Tuesday, December 29, 2009

The Costs & Rewards of a College Education

Part 8 - The Basics of Financial Aid: Grants

As nervous as college freshmen may be, their cash-strapped parents are probably trembling more.  Disciplined savings using any or a combination of the options mentioned above may not cover the full expense of a college education.  As they have for the last ten years, college costs rose faster than inflation this year.  For the 2009-10 school year, a college freshman can expect to pay anywhere between $15,000 and $60,000 for a full year of tuition, room and board, books, etc.

But many college students don’t pay full sticker price.  63% of students receive some form of aid, either loans, grants, or both, according to the National Association of Student Financial Aid Administrators.

This year's College Board data on financial aid show that almost $143 billion in student aid was distributed in academic year 2007-08—almost $10 billion more than the previous year. In addition, students borrowed almost $19 billion dollars from nonfederal sources to help finance their education.  On average, undergraduate students received an average of $8,896 in aid in the form of grants and tax benefits.  Graduate students received an average of $20,320 in aid.

College financial aid departments will require the Department of Education's Free Application for Federal Student Aid (FAFSA) form, available at www.fafsa.ed.gov, which provides financial details of the parents and student.  It is important to file the FAFSA form early as some grants are given on a first-come-first-serve basis.

Financial aid is intended to make up the difference between what a family can afford and what college costs. The federal government and all public college financial aid offices use a “need formula” that analyzes a family’s financial circumstances and compares them with other families.  The results will vary by college and by state, but the Expected Family Contribution (EFC) formula assumes family contributions are met with savings, income and borrowing.  If a shortfall of college funds does exist, financial aid is awarded. This aid can be in the form of grants, loans, and work-study programs.


Gift-aid programs include the Federal Pell Grant Program and the Federal Supplemental Educational Opportunity Grant (FSEOG) Program. These grants are generally available only to students who do not yet have bachelor's degrees. In some cases they might be awarded to students enrolled in post-baccalaureate teacher certification programs.

Pell Grants

A Federal Pell Grant, unlike a loan, does not have to be repaid. Pell Grants are awarded usually only to undergraduate students who have not earned a bachelor's or a professional degree. (In some cases, however, a student enrolled in a post-baccalaureate teacher certification program might receive a Pell Grant.) Pell Grants are considered a foundation of federal financial aid, to which aid from other federal and nonfederal sources might be added.

Starting July 1, 2009, the maximum Pell grant annual allowance will increase from $4,731 to $5,350 for the 2009-10 school year, the largest increase since the program began.  It will increase again to $5,550 for the 2010-11 school year.  The increased grant will cover approximately one-third of the total annual cost of attendance, room and board included, at the average public, four-year in-state school, or about 15 percent of one year at the average private college or university, according to the College Board.  The increased Pell grant doesn't just sweeten the pot for those who already qualify for the award; it also means a greater number of students are now eligible for the grant.

The maximum amount can change each award year and depends on program funding. The amount you get, though, will depend not only on your financial need, but also on your costs to attend school, your status as a full-time or part-time student, and your plans to attend school for a full academic year or less.

The school the student is attending can apply Pell Grant funds to your school costs, pay you directly (usually by check), or combine these methods. The school must tell you in writing how much your award will be and how and when you'll be paid. Schools must disburse funds at least once per term (semester, trimester, or quarter). Schools that do not use semesters, trimesters, or quarters must disburse funds at least twice per academic year.

Federal Supplemental Educational Opportunity Grants (FSEOG)

The Federal Supplemental Educational Opportunity Grant (FSEOG) program is for undergraduates with exceptional financial need. Pell Grant recipients with the lowest expected family contributions (EFCs) will be considered first for a FSEOG. Just like Pell Grants, the FSEOG does not have to be repaid.

You can receive between $100 and $4,000 a year, depending on when you apply, your financial need, the funding at the school you're attending, and the policies of the financial aid office at your school.

If you're eligible, your school will credit your account, pay you directly (usually by check), or combine these methods. Your school must pay you at least once per term (semester, trimester, or quarter). Schools that do not use semesters, trimesters, or quarters must disburse funds at least twice per academic year.

FSEOGs have a few limitations that Pell Grants don't. For one, the amount of your FSEOG can be reduced if you receive other forms of student aid. Also, each school receives a limited amount of FSEOG money; when it's gone, it's gone. That's why it's very important to apply for financial aid as early as you can. You'll have a better chance of obtaining FSEOG money if you're eligible for it.

Next week I will discuss the other two options of financial aid - loans and work-study programs.

Tuesday, December 22, 2009

The Costs & Rewards of a College Education

Part 7 - Tax Incentives for Higher Education Expenses: The Lifetime Learning Credit

The lifetime learning credit provides a tax credit of 20% of up to $10,000, or up to $2,000, of qualified expenses per taxpayer per year.  It is available for all years of post-secondary education and for courses taken to acquire or improve job skills.  This credit is available even if the student is enrolled in just one course at an eligible institution.  There is no limit on the number of years the lifetime learning credit can be claimed for each student.

Generally, the same expenses that either qualify or do not qualify for the Hope credit apply to the lifetime learning credit.  See the summary of these expenses in the Hope credit summary above.  Additionally, the same prohibited actions for the Hope credit applies to the lifetime learning credit.

You cannot claim the Hope and the lifetime learning credit for the same student in the same year.  To claim the Hope Credit or Lifetime Learning Credit, complete IRS Form 8863.

Comparison of Education Credits

Amount of Credit      
Hope Credit - Up to $1,800 credit per eligible student 1
Lifetime Learning Credit - Up to $2,000 credit per return

When Available
Hope Credit - Available ONLY until the first 2 years of post- secondary education are completed.1
Lifetime Learning Credit - Available for all years of post-secondary education and for courses to acquire or improve job skills.

Educational Pursuit  
Hope Credit - Student must be pursuing an undergraduate degree or other recognized education credential.
Lifetime Learning Credit - Student does not need to be pursuing a degree or other recognized education credential

Enrollment Requirements
Hope Credit - Student must be enrolled at least half time for at least one academic period beginning during the year.
Lifetime Learning Credit - Available for one or more courses

Prior Legal Issues
Hope Credit - No felony drug conviction on student’s record.
Lifetime Learning Credit - Felony drug conviction rule does not apply

1    For 2009 and 2010, these features fall under the provisions of the American Opportunity Tax Credit.  Please refer to these features as described in the Hope Credit section of this report.

Next week I will begin discussing the basics of financial aid, including discussions on grants, loans, and steps to take now to increase your chances of obtaining financial aid for yourself or your child.

Tuesday, December 15, 2009

The Costs & Rewards of a College Education

Part 6 - Tax Incentives for Higher Education Expenses: The Hope Tax Credit

There are two tax credits available to help you offset the costs of higher education by reducing the amount of your income tax. They are the Hope Credit and the Lifetime Learning Credit, also referred to as education credits.  A tax credit reduces the amount of income tax you may have to pay. Unlike a deduction, which reduces the amount of income subject to tax, a credit directly reduces the tax itself.  This week, I will be focusing on the Hope Tax Credit

Hope Tax Credit

Traditionally, the Hope credit provides a tax credit of up to 100% of the first $1,200 of qualified education expenses plus 50% of the next $1,200, per student per year.  However, in February, 2009 the American Recovery and Reinvestment Act of 2009 was passed which modified the provisions of the Hope credit.  These new provisions are explained in greater detail below and are applicable for 2009 and 2010 only.

The credit is based on qualified education expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption on your tax return.  Further, the Hope credit is only available for full-time students in the first two years of post-secondary education at an eligible institution.

For purposes of the Hope credit, qualified education expenses include tuition and certain related expenses required for enrollment or attendance at an eligible educational institution.  Student-activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees and expenses must be paid to the institution as a condition of enrollment or attendance.  Expenses such as room and board, insurance, and medical expenses (including student health fees) do not qualify for the Hope credit.

Generally, the credit is allowed for qualified education expenses paid in a calendar year for an academic period beginning in that year or in the first 3 months of the following year.  For example, if you paid $2,000 in December 2008 for qualified tuition for the Spring 2009 semester beginning in January 2009, you may be able to use that $2,000 in figuring your 2008 credit.

The amount of your Hope credit for 2008 is gradually reduced (phased out) if you are filing single and your modified adjusted gross income (MAGI) is between $48,000 and $58,000 ($96,000 and $116,000 if you file a joint return). You cannot claim a credit if your MAGI is $58,000 or more ($116,000 or more if you file a joint return).  For most tax-payers, MAGI is simply their adjusted gross income (AGI) as figured on their federal income tax return.

To claim the Hope tax credit, the student for whom you pay qualified education expenses must be an eligible student. This is a student who meets all of the following requirements:
  •  The student did not have expenses that were used to figure a Hope credit in any 2 earlier tax years.
  • The student had not completed the first 2 years of postsecondary education (generally, the freshman and sophomore years of college) before the current calendar year.
  • For at least one academic period beginning in the current calendar year, the student was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential.
  • The student has not been convicted of any federal or state felony for possessing or distributing a controlled substance as of the end of the current calendar year.
Per IRS regulations, the following actions are prohibited with the Hope Credit:
  • Deduct higher education expenses on your income tax return (as, for example, a business expense) and also claim a Hope credit based on those same expenses.
  • Claim a Hope credit in the same year that you are claiming a tuition and fees deduction for the same student.
  • Claim a Hope credit and a lifetime learning credit based on the same qualified education expenses.
  • Claim a Hope credit based on the same expenses used to figure the tax-free portion of a distribution from a Coverdell education savings account (ESA) or qualified tuition program (QTP), such as a 529 plan.
  • Claim a credit based on qualified education expenses paid with a tax-free scholarship, grant, or employer-provided educational assistance.

As mentioned earlier in this section, the American Recovery and Reinvestment Act of 2009 temporarily modified some of the provisions of the Hope credit.  For 2009 and 2010 the American Opportunity Tax Credit is the new name of the Hope credit program.  The new law temporarily enhances the existing Hope education credit for 2009 and 2010 only in:
  • Amount – The maximum amount of the Hope Credit increases from $1,800 to $2,500 per student.
  • Availability – The Hope Credit can now be claimed for the first four years of post-secondary education, and
  • Phase-out level – The credit is phased out (gradually reduced) if your modified adjusted gross income (AGI) is between $80,000 and $90,000 ($160,000 and $180,000 if you file a joint return).

Under the new credit, the maximum $2,500 per year would be allowed on $4,000 in qualifying payments (100 percent of the first $2,000 and 25 percent of the next $2,000). Although this credit would be made retroactive to January 1, 2009, it does not automatically apply to a college semester that begins in 2009. Tuition paid late in 2008 for an upcoming 2009 semester qualifies only for a 2008 credit under existing rules.  Further, forty percent (.40) of the Hope Credit is now a refundable credit, which means that you can receive up to $1,000 even if you owe no taxes.

Next week, I will focus on the Lifetime Learning Credit and how it can be an additional benefit for college expenses.

Monday, December 7, 2009

The Costs & Rewards of a College Education

Part 5 - College Funding Options: IRAs, Insurance, and Rebate Programs

There are other, less recommended, alternatives in funding a child’s education.  Examples include taking distributions from your IRA accounts, variable life insurance policies, and using reward/rebating programs.

IRA Distributions

Generally, if you take a distribution from your IRA before you reach age 59½, you must pay a 10% additional tax on the early distribution. This applies to any IRA you own, whether it is a traditional IRA (including a SEP-IRA), a Roth IRA, or a SIMPLE IRA. The additional tax on an early distribution from a SIMPLE IRA may be as high as 25%.  However, you can take distributions from your IRAs for qualified higher education expenses without having to pay the 10% additional tax. You may owe income tax on at least part of the amount distributed, but you may not have to pay the 10% additional tax. The part not subject to the additional tax is generally the amount of the distribution that is not more than the adjusted qualified education expenses for the year.

For purposes of the 10% additional tax, these expenses are tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance.  In addition, if the student is at least a half-time student, room and board are qualified education expenses.

Variable Life Insurance Policies

Variable Life combines life insurance with a tax-deferred investment account, and provides tax-free access to the cash value of the policy. Some insurance companies promote variable life insurance policies as a college savings vehicle because the value of the policy is sheltered from financial aid need analysis formulas.

The advantages of a variable life policy are as follows:

§    The money is sheltered from the financial aid need analysis process and has no impact on financial aid.
§    Very high limits on the amounts you can invest.
§    The parent retains control over the money.
§    One can withdraw or borrow contributions tax-free without penalty.

The disadvantages to such policies are as follows:

§    Variable life insurance products tend to be expensive, with high commissions and expenses. The total return after subtracting costs often makes such policies less attractive when compared with other college saving options.
§    The premiums on a variable life insurance policy will eat into the gains you could make from the money you are paying.
§    Premiums are not tax deductible.
§    Withdrawals from a variable life policy will reduce the death benefit.
§    If you withdraw more money than the premiums you paid into the policy, you will pay income taxes on the difference.
§    Withdrawals from a variable life policy cause the insurer to move a portion of the remaining balance into a fixed-return account to minimize the company's risk.

Loyalty Reward / Rebating Programs

Loyalty programs, also known as affinity programs, provide a rebate to the consumer in exchange for shopping at particular retailers or purchasing particular products or services.

Typically, such programs do not require you to show a membership card to get the rebates. Instead, you register your credit cards with them and they track the purchases you make at participating merchants using the cards. You can also earn rebates by shopping online through the company web sites. This makes the programs a painless way to earn a little extra money for college.

Affinity programs with a college savings emphasis include:

BabyCenter:  (http://www.babycenter.com/index.htm)
BabyMint (https://www.babymint.com/)
FutureTrust:  (http://www.futuretrust.com/)
LittleGrad:  (http://www.littlegrad.com/)
SAGE Tuition Rewards Program:  (http://www.tuitionrewards.com/)
Upromise:  (http://www.upromise.com/)

Of these, Upromise has the largest retailer network, followed by BabyMint. LittleGrad has the largest online retailer network, and all programs listed are completely free to the user.

A key benefit of all of these programs is that you do not need to change your purchasing habits to earn rebates for college savings. The retailer networks associated with these programs are large enough that most families will earn some rebates without altering their spending patterns. Of course, by carefully targeting your purchases, you can maximize your rebates.

Some of the loyalty programs allow one to redeem the rebates as cash instead of investing them in a section 529 college savings plan. Some also allow one to transfer the rebates to repay student loans.

The rebates received from a loyalty program are not subject to income tax or sales tax. (Many states charge sales taxes on all gross receipts from sales, including rebates for which the retailer is reimbursed. However, the consumer already paid sales tax on the amount of the rebate when they purchased the product or service that generated the loyalty program rebate, so no additional sales tax is due when the rebate is received.)

We do not recommend spending more money just to earn a rebate. If two products provide equivalent value, but the more expensive item offers a rebate, sometimes it is better to buy the less expensive item. Compare net prices after subtracting the amount of the rebate. The average rebate is between 4% and 5%.

Over the next few weeks I will begin discussing the various income tax incentives for college savings and expenses.  More specifically, I will be outlining how the Hope Tax Credit and the Lifetime Learning Credit can be utilized to give you a more advantageous tax liability each year.