question 9

Federal Supplemental Educational Opportunity Grants (FSEOGs)

Answer 9

funded by the federal government but are administered by individual schools.

Undergrad only and needs based

Pell Grant recipients are given highest priority in receiving FSEOGs

Question 10

Federal Work-Study program

Answer 10

Under the Federal Work-Study program, eligible students are provided employment, which may be on or off campus, to help cover the cost of their education.

The government and the employer share in the payments made to students.

Eligibility is based on financial need.

Question 11

Custodial accounts (UGMA & UTMA)

Answer 11

Custodial accounts were a popular way of income shifting and saving for college in a child’s name.

The first custodial accounts consisted of those established under the Uniform Gift to Minors Act (UGMA), although in many states, UGMA accounts were then superseded by those established under the Uniform Transfers to Minors Act (UTMA).

Both accounts, however, suffered from a major practical disadvantage: when the child attained the age of majority, either age 18 or 21 depending on state law, the child could gain access to the funds in the account, regardless of whether the funds were used to pay for a college education.

Also, accounts are specific to one child meaning if there is more than enough money for the eldest, the money cannot be reapplied to an account for a younger child

Although a parent may elect to be appointed custodian on an UGMA or UTMA account, the child is considered the owner of the assets within the account.
As a result, UGMA and UTMA assets will be included at the child’s rate of 20% when calculating the EFC for financial aid.

Question 12

Uniform Gift to Minors Act (UGMA)

Answer 12

Initial custodial account

Major issues where child gains full access to funds at age of majority.

Also, accounts are specific to only one child

Also, the account is considered an asset of the child and thus increases EFC (expected family contribution)

Question 13

Series EE & I Savings Bonds (saving for college)

Answer 13

The savings bond education tax exclusion permits qualified taxpayers to exclude from their gross income all or a portion of the interest earned on the redemption of eligible Series EE and I bonds issued after 1989.

the bondholder(s) must be at least 24 years old when the bond is purchased and the taxpayer, the taxpayer’s spouse, or the taxpayer’s dependent at certain postsecondary educational institutions must incur tuition and other educational expenses.

Individuals with incomes above certain thresholds may not be eligible to participate.

This phaseout restriction will be in place when the distribution occurs, so it is important to monitor the client’s income compared to the phaseout.

Room & Board / books are not eligible expenses

Question 14

Coverdell Education Savings Account (CESA)

Answer 14

serves as an incentive for parents, grandparents, and others to save for a child’s education expenses.

Up to $2K contribution each year for parents/grandparents/etc (limited to 2K per year per child regardless of the number of donors)

Earnings on the account are tax free income

CESAs can pay for private elementary all the way through to college

Contributions are subject to AGI phaseout

All funds within the CESA must be used before the student reaches age 30. Any remaining funds will be disbursed to the CESA beneficiary, and the earnings will be subject to income tax and a 10% penalty.
However, can rollover to another beneficiary

Question 15

Section 529 Plans

Answer 15

A Section 529 plan, also known as a Qualified Tuition Program (QTP), is a tax-advantaged program that helps families save money for college expenses incurred when pursuing a degree.

Significant tax benefits
the ability to make contributions regardless of the contributor’s average gross income
tax-free earnings growth
tax-free withdrawals to the extent they are used to pay qualified higher education expenses

Maximum of 10K tax-free distribution per year for elementary and secondary school.
Once the student reaches college, accounts can be disbursed without limits for qualified expenses

Contribution limits to the QTP vary from around $100,000 to $250,000 depending on the state in which the program is established.
Gift tax is in place but two parents can combine their 16K years limit and do a one time contribution (every five years) of 160,000 to the beneficiary (1652 = 160K) (known as accelerated 529 contribution (x2))

Do not gain access to account at age of majority

Two types of Section 529s - Prepaid tuition plan (state dependent) vs college savings plan

Question 16

Prepaid Tuition Plans (Older Section 529 Plan)

Answer 16

Prepaid tuition plans permit contributors (usually parents) to prepay future tuition at today’s tuition rates or purchase tuition credits (units) to apply to future tuition costs.

This type of program also usually requires that the designated beneficiary (usually the contributor’s child) go to any public college or university within the state (or the specific private institution) that established the QTP.

Only 11 states offer it now when previously 18 did

Question 17

College Savings Plan (Newer 529 Plan)

Answer 17

College savings plans may be offered only by states, state-sponsored organizations, and eligible educational institutions.

Market based - no guarantee of what will be total amount to be used for paying for college

In this type of plan, tuition is not being prepaid, but, rather, a tax-advantaged savings plan is established from which tax-free distributions are made to pay for qualified education expenses.

The investment options offered in college savings plans often include stock mutual funds, bond mutual funds, and money market mutual funds.

Can go to any college

Funds can also be used for a broader set of education needs including room and board and books

Question 18

UGMA 529 accounts & UTMA 529 accounts

Answer 18

Most states that have previously established a Section 529 QTP plan will permit a contributor to roll over UGMA or UTMA proceeds to the Section 529 plan account on behalf of the child.

Question 19

ABLE Accounts (Achieving a Better Life Experience Act)

Answer 19

ABLE accounts provide individuals with disabilities and their families with the ability to fund a tax-preferred savings account to pay for qualified disability-related expenses.

Question 20

Kiddie Tax

Answer 20

taxes certain unearned income of a child at the parent’s marginal rate

In reference to custodial accounts - The kiddie tax applies to unearned (i.e., investment) income received by children under age 19, or under age 24 if a full-time student. In essence, a first tier of unearned income is not taxed because it is offset by the limited standard deduction; a second tier of unearned income is taxed at the child’s marginal tax rate; all unearned income exceeding this small amount is taxed at the estates and trusts marginal income tax brackets.

Question 21

Minors Trust [2503(c)]

Answer 21

A minor’s trust is designed to use the annual gift tax exclusion

a gift to an individual under 21 will not be considered a gift of a future interest as long as the property and its income are payable to the child at age 21

In addition, the minor’s trust permits income to escape the kiddie tax by allowing the trustee to accumulate more income at the trust’s separate tax bracket.

Unfortunately, changes in tax law have resulted in the income retained in trusts being taxed at the highest personal rate, even at relatively low levels.
Simply put, if money is put into this kind of trust for a child, the potential taxes may be higher than the child’s or parent’s tax brackets.

Child gets all funds at age of majority (21)

Question 22

Current Income Trust [2503(b)]

Answer 22

The current income trust must have its income paid out at least annually to the beneficiary with no discretion left to the trustee to accumulate income.

This typically presents problems in avoiding the kiddie tax; however, it has a substantial offsetting advantage to many grantors (the persons putting the money in the trusts).
The trust property, or principal, need not be distributed to the child at any specified age
This ensures the segregated funds are used only for the purpose they were intended—that is, the child’s college education.

With this type of trust, it is important to choose investments that increase in value but do not pay income while the child is young. Without this approach, all of the income earned in the trust will be paid to the child and the fund will not grow.

Question 23

Crummey Invasion Trust

Answer 23

an effective mix of the best attributes of the minor’s and current income trusts.

It transfers money from one individual to a trust for the benefit of another in a way that avoids gift taxes and keeps the money out of the estate of the donor.

It permits the beneficiary to withdraw from the trust an amount equal to the lesser of the annual addition to the trust or the annual gift tax exclusion

In addition, rather than requiring trust property to be distributed to the beneficiary at age 21, the demand trust allows distribution at any age chosen by the grantor.

However, if the demand trust accumulates income and it is taxed to the trust itself, the tax rates are high.

Question 24

Retirement plans to fund college

Answer 24

Many qualified retirement plans permit a participant to borrow from the plan without imposing the premature distribution penalty.

Under the “substantially equal periodic payment” exception to IRC Section 72(t), a participant can turn some or all of his retirement account (including an individual retirement account) into a period certain or life annuity for preretirement use at any time without the usual 10% premature distribution penalty. As long as the participant withdraws roughly equal amounts from his retirement plan annually for at least five years following commencement of distributions, or until reaching age 591⁄2 (whichever is later), retirement money can be used for any reason.

Question 25

Portability of funds

Answer 25

529s, if the parents are owners, can be transferred to another beneficiary (e.g., Student A’s sibling or cousin) if permitted by the plan.
So if one child does not decide to go to college, the plan can be
rolled over to another sibling or cousin or grandchild

Coverdell ESAs (CESAs) can be transferred to another beneficiary
Coverdell ESAs can be transferred to a 529.

UGMAs and UTMAs cannot be transferred to another child.

Trusts can be established individually or with multiple beneficiaries. In both cases, funds need to be allocated to the stated beneficiary. There are pot trusts that pool money for beneficiaries but do not specifically allocate. Treatment of trust funds is commonly spelled out at inception, not designed to switch beneficiaries.

Question 26

Control funds at the age of majority

Answer 26

529s: Account owner’s assets; the funds are not transferred to the student at age 18

Coverdell (CESA): All funds must be used before child reaches 30

UGMA and UTMA: Custodial accounts in the child’s name; when child reaches age of majority (18 or 21 depending on state), they assume ownership of the account and are not required to use the funds for education

Trusts 2503(b): Can hold funds beyond beneficiary’s age of majority; 2503(c)—principal or income required to be distributed by age 21; trust with spendthrift provision—disburses funds for college expenses only and remains in the control of the trustee beyond the age of majority

Question 27

Accelerated 529 Contribution (x2)

Answer 27

In a proper planning scenario, a couple can combine their five-year accelerated 529 contributions and deposit 160,000 (2022) without having to pay gift taxes

Question 28

American Opportunity Tax Credit (AOTC)

Answer 28

intended to help families pay for postsecondary education for their children.

In 2022, the American Opportunity Tax Credit reduces a family’s tax dollar-for-dollar in an amount equal to 100% of the first $2,000 of qualified post secondary expenses and 25% of the next $2,000 of qualified expenses incurred for the first four years of postsecondary education.
Therefore, a maximum credit of $2,500 is allowed.
Only need to spend 4K to get 2500

Qualified expenses include tuition, fees, and course materials (e.g., books, equipment)
room and board are excluded

The availability of the credit is also subject to phaseout for taxpayers with income above certain limits.

Have to be at least half time student going for a specific degree or certificate

No felony drug convictions

Question 29

Lifetime Learning Credit

Answer 29

Unlike the American Opportunity Tax Credit, the Lifetime Learning Credit may be claimed for an unlimited number of years while the student is pursuing their education

Furthermore, the Lifetime Learning Credit neither requires enrollment in a degree program, nor does it necessitate at least half-time enrollment.

Lifetime Learning Credit permitted is 20% of the first $10,000 of qualified tuition expenses paid by the taxpayer for any year in which the American Opportunity Tax Credit is not claimed for the same student.
Need to spend 10K to get a similar amount of money (2K) to
American Opportunity Tax Credit (2.5K)

This results in a maximum nonrefundable credit of $2,000 per return or per family.

Can have a felony drug conviction

subject to phaseout for taxpayers with income above certain limits.

Question 30

Student Loan Interest Deduction

Answer 30

This deduction is allowed to the student or parent (if it is a PLUS loan) for interest paid on loans incurred solely to pay qualified higher education expenses at an eligible educational institution.

up to a maximum of $2,500 per year

Phaseout limitations apply

Question 31

Employer Assistance Programs

Answer 31

An employer may provide an unlimited amount of educational assistance to an employee so long as this assistance is job related.

This is known as a Section 162 employee benefit

An employer may also provide up to $5,250 of non-job-related educational assistance to an employee during any one year as a tax-free employee benefit under IRC Section 127.