Prepaid tuition 529 plans vs. 529 savings plans. A prepaid tuition plan is designed to let you lock in future tuition costs at today’s prices. Often, the tuition credits can only be used at certain colleges. Meanwhile, a 529 savings plan allows you to amass money for college costs by investing in the financial markets, typically through mutual funds. Both 529 savings and prepaid plans will give you tax-free growth if the money is used for qualifying education expenses.
Kiddie tax. This can be an issue for families that save for college using custodial accounts. The kiddie tax can apply to children under age 19, or under 24 if they were fulltime students as of year-end. In 2020, the first $1,100 of a child’s investment gains is tax-free and the next $1,100 is taxed at the child’s rate. Gains above $2,200 are taxed at the parents’ rate.
Expected family contribution. This is the sum a family is expected to contribute each year toward their child’s college costs. If a college’s total annual cost is greater than a family’s expected family contribution, needs-based financial aid is typically provided to fill the gap.
Need vs. merit. Historically, most financial aid has been awarded based on a family’s financial need. Over the past few decades, however, there has been a sharp increase in merit-based aid, which is awarded because the students are considered talented academically, athletically or in some other way.
Loans vs. grants. The two main types of financial aid are grants, which never have to be repaid, and loans. The latter may have a subsidized interest rate, but the money borrowed eventually has to be paid back. There is also a third type of financial aid: work-study jobs. Those jobs can be on or off campus and must pay at least the federal minimum wage.
Federal vs. institutional methodology. These are the two formulas used by the federal government and private colleges when determining a student’s expected family contribution. The two formulas have two major differences. First, the institutional formula considers home equity, while the federal formula doesn’t. Second, if the parents are divorced, the federal formula only considers the finances of the custodial parent and his or her new spouse, if any. By contrast, the institutional formula will consider the finances of both parents, and also those of their current spouses.
Parental assets vs. children’s assets. Under the aid formulas, a child’s assets are assessed much more heavily than the assets of the parents. This means that, if there are substantial assets in the child’s name, the family will be expected to use most of those assets for college costs—and hence their aid eligibility will be significantly less.
Tax deduction vs. credit. Families with a student attending college may be able to take advantage of a variety of education tax deductions and credits. A tax deduction reduces the amount of income that’s subject to taxation. For instance, if you’re in the 25% tax bracket and have a $1,000 tax deduction, you would save $250 in taxes. By contrast, a tax credit reduces the amount of tax you owe dollar-for-dollar, so a $500 credit would trim your tax bill by $500.
Revised Pay As You Earn. This is the name for the federal loan repayment program that caps student-loan payments at 10% of income and forgives all undergraduate debt after 20 years.
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