Speak with a team who understands 480.729.8000
Common Questions about Social Security

Common Questions about Social Security

Social security provides a support of income which workers can shape to plan for their retirement. It also much more than a retirement plan. It provides valuable social insurance protection to workers who become disabled and to families whose breadwinner passes away. You are able to begin to receive social security benefits as early as age 62. However, you can expect a 30% reduction in monthly benefits with lesser reductions as you approach the full retirement age, which is 67. Navigating your way through social security can oftentimes be overwhelming. Here are a few common questions about social security.

What is SII?

Supplemental Security Income, or SSI, is a cash assistance program that provides minimum income to people who are aged, blind, or disabled. SSI is based on financial need. It’s a program of last resort–you can apply for it only after you’ve filed for all other benefits for which you might be eligible, including Social Security. Because eligibility requirements are similar, people who receive SSI also qualify for food stamps and Medicaid.

You may be eligible for SSI benefits if you are age 65 or over, blind (regardless of age), or disabled (regardless of age), as long as your income and resources don’t exceed the limits set by your state. To find out what your state requirements are, contact your local Social Security Administration office or call toll free at (800) 772-1213.

Are my Social Security benefits subject to income tax?

About 40% of people who get Social Security must pay federal income taxes on their benefits. This usually happens if you have other substantial income in addition to your benefits. Substantial income includes wages, earnings from self-employment, interest, dividends, and other taxable income that must be reported on your tax return.

You will pay tax on your Social Security benefits based on Internal Revenue Service (IRS) rules if you:

  • File a federal tax return as an “individual” and your combined income* is
    • Between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits.
    • More than $34,000, up to 85% of your benefits may be taxable.
  • File a joint return, and you and your spouse have a combined income* that is
    • Between $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits.
    • More than $44,000, up to 85% of your benefits may be taxable.

Consult an accountant or other tax professional for more information. Or, contact the Internal Revenue Service at (800) 829-1040 or www.irs.gov.

I‘m getting remarried. How will this affect my Social Security benefits?

If you’re receiving benefits based on your own work record, your benefits will continue. If you’re receiving spousal benefits based on your former spouse’s work record, those benefits will generally end upon your getting remarried, but you may be able to receive benefits based on your new spouse’s work record, or on your own.

Your SSI payment amount may change as a result of your new spouse’s income and assets. If you and your spouse both get SSI, your payment amount will change from an individual rate to a couple’s rate.

If you remarry between the ages of 50 and 59, you can’t get benefits. Take note, if you remarry before you turn 60 and that marriage ends, you may become entitled or re-entitled to benefits on your prior deceased spouse’s earnings record. Your benefits begin the first month in which the subsequent marriage ended if all entitlement requirements are met. If you remarry after age 60, you may still become entitled to benefits on your prior deceased spouse’s Social Security earnings record.

source: ssa.gov
cbpp.org

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

Choosing Investment Vehicles: U.S. Savings Bonds

Choosing Investment Vehicles: U.S. Savings Bonds

An investment vehicle is a financial account or product used to create returns. Real estate, Exchange Traded Funds (ETF’s), mutual bonds, and stocks are common investment vehicles. When selecting a vehicle, most investors center on a few key types that best match current and future financial goals. If you are looking for a low risk type of investment, U.S. Savings Bonds might be the best investment vehicle for you.

Are government savings bonds risk free?

Government savings bonds are generally deemed risk free because they are backed by the full faith and credit of the federal government. Most investors feel confident that the U.S. government will not default on its obligations to bond holders. However, there are other types of risk to consider.

Perhaps the biggest risk you face when buying government savings bonds is inflation risk. Most savings bonds have interest rates that are pegged to other government securities and are not adjusted for inflation (the exception is Series I bonds, which are adjusted semiannually for inflation). As inflation goes up, the spending power of your dollars goes down. With government securities, there is always the risk that inflation will outpace your rate of return, effectively diminishing the spending power of your savings.

Are savings bonds a good way to save?

Savings bonds may or may not be the best way for you to save. It depends in large part on your savings goals and needs. Savings bonds are backed by the full faith and credit of the U.S. government. As such, they are generally deemed very safe investments. In addition, savings bonds are readily available and can be exchanged at most banks. They are also available through payroll deduction plans and automatic purchase plans. Moreover, interest earned on savings bonds is exempt from state and local taxes. In some cases, interest income may also be exempt when the proceeds are used for educational expenses. In short, if you have low tolerance for risk and want a tax-advantaged savings vehicle that is both liquid and simple to administer, you should definitely consider savings bonds.

Savers who shun savings bonds argue that it is difficult to calculate the value of savings-bond interest rates. Multiple rate schedules, interest rates pegged to other government securities, and yet-to-be-determined rate structures make it difficult for most consumers to calculate how much they are earning on their investments and how much “savings” they have accumulated on any given date. Moreover, most savings bonds will not protect you from inflation (Series I bonds are the exception, with semiannual adjustments for inflation). Finally, your savings bonds cannot be sold or used as collateral for a loan.

Do Series EE bonds offer any special advantages if used for college savings?

Yes. Series EE bonds (which may also be called Patriot bonds) are generally inexpensive, low-risk investments whose earnings are exempt from state and local taxes. In addition, in the college savings game, the interest earned by Series EE bonds (and Series I bonds) may be exempt from federal tax if the following requirements are met:

  • The qualified education expenses have not already been covered by financial aid, scholarships, 529 accountsEducation Savings Accounts (ESAs), or other tax breaks.
  • The funds are used for qualified educational expenses for parent or dependent child. These include tuition and fees for courses that count toward a degree or certificate program. Books and room and board are not qualified expenses.
  • The expense occurs in the same tax year in which the bonds are redeemed.
  • Both the principal and the interest from the bonds are used.
  • Your filing status is not married filing separately.

Any bond redemptions not used for qualified college expenses are taxable as regular income. If the bond redemption exceeds the amount used for educational expenses, the interest will be taxed on a prorated basis.

However, despite this potential tax advantage, Series EE bonds have relatively low growth potential in an arena where it’s crucial to keep up with annual college cost increases.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

*sources: collegedata.com

Common Student Loan Questions

Common Student Loan Questions

A student loan is a type of loan designed to help students pay for post-secondary education and the associated fees, such as tuition, books and supplies, and living expenses. As college tuition costs rise every year, many people find themselves wondering how they will be able to pay off their loans,. Here are some common questions that come up when figuring out how student loans will affect your finances and what you can do to prepare yourself.

Are my student loan payments tax deductible?

The interest portion might be, thanks to the student loan interest deduction. The maximum deduction is $2,500 in 2023. You don’t need to itemize to claim this deduction.

To qualify, you must meet a couple requirements:

The student loan on which you’re paying interest must be one that you incurred to pay college expenses when you were at least a half-time student. This requirement excludes part-time adult learners or other nontraditional students.

In addition, you must meet income limits. If your modified adjusted gross income (MAGI) is not more than $75,000, you can claim up to $2,500. The deduction amount is gradually reduced if your MAGI ranges from above $75,000 to less than $90,000. If your MAGI is $90,000 or more, you may not claim the deduction.

If you paid over $600 of interest to a single lender on a qualified student loan during the year, you should receive Form 1098-E from your lender, showing the total amount of interest you paid for the year. If not, contact your lender to request this information.

Can I refinance my student loan?

Generally, the standard repayment option for student loans involves a fixed monthly payment for a 5- to 10-year term. With increasing tuition costs, however, it’s possible you may graduate with student loan payments that are simply unaffordable. Moreover, if you have multiple student loans, you may be required to make several different monthly payments to different loan servicers. Consolidation of your loans may thus make your debt more manageable.

You can consolidate your federally subsidized student loans through a variety of programs. The process pays off your existing loans with a single new loan. Most consolidation programs offer a variety of repayment options. You can choose an extended payment option, a graduated payment option, or (in some cases) an income-sensitive repayment option.

An extended payment option allows the term for repayment to be as long as 30 years. Although this can dramatically lower your monthly payment, it can also dramatically increase the total cost of the loan. The interest rate may be higher, and interest charged on any unpaid principal will continue to accrue for a longer period of time. However, as with all consolidation programs, you can make prepayments against principal at any time without penalty.

A graduated payment option starts off with lower monthly payments that increase over the term of the loan. Theoretically, as your income increases, you are better able to afford the higher payments.

An income-sensitive repayment option ties your monthly payments to your income level. The higher your income, the higher the required payment. Conversely, if your income drops, the required monthly payments may be reduced. This option requires you to allow the lender access to your federal tax return information.

Of course, you are always free to explore other refinancing options, such as an equity loan or a loan against a retirement plan. However, you should explore carefully the advantages and disadvantages of these options before pursuing any one of them.

How will I ever pay off my student loans?

As the cost of post-secondary education continues to increase and you take on further student loan indebtedness to pay for it, you may feel as if you are leaving the ivory tower with a mortgage on your back. You may be surprised to discover that some or all of your indebtedness can be forgiven if you are employed in certain public-service sectors, teach in teacher-shortage areas, or go into the Peace Corps.

If these choices aren’t available to you, you must find a way to budget for your student loan payments. Review your household income and expenses. Can you reduce your spending on entertainment, luxuries, and discretionary items? If so, you can divert these saved funds toward monthly principal prepayment of your student loans, thus shortening the overall repayment term and saving on interest charges. You are always permitted to prepay the principal of student loans, partially or in full, without penalty.

Would consolidating your loans or refinancing your loans make the payment schedule easier? Check with your current lender to see what options you might have.

Are you in a position to take on a second, part-time job? The income from this job could be used to reduce your student loan indebtedness. Can you devote a tax refund, gift money, or inheritance to principal prepayment? Even infrequent payments of this sort will ultimately reduce your loan balance and save you both time (repaying the debt) and money (the interest on the debt).

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

sources: investopedia

The Best Ways to Save for College

The Best Ways to Save for College

In the college savings game, all strategies aren’t created equal. The best savings vehicles offer special tax advantages if the funds are used to pay for college. Tax-advantaged strategies are important because over time, you can potentially accumulate more money with a tax-advantaged investment compared to a taxable investment. Ideally, though, you’ll want to choose a savings vehicle that offers you the best combination of tax advantages, financial aid benefits, and flexibility, while meeting your overall investment needs.

529 plans

Since their creation in 1996, 529 plans have become to college savings what 401(k) plans are to retirement savings–an indispensable tool for helping you amass money for your child’s or grandchild’s college education. That’s because 529 plans offer a unique combination of benefits unmatched in the college savings world.

There are two types of 529 plans–college savings plans and prepaid tuition plans. Though each is governed under Section 529 of the Internal Revenue Code (hence the name “529” plans), college savings plans and prepaid tuition plans are very different college savings vehicles. There are typically fees associated with opening and maintaining each type of account.

Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about specific 529 plans is available in each issuer’s official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.

529 plans: college savings plans

A 529 college savings plan is a tax-advantaged college savings vehicle that lets you save money for college in an individual investment account. Some plans let you enroll directly, while others require that you go through a financial professional.

The details of college savings plans vary by state, but the basics are the same. You’ll need to fill out an application, where you’ll name a beneficiary and select one or more of the plan’s investment portfolios to which your contributions will be allocated. Also, you’ll typically be required to make an initial minimum contribution, which must be in cash.

529 college savings plans offer a unique combination of features that no other college savings vehicle can match:

  • Federal tax advantages: Contributions to your account grow tax deferred and are completely tax free if the money is used to pay the beneficiary’s qualified education expenses. The earnings portion of any withdrawal not used for college expenses is taxed at the recipient’s rate and subject to a 10 percent federal penalty.
  • State tax advantages: Many states offer income tax incentives for state residents, such as a tax deduction for contributions or a tax exemption for qualified withdrawals. However, be aware that some states limit their tax deduction to contributions made to the in-state 529 plan only.
  • High contribution limits: Most college savings plans have lifetime maximum contribution limits over $300,000.
  • Unlimited participation: Anyone can open a 529 college savings plan account, regardless of income level.
  • Professional money management: College savings plans are managed by designated financial companies who are responsible for managing the plan’s underlying investment portfolios.
  • Flexibility: Under federal rules, you can change the beneficiary of your account to a qualified family member at any time without penalty. And you can rollover the money in your 529 plan account to a different 529 plan once per year without income tax or penalty implications.
  • Wide use of funds: Money in a 529 college savings plan can be used at any college in the United States or abroad that’s accredited by the U.S. Department of Education and, depending on the individual plan, for graduate school.
  • Accelerated gifting: 529 plans offer an excellent estate planning advantage in the form of accelerated gifting. This can be a favorable way for grandparents to contribute to their grandchildren’s college education. Individuals can make a lump-sum gift to a 529 plan of up to $70,000 ($140,000 for married couples) and avoid federal gift tax, provided a special election is made to treat the gift as having been made in equal installments over a five-year period and no other gifts are made to that beneficiary during the five years.
  • Variety: Currently, there are over 50 different college savings plans to choose from because many states offer more than one plan. You can join any state’s college savings plan.

But college savings plans have drawbacks too. You relinquish some control of your money. Returns aren’t guaranteed–you roll the dice with the investment portfolios you’ve chosen, and your account may gain or lose money.

529 plans: prepaid tuition plans

Prepaid tuition plans are distant cousins to college savings plans–their federal tax treatment is the same, but just about everything else is different. A prepaid tuition plan is a tax-advantaged college savings vehicle that lets you pay tuition expenses at participating colleges at today’s prices for use in the future. Prepaid tuition plans can be run either by states or colleges. For state-run plans, you prepay tuition at one or more state colleges; for college-run plans, you prepay tuition at the participating college(s).

As with 529 college savings plans, you’ll need to fill out an application and name a beneficiary. But instead of choosing an investment portfolio, you purchase an amount of tuition credits or units (which you can then do again periodically), subject to plan rules and limits. Typically, the tuition credits or units are guaranteed to be worth a certain amount of tuition in the future, no matter how much college costs may increase between now and then. As such, prepaid tuition plans provide some measure of security over rising college prices.

  • Federal and state tax advantages: The federal and state tax advantages given to prepaid tuition plans are the same as for college savings plans.
  • Other similarities to college savings plans: Prepaid tuition plans are open to people of all income levels, and they offer flexibility in terms of changing the beneficiary or rolling over to another 529 plan once per year, as well as accelerated gifting.

Prepaid tuition plans have some limitations, though, compared to college savings plans. One major drawback is that your child is generally limited to your own state’s prepaid tuition plan, and then your child is limited to the colleges that participate in that plan. If your child attends a different college, prepaid plans differ on how much money you’ll get back. Also, some prepaid plans have been forced to reduce benefits after enrollment due to investment returns that have not kept pace with the plan’s offered benefits. Even with these limitations, some college investors appreciate the peace of mind that comes with not worrying about college inflation each year by locking in college costs today.

Coverdell education savings accounts

A Coverdell education savings account (Coverdell ESA) is a tax-advantaged education savings vehicle that lets you save money for college, as well as for elementary and secondary school (K-12) at public, private, or religious schools. Here’s how it works:

  • Application process: You fill out an application at a participating financial institution and name a beneficiary. Depending on the institution, there may be fees associated with opening and maintaining the account. The beneficiary must be under age 18 when the account is established (unless he or she is a child with special needs).
  • Contribution rules: You (or someone else) make contributions to the account, subject to the maximum annual limit of $2,000. This means that the total amount contributed for a particular beneficiary in a given year can’t exceed $2,000, even if the money comes from different people. Contributions can be made up until April 15 of the year following the tax year for which the contribution is being made.
  • Investing contributions: You invest your contributions as you wish (e.g., stocks, bonds, mutual funds, certificates of deposit)–you have sole control over your investments.
  • Tax treatment: Contributions to your account grow tax deferred, which means you don’t pay income taxes on the account’s earnings (if any) each year. Money withdrawn to pay college or K-12 expenses (called a qualified withdrawal) is completely tax free at the federal level(and typically at the state level too). If the money isn’t used for college or K-12 expenses (called a nonqualified withdrawal), the earnings portion of the withdrawal will be taxed at the beneficiary’s tax rate and subject to a 10 percent federal penalty.
  • Rollovers and termination of account: Funds in a Coverdell ESA can be rolled over without penalty into another Coverdell ESA for a qualifying family member. Also, any funds remaining in a Coverdell ESA must be distributed to the beneficiary when he or she reaches age 30 (unless the beneficiary is a person with special needs).

Unfortunately, not everyone can open a Coverdell ESA–your ability to contribute depends on your income. To make a full contribution, single filers must have a modified adjusted gross income (MAGI) of less than $95,000, and joint filers must have a MAGI of less than $190,000. And with an annual maximum contribution limit of $2,000, a Coverdell ESA probably can’t go it alone in meeting today’s college costs.

Custodial accounts

Before 529 plans and Coverdell ESAs, there were custodial accounts. A custodial account allows your child to hold assets–under the watchful eye of a designated custodian–that he or she ordinarily wouldn’t be allowed to hold in his or her own name. The assets can then be used to pay for college or anything else that benefits your child (e.g., summer camp, braces, hockey lessons, a computer). Here’s how a custodial account works:

  • Application process: You fill out an application at a participating financial institution and name a beneficiary. Depending on the institution, there may be fees associated with opening and maintaining the account.
  • Custodian: You also designate a custodian to manage and invest the account’s assets. The custodian can be you, a friend, a relative, or a financial institution. The assets in the account are controlled by the custodian.
  • Assets: You (or someone else) contribute assets to the account. The type of assets you can contribute depends on whether your state has enacted the Uniform Transfers to Minors Act (UTMA) or the Uniform Gifts to Minors Act (UGMA). Examples of assets typically contributed are stocks, bonds, mutual funds, and real property.
  • Tax treatment: Earnings, interest, and capital gains generated from assets in the account are taxed every year to your child. Assuming your child is in a lower tax bracket than you, you’ll reap some tax savings compared to if you had held the assets in your name. But this opportunity is very limited because of special rules, called the “kiddie tax” rules, that apply when a child has unearned income. Under these rules, children are generally taxed at their parents’ tax rate on any unearned income over a certain amount. Currently, this amount is $2,000 (the first $1,000 is tax free and the next $1,000 is taxed at the child’s rate). The kiddie tax rules apply to: (1) those under age 18, (2) those age 18 whose earned income doesn’t exceed one-half of their support, and (3) those ages 19 to 23 who are full-time students and whose earned income doesn’t exceed one-half of their support.

A custodial account provides the opportunity for some tax savings, but the kiddie tax sharply reduces the overall effectiveness of custodial accounts as a tax-advantaged college savings strategy. And there are other drawbacks. All gifts to a custodial account are irrevocable. Also, when your child reaches the age of majority (as defined by state law, typically 18 or 21), the account terminates and your child gains full control of all the assets in the account. Some children may not be able to handle this responsibility, or might decide not to spend the money for college.

U.S. savings bonds

Series EE and Series I bonds are types of savings bonds issued by the federal government that offer a special tax benefit for college savers. The bonds can be easily purchased from most neighborhood banks and savings institutions, or directly from the federal government. They are available in face values ranging from $50 to $10,000. You may purchase the bond in electronic form at face value or in paper form at half its face value.

If the bond is used to pay qualified education expenses and you meet income limits (as well as a few other minor requirements), the bond’s earnings are exempt from federal income tax. The bond’s earnings are always exempt from state and local tax.

In 2013, to be able to exclude all of the bond interest from federal income tax, married couples must have a modified adjusted gross income of $112,050 or less at the time the bonds are redeemed (cashed in), and individuals must have an income of $74,700 or less. A partial exemption of interest is allowed for people with incomes slightly above these levels.

The bonds are backed by the full faith and credit of the federal government, so they are a relatively safe investment. They offer a modest yield, and Series I bonds offer an added measure of protection against inflation by paying you both a fixed interest rate for the life of the bond (like a Series EE bond) and a variable interest rate that’s adjusted twice a year for inflation. However, there is a limit on the amount of bonds you can buy in one year, as well as a minimum waiting period before you can redeem the bonds, with a penalty for early redemption.

Financial aid impact

Your college saving decisions impact the financial aid process. Come financial aid time, your family’s income and assets are run through a formula at both the federal level and the college (institutional) level to determine how much money your family should be expected to contribute to college costs before you receive any financial aid. This number is referred to as the expected family contribution, or EFC.

In the federal calculation, your child’s assets are treated differently than your assets. Your child must contribute 20 percent of his or her assets each year, while you must contribute 5.6 percent of your assets.

For example, $10,000 in your child’s bank account would equal an expected contribution of $2,000 from your child ($10,000 x 0.20), but the same $10,000 in your bank account would equal an expected $560 contribution from you ($10,000 x 0.056).

Under the federal rules, an UTMA/UGMA custodial account is classified as a student asset. By contrast, 529 plans and Coverdell ESAs are considered parental assets if the parent is the account owner or for student-owned or UTMA/UGMA-owned 529 accounts. Accounts owned by grandparents aren’t counted as a parent asset. And distributions (withdrawals) from 529 plans and Coverdell ESAs that are used to pay the beneficiary’s qualified education expenses are not classified as parent or student income on the federal government’s aid form, which means that some or all of the money is not counted again when it’s withdrawn. Other investments you may own in your name, such as mutual funds, stocks, U.S. savings bonds (e.g., Series EE and Series I), certificates of deposit, and real estate, are also classified as parental assets.

Regarding institutional aid, colleges are generally a bit stricter than the federal government in assessing a family’s assets and their ability to pay college costs. Most use a standard financial aid application that considers assets the federal government does not, for example, home equity. Typically, though, colleges treat 529 plans, Coverdell accounts, and UTMA/UGMA custodial accounts the same as the federal government, with the caveat that distributions from 529 plans and Coverdell accounts are often counted again as available income.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

ABC’s of Financial Aid

ABC’s of Financial Aid

These days, it’s hard to talk about college without mentioning financial aid. Yet this pairing isn’t a marriage of love, but one of necessity. In many cases, financial aid may be the deciding factor in whether your child attends the college of his or her choice or even attends college at all. That’s why it’s important to develop a basic understanding of financial aid before your child applies to college. Without such knowledge, you may have trouble understanding the process of aid determination, filling out the proper aid applications, and comparing the financial aid awards that your child receives.

But let’s face it. Financial aid information is probably not on anyone’s top ten list of bedtime reading material. It can be an intimidating and confusing topic. There are different types, different sources, and different formulas for evaluating your child’s eligibility. Here are some of the basics to help you get started.

What is financial aid?

Financial aid is money distributed primarily by the federal government and colleges in the form of loans, grants, scholarships, or work-study jobs. A student can receive both federal and college aid.

Grants and scholarships are more favorable than loans because they don’t have to be repaid–they’re free money. In a work-study program, your child works for a certain number of hours per week (either on or off campus) to earn money for college expenses. Obviously, an ideal financial aid package will contain more grants and scholarships than loans.

Need-based aid vs. merit aid

Financial aid can be further broken down into two categories–need-based aid, which is based on your child’s financial need; and merit aid, which is awarded according to your child’s academic, athletic, musical, or artistic merit.

The majority of financial aid is need-based aid. However, in recent years, merit aid has been making a comeback as colleges (particularly private colleges) use favorable merit aid packages to lure the best and brightest students to their campuses, regardless of their financial need. However, the availability of merit aid tends to fluctuate from year to year as colleges decide how much of their endowments to spend, as well as which specific academic and extracurricular programs they want to target.

Sources of merit aid

The best place to look for merit aid is at the colleges that your child is applying to. Does the college offer any grants or scholarships for academic, athletic, musical, or other abilities? If so, what is the application procedure? College guidebooks can give you an idea of how much merit aid (as a percentage of a general student’s overall aid package) each college has provided in past years.

Besides colleges, a wide variety of private and public companies, associations, and foundations offer merit scholarships and grants. Many have specific eligibility criteria. In the past, sifting through the possibilities could be a daunting task. Now, with the Internet, there are websites where your child can input his or her background, abilities, and interests and receive (free of charge) a matching list of potential scholarships. Then it’s up to your child to meet the various application deadlines. However, though this avenue is certainly worth exploring, such research (and subsequent work to complete any applications) shouldn’t come at the expense of researching and applying for the more common need-based financial aid.

Sources of need-based aid

The main provider of need-based financial aid is the federal government, followed by colleges. States come in at a distant third. The amount of federal aid available in any given year depends on the amount that the federal budget appropriates, and this aid is spread over several different financial aid programs. For colleges, need-based aid comes from a college’s endowment, and policies may differ from year to year, resulting in an uneven availability of funds. States, like the federal government, must appropriate the money in their budgets.

The federal government’s aid application is known as the FAFSA, which stands for Free Application for Federal Student Aid. The federal government and colleges use the FAFSA when federal funds are being distributed (colleges are responsible for administering certain federal financial aid programs). When colleges distribute their own financial aid, they use one of two forms. The majority of colleges use the PROFILE application, created by the College Scholarship Service of Princeton, New Jersey. A minority of colleges use their own institutional applications. The states may use the FAFSA or may require their own application. Contact your state’s higher education authority to learn about the state aid programs available and the applications that you’ll need to complete.

The FAFSA is filed as soon after January 1 as possible in the year your child will be attending college. You must wait until after January 1 because the FAFSA relies on your tax information from the previous year. The PROFILE (or individual college application) can usually be filed earlier than the FAFSA. The specific deadline is left up to the individual college, and you’ll need to keep track of it.

How is my child’s financial need determined?

The way your child’s financial need is determined depends on which aid application you’re filling out. The FAFSA uses a formula known as the federal methodology; the PROFILE (or a college’s own application) uses a formula known as the institutional methodology. The general process of aid assessment is called needs analysis.

Under the FAFSA, your current income and assets and your child’s current income and assets are run through a formula. You are allowed certain deductions and allowances against your income, and you’re able to exclude certain assets from consideration. The result is a figure known as the expected family contribution, or EFC. It’s the amount of money that you’ll be expected to contribute to college costs before you are eligible for aid.

Your EFC remains constant, no matter which college your child applies to. An important point: Your EFC is not the same as your child’s financial need. To calculate your child’s financial need, subtract your EFC from the cost of attendance at your child’s college. Because colleges aren’t all the same price, your child’s financial need will fluctuate with the cost of a particular college.

For example, you fill out the FAFSA, and your EFC is calculated to be $5,000. Assuming that the cost of attendance at College A is $18,000 per year and the cost at College B is $25,000, your child’s financial need is $13,000 at College A and $20,000 at College B.

The PROFILE application (or the college’s own application) basically works the same way. However, the PROFILE generally takes a more thorough look at your income and assets to determine what you can really afford to pay (for example, the PROFILE looks at your home equity and retirement assets). In this way, colleges attempt to target those students with the greatest financial need.

What factors the most in needs analysis? Your current income is the most important factor, but other criteria play a role, such as your total assets, how many family members are in college at the same time, and how close you are to retirement age.

How does financial need relate to my child’s financial aid award?

When your child is accepted at a particular college, the college’s financial aid administrator will attempt to create a financial aid package to meet your child’s financial need. Sometime in early spring, your child will receive these financial aid award letters that detail the specific amount and type of financial aid that each college is offering.

When comparing awards, first check to see if each college is meeting all of your child’s need (colleges aren’t obligated to meet all of it). In fact, it’s not uncommon for colleges to meet only a portion of a student’s need, a phenomenon known as getting “gapped.” If this happens to you, you’ll have to make up the shortfall, in addition to paying your EFC. College guidebooks can give you an idea of how well individual colleges meet their students’ financial need under the entry “average percentage of need met” or something similar. Next, look at the loan component of each award and compare actual out-of-pocket costs. Remember, grants and scholarships don’t have to be repaid and so don’t count toward out-of-pocket costs. Again, you would like your child’s need met with the highest percentage of grants, scholarships, and work-study jobs and the least amount of loans.

If you’d like to lobby a particular school for more aid, tread carefully. A polite letter to the financial aid administrator followed up by a telephone call is appropriate. Your chances for getting more aid are best if you can document a change in circumstances that affects your ability to pay, such as a recent job loss, unusually high medical bills, or some other unforeseen event. Also, your chances improve if your child has been offered more aid from a direct competitor college, because colleges generally don’t like to lose a prospective student to a direct competitor.

How much should our family rely on financial aid?

With all this talk of financial aid, it’s easy to assume that it will do most of the heavy lifting when it comes time to pay the college bills. But the reality is you shouldn’t rely too heavily on financial aid. Although aid can certainly help cover your child’s college costs, student loans make up the largest percentage of the typical aid package, not grants and scholarships. As a general rule of thumb, plan on student loans covering up to 50 percent of college expenses, grants and scholarships covering up to 15 percent, and work-study jobs covering a variable amount. But remember, parents and students who rely mainly on loans to finance college can end up with a considerable debt burden.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

Quick Tips: Tax- Advantaged College Savings Options

Quick Tips: Tax- Advantaged College Savings Options

Federal tax-deferred-growth and tax-free earnings when withdrawals are used for qualified education expenses.

529 Plans

529 college savings plan: You open an individual investment account and direct your contributions to one or more pre-established investment portfolios offered by the plan. Typically, there are fees and expenses associated with opening and/or maintaining a college savings plan account (e.g., annual maintenance fee, administrative fees, and investment expenses based on a percentage of total account value).

529 prepaid tuition plan: You prepay college tuition now at a participating college for use by your child in the future. Your contributions are pooled into the plan’s general investment fund, and you are generally guaranteed a certain rate of return (or a certain amount of tuition). Typically, there are enrollment and administrative fees associated with opening and/or maintaining a prepaid tuition plan account.

State tax benefits may also apply for those who invest in the state plan where they reside.

Coverdell Education Savings Account (ESA)

Allows saving for elementary and secondary school (K-12), as well as college. You establish an individual investment account and select the underlying investments for your contributions (i.e., stocks, mutual funds). Depending on the financial institution, there may be fees associated with opening and/or maintaining a Coverdell ESA.

Income limits restrict who can open an account, and the maximum contribution allowed per year is $2,000.

State tax benefits may also apply.

U.S. Savings Bonds (Series EE and Series I)

For the bond’s earnings to be exempt from federal income tax, you must meet income limits in the year you redeem the bond (the proceeds are added to your income for this determination). The earnings on federal savings bonds are always exempt from state income tax. Typically, there are no fees and expenses, except for the possibility of brokerage fees if the bonds are purchased through a broker.

Earnings taxed at the child’s tax rate, but no special treatment for withdrawals to pay education expenses:

Custodial Accounts

Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) custodial accounts are established for the benefit of a minor child and managed by you or another custodian you designate. The exact type of property that can be held in the account, although generally quite broad, depends on whether your state has enacted UGMA or UTMA. Depending on the financial institution, there may be fees associated with opening and/or maintaining a custodial account.

Assets transferred to the account are irrevocable gifts to the child, and withdrawals can be used only for the child’s benefit. When the child reaches age 18 or 21 (depending on state law), the custodianship ends and the child receives full control of the remaining assets.

Earnings are taxed each year at the child’s tax rate, but children under 19 years old and full-time students under age 24 (who do not earn more than one-half of their support) are taxed at their parents’ tax rate on any earnings over a certain amount according to the kiddie tax rules.

Investors should consider the investment objectives, risks, charges and expenses associated with 529 plans carefully before investing. More information about 529 plans is available in the issuer’s official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.

The availability of the tax or other benefits mentioned above may be conditioned on meeting certain requirements.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.