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This depends on how much you think your children's education will cost. The best way is to start saving before they are born. The sooner you begin the less money you will have to put away each year.
Another advantage of starting early is that you'll have more flexibility when it comes to the type of investment you'll use. You'll be able to put at least part of your money in equities, which, although riskier in the short-run, are better able to outpace inflation than other investments in the long-run.
How much will your child's education cost? It depends on whether your child attends a private or state school. According to the College Board, for the 2020-21 school year the total expenses - tuition, fees, board, personal expenses, and books and supplies - for the average four-year private college are about $54,880 per year and about $26,820 per year for the average four-year in-state public college. However, these amounts are averages: the tuition, fees, and board for some private colleges can exceed $75,000 per year whereas the costs for a state school can often be kept under $10,000 per year. It should also be noted that in 2020-21 the average amount of grant aid for a full-time undergraduate student was about $7,330 and $21,660 for four-year public and private schools, respectively. More than 70 percent of full-time students receive grant aid to help pay for college.
As with any investment, you should choose those that will provide you with a good return and that meet your level of risk tolerance. The ones you choose should depend on when you start your savings plan-the mix of investments if you start when your child is a toddler should be different, from those used if you start when your child is age 12.
The following are often recommended as investments for education funds:
The American Opportunity Tax Credit (AOTC) was made permanent by the Protecting Americans from Tax Hikes Act of 2015 (PATH). The maximum credit, available only for the first four years of post-secondary education, is $2,500. You can claim the credit for each eligible student you have for which the credit requirements are met.
Income limits. To claim the American Opportunity Tax Credit, your modified adjusted gross income (MAGI) must not exceed $90,000 ($180,000 for joint filers). To claim the Lifetime Learning Credit, MAGI must not exceed $69,000 ($138,000 for joint filers). "Modified AGI" generally means your adjusted gross income. The "modifications" only come into play if you have income earned abroad.
Amount of credit. For most taxpayers, 40 percent of the AOTC is a refundable credit, which means that you can receive up to $1,000 even if you owe no taxes.
Which costs are eligible? Qualifying tuition and related expenses refer to tuition and fees, and course materials required for enrollment or attendance at an eligible education institution. They now include books, supplies, and equipment needed for a course of study whether or not the materials must be purchased from the educational institution as a condition of enrollment or attendance.
"Related" expenses do not include room and board, student activities, athletics (other than courses that are part of a degree program), insurance, equipment, transportation, or any personal, living, or family expenses. Student-activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. For expenses paid with borrowed funds, count the expenses when they are paid, not when borrowings are repaid.
In the past, parents would invest in the child's name in order to shift income to the lower-bracket child. However, the addition of the "kiddie tax" mostly put an end to that strategy.
In 2021, the amount that can be used to reduce the net unearned income reported on the child's return that is subject to the "kiddie tax" is $1,100 (same as 2020). The same $1,100 amount is used to determine whether a parent may elect to include a child's gross income in the parent's gross income and to calculate the "kiddie tax." For example, one of the requirements for the parental election is that a child's gross income for 2021 must be more than $1,100 but less than $11,000.
For 2021, the net unearned income for a child under the age of 19 (or a full-time student under the age of 24) that is not subject to "kiddie tax" is $2,200 (same as 2020).
In 2021, you can contribute up to $2,000 each year to a Coverdell education savings account (Section 530 program) for a child under 18. These contributions are not deductible, but they grow tax-free until withdrawn. Contributions for any year (e.g., 2021) can be made through the [unextended] due date for the return for that year (April 15, 2022).
In 2021, the maximum contribution amount for each child is phased out for modified AGI between $190,000 and $220,000 (joint filers) and $95,000 and $110,000 (single filers). These amounts are not indexed to inflation.
Only cash can be contributed to a Section 530 account and you cannot contribute to the account after the child reaches his or her 18th birthday.
Anyone can establish and contribute to a Section 530 account, including the child, and you may establish 530s for as many children as you wish. The child need not be a dependent. In fact, he or she need not be related to you, but the amount contributed during the year to each account cannot exceed $2,000. In 2021, the maximum contribution amount for each child is phased out for modified AGI between $190,000 and $220,000 (joint filers) and $95,000 and $110,000 (single filers). These amounts are not indexed to inflation.
If you have insufficient savings for your child's education when he is close to entering college, what should you do?
Many families find themselves in the same boat. Fortunately, there are ways to generate additional funds both now and when your child is about to enter school:
Grants. The best type of financial aid because they do not have to be paid back -- are amounts awarded by governments, schools, and other organizations. Some grants are need-based and others are not.
There are various student loan programs available. Some are need-based, and others are not. Here is a summary of loans:
Here are some strategies that may increase the amount of aid for which your family is eligible:
Detail any financial hardships. If you have any financial hardships, let the deciding authorities know (via the statement of financial need) exactly what they are if they are not clear from the application. The financial aid officer may be able to assist you in explaining hardships.
Have your child become independent. In this case, your income is not considered in determining how much aid your child will be eligible for. Students are considered independent if they:
If you decide to invest in your child's name, here are some tax strategies to consider: