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TAX REPORT

College Savings Can Have Tax Bite

By ROB WELLS
Staff Reporter of THE WALL STREET JOURNAL
April 22, 2004; Page D2

Choosing the wrong college-savings plan can be a costly mistake for
families, including top earners, when they start hunting for college
financial aid, a new study says.

It's long been known that a healthy balance in a college-savings
account can reduce a family's ability to qualify for financial aid.
Yet a new study by Harvard University Prof. Susan Dynarski shows
exactly how much people stand to lose.

The study said a family making $100,000 can see a reduction in certain
college financial aid by $1.94 for every after-tax dollar from a
Uniform Transfer to Minors Act account, a custodial account for
minors. The problem is less marked with state-sponsored Qualified
Tuition Programs or Section 529 college-savings plans, but it still
hurts. Such a family would see a 21 cent reduction for every after-tax
dollar from these accounts.

For money in a non-tax-advantaged mutual fund, financial aid would be
reduced by 76 cents for every after-tax dollar.

"For families caught in the crossfire between aid policy and tax
policy, the impact on the bottom line is not pretty," she adds.

College financial aid is prevalent among affluent families, with some
22% of families making $100,000 or more getting a grant, loan or other
form of need-based aid in 2000, the study said. Average aid for these
families was $4,975.

Such aid is more prevalent as tuition costs soar. Average
private-college tuition and fees rose 6% to nearly $19,710 in the
2003-2004 school year, according to the College Board. Tuition costs
for four-year public institutions rose 14% to $4,694.

One tax expert, Jeff Kelson of BDO Seidman LLP in New York, cautioned
that the Harvard study assumes the financial aid and tax laws will
remain the same over an 18-year period. Congress has been altering
education tax laws with regularity, particularly since 1997.

Ms. Dynarski calculates a reduction in financial aid as a "tax," and
said this most affects the families on the margin of qualifying for
financial aid. About 25% of families with income above $100,000 are on
the margin of getting more financial aid, she said.

With the Uniform Transfer to Minors Act accounts, the losses are
drastic because the college financial-aid system considers such funds
to be assets of the child, which penalizes families in the aid
formula.

By contrast, state college-savings plans, known as 529 plans, are
considered assets of the parent and not the child, and therefore
aren't subject to such a sharp erosion.

Financial planner Susan Hirshman of J.P. Morgan Fleming Asset
Management said such findings illustrate why parents should seek
professional advice on juggling their retirement and education savings
goals.

One trick, Ms. Hirshman said, is to draw down a child's assets as much
as possible before applying for aid. If your college-bound teenager is
looking for a car, "instead of you purchasing the car, if they have
money in their own name, use that money to purchase the car," she
said.

Ms. Dynarski's study showed that the state-backed 529 savings plans,
as well as the revamped Coverdell Education Savings Accounts, had the
lowest "tax" penalty from the financial-aid system. She said that if a
taxpayer's state doesn't offer a 529 plan with an upfront tax
deduction, the taxpayer should shop around for other state plans with
low fees, or consider a Coverdell Education Savings Account. The
Harvard professor is setting aside money for her children in a 529
plan in Utah.


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http://online.wsj.com/article/0,,SB108258577280989799,00.html