11/10/97 THE TAXMAN HELPETH--A LITTLE

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THE TAXMAN HELPETH--A LITTLE

Like many new parents, Mark Heaphy already is plotting a way to send his 1-year-old son to college--a proposition that could cost $60,000 a year by the time his boy enrolls. To get the ball rolling, the 25-year-old tax accountant is considering opening a new Education IRA next year. ''I figure I'd better start saving,'' he says.
The Education IRA is one of several new provisions in the sweeping 1997 tax bill that aims to help parents pay for college. Also included are another new individual retirement account, tax credits, and modified tax rules for children's earnings (table). But these incentives are confusing, so you'll have to read the fine print carefully to take full advantage of them.
IN FLUX. Congress already is fighting over details of a few provisions, and some laws passed this year are likely to change before a baby born in 1997 enters college. Also, it's unclear how schools will view the new investments and tax credits as they calculate financial aid. Currently, schools do not consider parents' IRAs when awarding scholarships or loans. But financial planners fret that if you have a large sum of money socked away in an Education IRA, that may count against you. ''We don't know how institutions are going to deal with this yet,'' admits Lawrence Gladieux, executive director for policy at The College Board, a nonprofit that represents academic institutions.
The plan's main tuition-savings vehicle is the Education IRA. It allows parents with joint incomes of up to $150,000 ($95,000 for singles) to put away $500 per child until the dependent is 18. The money can then can be withdrawn tax-free for college. If you exceed the income cap, another qualifying family member or friend can open an account for you. And if your eldest decides to teach skiing instead of enrolling in Harvard University, you can transfer the money to a sibling's account. One catch: The funds must be used by the time the child is 30, or you face a 10% penalty.
Many financial advisers see problems, though. For one, if you invest $500 a year for 18 years, with an annual return of 9%, you'll end up with $25,000--hardly enough to pay for college. Republicans tried to increase the limit to $2,500 a year and allow money to be used for elementary and secondary schools. Although they didn't succeed this year, they vow to continue pressing for the changes. Something that might help their case is that mutual-fund companies may not offer the accounts. ''They'd be very expensive to administer for such low contributions,'' says Steven Norwitz, a vice-president at T. Rowe Price Associates in Baltimore. That means your money could be parked in a bank, earning 5% a year.
If you meet the criteria, you might want to open a new Roth IRA. It allows each parent to set aside $2,000 annually, which can be withdrawn without penalty after five years for education, among other things. For example, if a couple invested $4,000 a year over 10 years, they'd have $40,000 in principal to spend. You wouldn't want to take out the earnings before age 59 1/2, because otherwise they'd be taxed as ordinary income. Again, the income phase-out is $150,000 for joint filers. Most children wouldn't qualify themselves because they don't have earned income.
A few tax credits--the Hope Scholarship and the Lifetime Learning Credit--are thrown in, too. But you won't be eligible unless you make less than $80,000 for joint filers. A high-income family could use the credits, but only if the parents do not declare the child as a dependent on their tax returns. In that case, the child could claim the credits.
The tax bill included another, less obvious, education incentive: a capital-gains-rate cut that affects children's assets. This could benefit even families not likely to qualify for the new IRAs or tax credits. For assets held at least 18 months, the capital-gains rate drops from 15% to 10% for those in the 15% income bracket, which includes most children. Taxpayers in higher brackets pay 20%. And in 2001, children can sell assets they have held at least five years and pay at an 8% rate.
To utilize this change for college planning, you might consider setting aside money in your child's name under the Uniform Gifts to Minors Act (UGMA). Once the child turns 14, UGMA-account assets are taxed at the child's rate. So the idea is to transfer assets--a maximum of $20,000 per couple a year tax-free is allowed--into your child's account at least five years before college, then withdraw the money at the lower capital-gains rate for tuition.
True, these provisions won't finance four years at a fancy private school. But given the enormous cost of going to college, they sure can help.
Mary Beth Regan

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