1 chapter 13 educational planning. 2 chapter goals create an educational planning policy. calculate...

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Chapter 13

Educational Planning

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Chapter Goals

Create an educational planning policy. Calculate the amount of educational savings needed

annually. Establish the relevance of educational planning to overall

needs. Select the proper educational structure for savings. Differentiate the educational investment policy from

others. Identify the financial literacy problem and what can be

done about it.

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Overview

Educational planning: The programming of direct financial and time resources that enables household members to improve their capabilities, typically through enrolling at a college or university.

We can estimate educational cost and savings needed to fund education well before the actual event, best reflected in an education policy statement.

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Overview, cont.

The steps in the educational policy statement process are as follows:

– Establish educational goals. – Calculate the cost of education.– Project the potential for financial aid.– Estimate the total cost for parents.– Determine best savings structures.– Establish investment policy.– Estimate the amount of annual funding needed.

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Establish Educational Goal and Calculate the Cost of Education

Establish Educational Goal: – The overall goal is to provide a quality education that enables

the recipient to receive a high return on investment.

Calculate the Cost of Education: – Will vary depending on the type of school, region of the country,

and whether the student lives at home or at school. Expenses include tuition, books, rent, food, entertainment and transportation costs.

– In projecting college costs, a figure in excess of the overall inflation rate is generally called for.

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Project the Potential for Financial Aid

All government aid applied for through Free Application for Federal Student Aid (FAFSA) which is offered by U.S. Department of Education. Early application for those eligible for aid increase chance of receiving aid.

Grants:– Pell grants for undergraduates (maximum of $4,000). – Federal Supplementary Education Opportunity Grants (FSEOG)

are for undergraduates with particularly low family income. – Colleges, states, corporations, or other institutions may provide

aid.

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Project the Potential for Financial Aid, cont.

Work-Study Programs:– The program may be set up by the Federal government as part

of a grant or by the college itself. Loans:

– Stafford loans: Rate is a maximum of 8.3 percent regardless of market rates. For 2004-2005 the rate charge is 3.4 percent. The student is responsible.

– Federal PLUS loans: Rate is 4.2 percent for 2004-2005. The parents are responsible.

– Federal Perkins loans: Low-interest loans for graduate and undergraduate students who have exceptional need. Rate is 5 percent.

– Home equity loans: Under current regulations, interests payments on student loans are tax deductible up to $2,500 as of 2004.

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Estimate the Total Cost for Parents

Once the full education cost is known and the amount of any financial aid package has been estimated it is possible to estimate the parental cost.

Cost will vary depending on how much or what fraction of it parents are willing and able to assume.

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Determine Best Savings Structures

Coverdell Education Savings Accounts:– Special savings accounts set up with after-tax dollars for

educational purposes. – A maximum of $2,000 can be contributed for each child

each year with annual income limitations of $95,000-$110,000 for individuals and $190,000-$220,000 for people filing jointly.

– Income earned while in the account is not subject to federal taxation and is tax advantaged for many states as well.

– The tax benefit in 2005 is phased out for annual incomes between $95,000 and $110,000 for individuals and $190,000-$220,000 for people filing jointly.

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Determine Best Savings Structures, cont.

Qualified Tuition Plans – Section 529 Plans:– Prepaid plans provide advance payment of monies to the

state. If required minimums are met, the student may attend a state college at no further charge.

– Private savings plans employ after-tax dollars as deposits. There is no further federal taxation, provided the funds are used for a broad variety of college expenses. The tax-free distribution program is in effect through 2010.

– No income qualifications for this program. – Run by the individual states. Many states allow cumulative

deposits of $200,000 or more. – Monies for these programs are deposited with a state-

designated investment advisory firm, which establishes the investment program.

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Qualified Tuition Plans – Section 529 Plans, cont.:– Must be used for qualified withdrawals otherwise a 10 percent

penalty will be incurred. – Funds in the account can be used by the beneficiary to attend

any post secondary educational institution that can participate in the Department of Education’s student aid program, including foreign schools.

– Contributions must be in cash. – Funds from existing custodian accounts can be transferred into

a 529 plan but they retain the character of a custodian account. – Leftover funds can be rolled over to relatives for their use. – Qualified rollovers include a father, mother, brother, sister, and

a first cousin of the beneficiary. The 529 plan is treated as a parental asset for educational aid purposes.

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Regular Investment Accounts:– Ordinary savings accounts with no special educational benefits. – Now more competitive due to special educational accounts

under the Jobs and Growth Tax Relief Reconciliation Act of 2003.

– Qualified dividends and capital gains on stocks and stock mutual funds are now taxed at a maximum of 15 percent on a federal basis.

– If assets are placed in the child’s name, the first $800 annually is not taxed at all and the next $800 is taxed at the child’s rate. If the child is 14 or over, the balance will be taxed at the child’s low tax rate.

– Regular investment accounts allow ultimate flexibility. You can place the money in any form of investment you wish and make withdrawals for any purpose without penalty.

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Other:– Regular IRAs and Roth IRAs may be used to fund

educational programs. Amounts deposited grow tax-free and withdrawals for educational purposes for regular IRAs are not subject to the 10 percent early distribution tax.

– The Uniform Gifts to Minors Act (UGMA) and Uniform Trust for Minors Act (UTMA) can be used to fund college monies.

– UGMAs are restricted to financial assets as investment vehicles.

– UTMAs can use real estate, limited partnerships, and other investment vehicles as well as financial assets.

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Establish Investment Policy and Estimate the Amount of Annual Funding Needed

Establish Investment Policy:– Investment policy is based on risk and return. – The risk of a disappointing outcome grows as the period to

college payment date draws nearer and nearer. – Therefore, the allocation to bonds and money market

assets will typically increase as the time to age 18 or another starting date draws closer.

Estimate the Amount of Annual Funding Needed:– At this point all the quantitative inputs that are required

have been established.

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Planning for Financial Literacy

Financial literacy refers to being educated in financial matters.

– In practical terms financial literacy means being able to make financial decisions capably.

– Many finance and economics theories assume that people have perfect knowledge of financial issues. Obviously, this is not the case.

– The CFP Board of Standards requires that financial planners hold frequent meetings with their clients to educate them about the financial planning process and their own financial situation.

– Thus, giving clients proper recommendations is not a CFP’s only responsibility. The planner should make sure the client understands the advice.

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Planning for Financial Literacy, cont.

The absence of financial literacy has important financial consequences.

– For many households the outcome is a lower accumulation of wealth and therefore a reduced standard of living.

– In some more extreme cases it leads to financial ruin. – From an economic standpoint it results in a misallocation of resources

that affects society’s productivity. There are many reasons why individuals are not adept in

financial matters. – A lack of exposure to financial issues as a child.– A belief that financial issues cannot be handled capably. – Poor mathematical skills.– A lack of interest in the subject. – Gender related issues

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Fostering greater financial awareness could be beneficial to many households.

Developing this awareness may be particularly important at the present time when:

– People are being asked to make more of their own savings and investment decisions regarding retirement in 401(k) and other pension plans.

– Investment alternatives are growing in number.– Some people are calling for do-it-yourself Social Security

investing.

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Planning for financial literacy can occur at any age and ranges from presenting simple financial tasks to children at home or in classroom settings to concentrated education when a surviving member assumes the household financial responsibilities previously handled by a deceased spouse.

Awareness can come from a number of sources including radio, television, books, newspapers, magazines, newsletters, audio or video tapes and discs, friends, relatives, advisors, and so on.

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Basic financial literacy principles:– Simplicity: Financial issues are daunting to many people.

Topics should be simple to explain and understand.– Easy to Relate To: The items described should be easy to

relate to, and emphasize everyday situations.– Practical Examples: It is not enough to demonstrate how

financial items relate to people’s lives. Practical examples with worked-out solutions should be established to assure an understanding and ability to implement them.

– Use a Process Approach: A detailed step-by-step approach will help people understand why something is being done and provide a systematic approach.

(Continued next slide)

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Basic financial literacy principles, cont.:– Accommodate Different Learning Styles: People have different

learning styles. Some learn best from lectures, discussions; others from reading; and others from illustrations, numbers, and tables, etc. A combination of approaches often works well.

– Provide the Benefits: Since financial issues can be difficult to understand, people need benefits for doing so. The more tangible and meaningful the benefits, the greater can be their motivation and therefore the greater their success rate in obtaining the requisite knowledge.

– Other Principles: When an outside person is providing the knowledge, an interesting style, reassuring manner, and dialogue with solicitation of questions can be helpful. Using a game approach such as a stock market game may also be useful.

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Financial literacy encompasses all parts of the financial planning process.

Often the two major issues are establishing an appropriate savings pattern and investing effectively. Some of the important topics to be discussed in helping people become financially literate are presented in the following slides.

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Goals:– How to establish goals.– How to use goals as a motivational tool.

Cash Flow:– Establishing a formal or informal family budget.– Planning for future household outlays.

Saving:– Why saving is important for you.– How to control unneeded spending.– Establishing a saving pattern.– How much saving is enough?– How to deal with savings setbacks.

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Debt:– The appropriate use of borrowed funds.– How to get out of debt.– What is the best source of credit.

Taxes: – Gaining a basic understanding of the tax code.– Developing knowledge of deductible items and planning to

maximize them.

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Investments:– Understanding risk and return.– Developing skepticism about seemingly high-return

investments.– Understanding prominent investment vehicles such as

bonds, stocks, and mutual funds.– Appreciating diversification and the benefits of long term

investing.– Understanding the advantage of index funds for low

maintenance supervision.– How to deal with impulsive investment behavior.– Explaining the most attractive way to purchase investment

selections.

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Risk Management:– Obtaining proper insurance coverage personally and for

possessions.– Developing healthy risk-management practices.– Placing emphasis on potential losses that could be injurious

to the household’s financial future, regardless of their probability of occurrence.

Retirement Planning:– Knowledge of 401(k) and other pension plans.– Awareness of the benefits of saving through a pension plan.– Knowing how much to save for retirement.– Starting retirement planning at an early age.

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Estate Planning:– Knowledge of the benefits of making out a will.– Planning for the family, particularly at an advanced age.

Educational Planning:– Planning to send children to college.

Overall: – Taking control of your financial life.– Dealing with adversity.– Allocating money when there are alternative demands for it.– Engaging in long-term thinking.– Learning not to worry about financial matters.– Finding and working successfully with advisors.– Communicating with other household members.

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Chapter Summary

Educational planning involves investing in obtaining information that enhances the knowledge base of household members. Steps include:

– Establish Goals.– Calculate the Cost of Education.– Project the Potential For Financial Aid.– Estimate Total Cost For Parents.– Determine Savings Structure.– Establish Investment Policy.– Estimate Amount of Annual Funding Needed.

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Chapter Summary, cont.

Financial literacy:– Is a major problem in some households that leads to

inefficient decision-making and a lower standard of living.– Can be rectified through a variety of methods ranging from

attending lectures, media presentation, seeking the advice of more experienced people, etc.

– Is a financial planning function and planners should educate their clients so that they can make choices based on knowledge.

1 chapter 13 educational planning. 2 chapter goals create an educational planning policy. calculate...

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