Borrowing for a college-bound daughter

Q: My daughter is going to college this fall and we'll be borrowing money to pay for it. Am I better off, from a tax standpoint, borrowing money for tuition in my name or my daughter's name? Also from a tax standpoint, is it better to get a federal loan, take a second mortgage, refinance, or borrow from my credit union?
L.S., Framingham, Mass.

A: Try borrowing in both the student's and parents' names, says Judy Miller, an Alameda, Calif., financial planner who specializes in college finances. That's because students have more years to repay loans than parents, while parents who spend all their money on college may leave themselves without enough money for retirement.

Ms. Miller suggests that all students take out a Stafford Student Loan. Depending on the student's family finances, the government may even cover interest payments while the student is in college. And after graduation, the student is eligible for the student-loan interest deduction on his or her federal income-tax return.

Parents get some breaks, too. The PLUS loan, or Parent Loan for Undergraduate Students, allows parents to borrow up to 100 percent of their child's college expenses.

A family may use both Stafford and PLUS and realize their tax deductibility so long as parent and student income is below the income phaseout limits of $130,000 for married filing jointly, or $65,000 for single filers.

If it's a second mortgage versus home-equity line of credit, Miller prefers the home-equity line because it allows the parent to borrow only the amount needed.

Finally, if you want to borrow money from your credit union, check with them about tax deductibility of any loan.

Q: Personal-care accounts are called "use it or lose it" accounts. So what happens to the money if you don't use it? Does the government get it? The employer?
C.G., Needham, Mass.

A: For the average working stiff, a Flexible Spending Account is one of the few true tax dodges around. But there is a drawback - that "use it or lose it" feature you mention.

An FSA allows you to set aside money from your annual wages and divert it to a wide range of medical bills that insurance may not cover (contact lenses, for example, or medical office co-pays; see IRS Publication 502 for guidance).

For income-tax purposes, it's as if that money were not paid to you, so it reduces your tax bill. In 2001, the American Federation of State, County and Municipal Employees estimated that a $1,500 contribution would save the average taxpayer $610.

But the IRS says that if you don't spend all that $1,500 in a 12-month period, the remainder goes back to the employer. In turn, the employer typically will use it to offset the cost of running the plan.

You'll have to ask the IRS why it thinks this is a good idea. While you're waiting for an answer, don't let this potential penalty scare you off. If you're not sure of your expenses in a given year, earmark several hundred dollars instead of several thousand. Generally people with more kids, or little insurance coverage, can make better use of such an account.

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