Education Planning

Which of the following statements regarding the American Opportunity Tax and Lifetime Learning Credits is CORRECT? I. A family may not take an American Opportunity Credit and Lifetime Learning Credit in the same year. II. A Lifetime Learning Credit may be used in combination with a student loan interest deduction.

The answer is II only. A family may take an American Opportunity Tax Credit and a Lifetime Learning Credit in the same year as long as they are not for the same student. Both the Lifetime Learning Credit and the American Opportunity Tax Credit may be used in combination with a student loan interest deduction. 8.3.1

Barbara is the beneficiary of a Section 529 college savings plan established by her parents. This year, Barbara withdraws $15,000 from the plan to furnish her new apartment. Which of the following statements regarding the tax treatment of this withdrawal is CORRECT? I. The withdrawal is included in Barbara's gross income. II. Only the income portion of the withdrawal is subject to a 10% tax penalty.

The answer is II only. Because Barbara did not use the withdrawal to pay for qualified education expenses, only the income portion of the withdrawal is included in her gross income and is subject to a 10% tax penalty. 8.2.4

For purposes of calculating the expected family contribution (EFC), which of the following assets is included in the student's calculation? I. Section 529 plan assets II. Custodial accounts III. Home equity IV. Life insurance cash value

The answer is II only. Custodial accounts (e.g., Uniform Gifts to Minors Act [UGMA] or Uniform Transfers to Minors Act [UTMA] accounts) are considered student assets. If the parents are listed as contributors-owners, Section 529 plan assets are considered parental assets. Home equity and life insurance cash value are exempt. 8.1.2

Kayla is interested in learning more about education grants. She made the following statements and asked you to confirm their accuracy. Which of her statements regarding education grants is CORRECT? I. Supplemental Educational Opportunity Grants (SEOGs) are federal grants for which priority is given to students who also receive Pell Grants. II. Pell Grants are disbursed to the educational institution for the benefit of the qualifying student. III. Federal Work-Study programs provide students attending college with part-time jobs. IV. Pell Grants are available to undergraduate and graduate students.

The answer is I and III. SEOGs, which are federal grants, give priority to students who also receive Pell Grants. Federal Work-Study programs provide students attending college with part-time jobs. In turn, the institution disburses the earned funds to the students. Pell Grants are dispersed directly to students and are available to undergrads only. 8.2.1

Justine completes the Free Application for Federal Student Aid (FAFSA) to see if she qualifies for financial aid. The value of which of the following assets will be included in the expected family contribution (EFC) calculation? I. Automobiles owned by Justine's parents II. Her father's Section 401(k) plan balance III. The equity in her parents' personal residence IV. Justine's UTMA (Uniform Transfers to Minors Account) account

The answer is IV only. All assets owned by a student's parents are included in the EFC calculation, with the notable exceptions of home equity, cars used for regular transportation, accrued benefit or account balances in any retirement plans (e.g., Section 401(k) plans), and the cash value of life insurance policies. The value of student-owned assets, in this case the UTMA account, is also included in the EFC calculation at 20%. 8.1.2

Which one of the following programs properly matches an accurate description of one of its features? A)Perkins loans are only available for undergraduate tuition. B)Stafford loans are available for undergraduate and graduate tuition. C)PLUS loans are based on the applicant's need. D)Parent Loans for Undergraduate Students loans (PLUS loans) are available for the student to utilize for either undergraduate or graduate tuition.

The answer is Stafford loans are available for undergraduate and graduate tuition. Perkins loans are available for undergraduate and graduate tuition. PLUS loans are for parents of undergrads. Graduate students can also avail themselves of the Stafford loan program. PLUS loans are not based on need. 8.2.4

All of the following statements regarding the expected family contribution (EFC) as it relates to student financial aid are CORRECT except A) the home equity in the parents' home is excluded from parental assets. B) student income includes only taxable income from the year preceding the award year. C) student assets include the value of everything the student owns or that has been saved on the student's behalf. D) student assets and income are assigned a higher rating in the EFC calculation than parental assets and income.

The answer is student income includes only taxable income from the year preceding the award year. Student income includes both taxable and nontaxable income from the year preceding the award year. 8.1.2

Which of the following is a non-need-based loan for which the borrower-student is responsible for the accrued interest during the life of the loan? A) Unsubsidized Stafford Loan B) Subsidized Stafford Loan C) Pell Grant D) Supplemental Educational Opportunity Grant (SEOG)

The answer is unsubsidized Stafford Loan. An unsubsidized Stafford Loan is a non-need-based loan for which the borrower-student is responsible for the accrued interest during the life of the loan. 8.2.1

To be eligible to receive federal student aid, you must

be a citizen or eligible noncitizen of the United States; have a valid Social Security number (Students from the Republic of the Marshall Islands, Federated States of Micronesia, and the Republic of Palau are exempt from this requirement.); have a high school diploma or a General Education Development (GED) certificate, or have completed homeschooling (If you don't, you may still be eligible for federal student aid if you were enrolled in college or career school before July 1, 2012. Go to https://studentaid.ed.gov/eligibility/basic-criteria for additional information); be enrolled in an eligible program as a regular student seeking a degree or certificate; maintain satisfactory academic progress; not owe a refund on a federal student grant or be in default on a federal student loan; register (or already be registered) with the Selective Service System, if you are a male and not currently on active duty in the U.S. Armed Forces; and not have a conviction for the possession or sale of illegal drugs for an offense that occurred while you were receiving federal student aid (such as grants, work-study, or loans). If you have such a conviction, you must complete the Student Aid Eligibility Worksheet to determine if you are eligible for aid or partially eligible for aid. 8.1.3

Exclusions of parental assets for purposes of Expected Family Contribution (EFC)

home equity, cars used for regular transportation, the cash value of a life insurance policy, and the parents' accrued benefit or account balances in any retirement plans.

1. Barry and Virginia have a six-year-old son, Daniel. They have plans for Daniel to attend a four-year private university at age 18. Currently, tuition at the local private university is $15,000 per year and is expected to increase at 7% per year. Assuming Barry and Virginia can earn an annual compound return of 10% and inflation is 4%, how much does the couple need to start saving at the end of each year (starting this year) to be able to pay for Daniel's college education? (Assume their last payment is made at the beginning of Daniel's first year in college.) A. $5,144.86 B. $5,899.93 C. $6,065.35 D. $8,886.18

C The answer is $6,065.35. They would need to deposit $6,065.35 per year to meet the education funding goal. Step 1: Determine the future cost of college for the first year. 15,000, +/−, PV 7, I/YR 12, N Solve for FV = 33,782.8738, or $33,782.87 Step 2: Determine the account balance necessary to fund college education. BEG mode (money is needed at the beginning of college) 33,782.8738, +/−, PMT [(1.10 ÷ 1.07) − 1] × 100 = 2.8037, I/YR 4, N Solve for PV = 129,703.2143 or $129,703.21 Step 3: Determine the required savings payments. END mode 129,703.2143, FV 12 N (payments continue until Daniel reaches 18) 10, I/YR Solve for PMT = -6,065.3523, or $6,065.35

8. George and Betty wish to establish a Section 529 college savings plan for both of their grandchildren. In 2019, what is the maximum amount that they can contribute without making a taxable gift for federal gift tax purposes? A. $75,000 B. $150,000 C. $265,000 D. $300,000

D The answer is $300,000. Because George and Betty have two grandchildren, they may contribute a maximum of $300,000 (or $150,000 for each account in 2019). However, they may make this contribution only once within a five-year period and must file a federal gift tax return reporting these transfers (even though there is no taxable gift).

3. To be eligible to receive federal student aid, a student must I. be a U.S. citizen. II. be an eligible noncitizen of the United States. III. maintain satisfactory academic progress. IV. not be in default on a federal student loan. A. II only B. I and III C. I, III, and IV D. I, II, III, and IV

D The answer is I, II, III, and IV. All of these are correct

Which of the following statements regarding the American Opportunity Tax Credits and Lifetime Learning Credits is CORRECT? I. A family may take an American Opportunity Tax Credit and a Lifetime Learning Credit in the same year. II. A Lifetime Learning Credit may not be used in combination with a student loan interest deduction.

The answer is I only. A family may take an American Opportunity Tax Credit and a Lifetime Learning Credit in the same year, as long as they are not for the same student. A Lifetime Learning Credit or an American Opportunity Tax Credit may be used in combination with a student loan interest deduction in the same year. 8.3.1

Which of the following characteristics apply to Pell Grants? I. Available to undergraduate part-time students II. Available to undergraduate full-time students III. Available to graduate students IV. Available to all undergraduate students

The answer is I, II and IV. All undergraduate students who meet the financial need requirements are eligible for Pell Grants. Graduate students are not eligible for Pell Grants. 8.1.3

Which of the following statements concerning Pell grants are CORRECT? I. Pell Grants are the primary type of grants dispersed directly to students. II. Financial need and availability of federal funds are the criteria for receipt. III. Receipt of other grants is sometimes contingent upon applying for or receiving a Pell grant. IV. The Pell grant is available to both undergraduates and graduate students.

The answer is I, II, and III. Only statement IV is incorrect. The Pell Grant is only available to undergraduates. 8.1.3

EFC FORMULA

total annual cost of college − ([22%-47% parent income + 5%-5.64% parent assets] + [50% student Income + 20% student assets]) = EFC

Three-Step Education Funding Calculation

Inflate (End mode) Find the inflation-adjusted annual college costs I/Y = inflation rate n = # of years to college PV = 1 year's tuition (-/+) Solve for FV Adjust (Begin mode) Determine the lump sum to cover all college costs n = # of years student will be in school I/Y = inflation adjusted rate of return PMT = Previous calculation's PV (-/+) Solve for PV Invest (End mode) Discount the future lump sum amount back to today's dollars FV = Previous calculation's PV n = Number of periods until student begins college I/Y = Expected return Solve for PV Level payment solve for PMT Serial PMT use inflation adjusted rate of return. Solve for PMT and keep inflating each year by the inflation rate. First year's must also be inflated since it will be paid at the end of the year.

Olen and Kiera Littrell have three children. Their oldest child is currently in college, their second child will be starting college next semester, and their third child is still in high school. Olen works at the assembly plant with an income of $45,000 and Kiera is a homemaker. They rent an apartment and carry various credit card balances. What potential avenues would they most likely have to finance college expenses? I. Perkins loans II. Stafford loans III. Parent Loans for Undergraduate Students loans (PLUS loans) IV. Pell grants

The answer is I, II, and IV. PLUS loans are taken out by the parents, which requires reasonable credit. Due to the Littrells' finances, they most likely would not qualify for a PLUS loan. Perkins loans, Pell grants, and FSEOG are needs-based. Stafford Loans can be subsidized or unsubsidized—subsidized are needs-based. Most likely they would qualify for the subsidized loans. 8.2.1

Assume Craig wants to save $50,000 (in today's dollars) for his son's college expenses in 5 years. Craig is comfortable using an inflation rate of 4% and an investment rate of return of 8%. Calculate the serial payment that Craig will make at the end of the third year.

The answer is $10,415.99. Step 1: Determine PMT at the beginning of the first year. 50,000 FV 5 N 3.8462 I/YR [(1.08 ÷ 1.04) - 1] × 100 = 3.8462 Solve for PMT = 9,259.7823, or $9,259.78 Step 2: Multiply by 1 + inflation rate, to find the payments due at the end of each year. $9,259.78 × 1.04 = $9,630.17 (first year) $9,630.17 × 1.04 = $10,015.38 (second year) $10,015.38 × 1.04 = $10,415.99 (third year) 8.1.1

Valarie is planning to go to college in the fall and wants to apply for a federal grant. She is interested in the Pell grant but does not know if she will be able to apply. Pell grants are available to which of the following students? I. Part-time students II. Full-time students III. Graduate students IV. Undergraduate students

The answer is I, II, and IV. Pell grants are available to half-time, full-time, and part-time (less than half-time) undergraduate students. 8.1.3

Which of the following is considered qualified education expenses for purposes of the income tax exclusion for redemptions of Series EE savings bonds? I. Room and board II. Tuition III. Fees IV. Personal auto

The answer is II and III. Qualified education expenses for purposes of the Series EE savings bond exclusion include tuition and fees but not room and board or a personal auto. 8.2.3

Nathan and Angela Flesher have three children. Their oldest child is currently in college, their second child will be starting college next semester, and their third child is still in high school. Nathan is a vice president at AJAX Corp with W2 income of $150,000 per year, and Angela is an administrative assistant earning $45,000 per year. What potential avenues would they most likely have to finance college expenses? I. Perkins loans II. Parent Loans for Undergraduate Students loans (PLUS loans) III. Pell grants IV. Work study program

The answer is II and IV. Perkins loans and Pell grants are needs-based, and Nathan and Angela most likely would not qualify based on their income. 8.2.1

John Hedrick wants to pay one-half of the college costs for his daughter, Ruth. She will be attending a private college with annual costs of $20,000 today. Ruth is 10 years old and will be starting college in eight years. If these costs are expected to increase annually by 8%, how much will Mr. Hedrick need to provide for her first year of college? A)$27,371 B)$23,409 C)$74,037 D)$37,019 E)$18,509

The answer is $18,509. You are just being asked to arrive at the inflated value of one-half of the first year's tuition payment. As such, this becomes a simple future value calculation with the following keystrokes: 8 N; 8 I; 10,000 PV (1/2 of $20,000); FV = $18,509. 8.1.1

Your client's oldest daughter will attend college 10 years from today. She will need $15,000 at the beginning of each academic year for 4 years. This cost has been guaranteed and will not increase in the period before or during college. What amount will your client need to deposit at the beginning of each month, starting now, to fund the daughter's college education if an 8% annual rate of return (compounded monthly) can be earned on these funds? Assume deposits into the education fund stop when the daughter starts college. A) $327.97 B) $487.14 C) $500.00 D) $291.35

The answer is $291.35. This requires a present value of an annuity due calculation. First, calculate the present value of total savings needed on a lump-sum basis as follows: BEG mode; 8 I/YR; 15,000 +/− PMT; 4 N; solve for PV of 53,656.45. Next, use the PV as an FV and discount back to calculate the monthly payment: BEG mode, 12 × 10 = 120 N; 8 ÷ 12 = 0.6667 I/YR; 53,656.45 FV; solve for PMT = −291.3488, or $291.35. 8.1.1

Jack and Barb Zapel have two children, Matt, age three, and Charity, age five. They want to invest a lump sum today that will provide for four years of education when Matt starts college at the age of 18. State College costs $14,000 annually today, and they believe education inflation will remain constant at 6% and that they can receive a 7% return on their investment. What is the amount they would require? A)$47,517 B)$49,336 C)$47,965 D)$55,220

The answer is $47,965. (NOTE: calculations were not rounded between steps. Your answers might vary slightly due to rounding.) Inflate today's college tuition to when child starts college: 15 [N]; 6 [I/YR]; 14,000 [PV] solve for [FV] = 33,551.8147. STEP 2 calculate present value needed at start of school, using inflation-adjusted interest rate: 1.06 [INPUT]; 1.07 [SHIFT] [%CHG] {0.9433} [I/YR]; 4 [N]; 33,551.8147 [PMT]. Set calculator to BEG mode [SHIFT] [Beg/End] solve for [PV] = 132,337.5434. STEP 3 take lump sum needed at start of college and calculate the present value needed today. 132,337.5434 [FV]; 15 [N]; 7 [I/YR]; solve for [PV] = 47,965.2159. 8.1.1

Identify the value of the protected amount in 2019‒2020 for purposes of calculating student assets in the expected family contribution (EFC) formula. A) $5,640 B) $6,660 C) $6,000 D) $5,000

The answer is $6,660. The protected amount for student assets is $6,660 (2019‒2020); 50% of student income above the protected amount is included in the calculation of EFC. 8.1.2

Which of the following statements regarding Pell Grants is CORRECT? I. They are the primary type of grant disbursed directly to students. II. They are need-based. III. They are available both to undergraduate and graduate students. IV. These programs provide students attending college with part-time jobs.

The answer is I and II. Statement III is incorrect; Pell Grants are available to undergraduates only. Statement IV is incorrect; Federal Work-Study (FWS) programs provide students attending college with part-time jobs. 8.2.1

Select the expenses for which the employer's educational assistance program could apply. I. Part-time, undergraduate-level tuition II. Full-time, graduate-level tuition III. Meals IV. On-campus housing

The answer is I and II. Under the educational assistance program, an employer can reimburse an employee's tuition (both graduate and undergraduate), enrollment fees, books, supplies, and equipment, and these benefits are excluded from the employee's income up to $5,250 per year. Meals, transportation, and lodging are not qualifying expenses for this program. 8.3.2

Which of the following statements regarding education grants is CORRECT? I. Supplemental Educational Opportunity Grants (SEOGs) are federal grants for which priority is given to students who also receive Pell Grants. II. Pell Grants are dispersed to the educational institution for the benefit of the qualifying student. III. Federal Work-Study programs provide students attending college with part-time jobs. IV. Pell Grants are available to both undergraduate and graduate students.

The answer is I and III SEOGs, which are federal grants, give priority to students who also receive Pell Grants. Federal Work-Study programs provide students attending college with part-time jobs; in turn, the institution disburses the earned funds to students. Pell Grants are dispersed directly to students and are available only to undergraduate students. 8.2.1

5. Assume that an adult client is currently in a low marginal income tax bracket and does not anticipate major income increases in the future. He is interested in a low-risk investment purchased in his name that may provide favorable income tax treatment when used for the higher education tuition expenses of his only child. He is also not interested in incurring the expense of establishing a trust when saving for his child's college education costs. Identify a viable alternative to recommend to the client. A. An UGMA account B. A passbook savings account in the child's name C. Municipal bonds purchased in the name of the client D. Series EE savings bond

D The answer is Series EE savings bond. Because the client is currently in a low tax bracket and does not anticipate significant income increases in the future, he does not need to worry about the phaseout amounts associated with a qualified savings bond. In addition, to qualify for the tax exclusion on savings bond interest, such a bond has to be purchased in the name of an individual who is at least age 24, unlike the UGMA account, which is the legal property of the child at the time the account is established

2. Select the parental assets that are excluded from consideration when calculating the Expected Family Contribution (EFC) for federal financial aid. A. Mutual fund ownership B. Annual contributions to a retirement plan C. Rental real estate property D. The excess of value over the amount owed on a personal residence

D The answer is the excess of value over the amount owed on a personal residence. The equity in a personal residence or home is not included in the calculation of the EFC. The accrued benefit or account balance in a retirement plan is an exempt parental asset

Employer Assistance programs

Does not go towards room and board (includes apparel)

Tim is single, 21 years old, and is in his third year of college. He has an AGI of $35,000 and receives no support from his parents. The college is a Title IV institution where students are eligible to receive federal financial aid, and Tim is pursuing an undergraduate degree in criminal justice. When Tim was 13, his parents established a Uniform Transfers to Minors Act (UTMA) account for him, and funded it with EE savings bonds. When Tim was a freshman, he was convicted of a felony drug possession charge. Which one of the following is CORRECT regarding Tim's situation? A)Tim could use both the American Opportunity tax credit and the Lifetime Learning credit in the same year. B)Tim qualifies for the American Opportunity tax credit C)Tim may redeem the EE bonds potentially tax-free if the proceeds are used for his qualifying education expenses. D)Tim qualifies for the Lifetime Learning credit.

The answer is Tim qualifies for the Lifetime Learning credit. His AGI is under the phaseout range. He is pursuing a degree at an eligible institution. The felony drug conviction would preclude the use of the American Opportunity tax credit, but not the Lifetime Learning credit. There is no exclusion available for EE bonds unless they are held by the individual who purchases the bonds or unless they are held jointly with a spouse. A bond that has been gifted to another taxpayer does not qualify for the exclusion. The American Opportunity tax credit and the Lifetime Learning credit may not be claimed in the same year for the same student. 8.3.1

A non-need-based loan available to parents of dependent, undergraduate students is A) a Perkins loan. B) a subsidized Stafford loan. C) a PLUS loan. D) a Pell loan.

The answer is a PLUS loan. If a parent does not otherwise qualify for financial aid because of high income level, the PLUS loan is the only loan that will typically be available to assist in the payment of college education expenses. The Pell Grant is not a loan but a need-based endowment. Both Perkins and subsidized Stafford Loans are also need-based. 8.1.3

Donnie is a director of operations at an alternative investment group. He is taking part-time evening classes to obtain a Master of Finance degree through an online college. This year, he incurred $10,000 in qualified educational expenses. Identify the program or credit(s) that Donnie could use to offset his expenses this year.

The answer is employer-provided assistance program + Lifetime Learning Credit. An employer can reimburse an employee's tuition (both graduate and undergraduate), enrollment fees, books, supplies, and equipment, and these benefits are excluded from the employee's income up to $5,250 per year. The employer or the employee cannot, however, also claim an education credit (American Opportunity Tax or Lifetime Learning Credit) for the same expenses. If the employee has expenses greater than $5,250, the employee will be permitted to claim an education credit for the expenses over $5,250 (assuming the employee also meets the requirements for the education credits). In Donnie's case, the Lifetime Learning Credit would apply after the educational assistance benefit because he is enrolled part time and on a graduate level. It would create a nonrefundable credit on 20% of all qualifying educational expenses above $5,250 ($950 reimbursement in Donnie's case [$4,750 × 0.20 = $950 LLC]). 8.3.2

Which of the following are common features between the Coverdell Education Savings Account (CESA) and the Section 529 plan? A)The CESA can only be used for K-12 education expenses. B)Neither provides any federal income tax deductibility to the contributors. C)Both have an age restriction for use of funds. D)Both have an income phaseout.

The answer is neither provides any federal income tax deductibility to the contributors. Only the CESA has an income phaseout and age restriction at age 30. Both can be used to pay for qualified elementary and secondary school expenses as well as college expenses, but neither plan is deductible for federal income tax purposes. 8.2.3