Question

1. Margaret is trying to decide whether to place funds in a qualified tuition program. Her son will be attending college in four years. She is in the 35% marginal tax bracket and she believes she can earn an 7% before tax return on alternative investments. Thus, $10,000 will accumulate to $11,948 (after-tax) in four years. Margaret expects tuition to increase at the rate of 5% each year to $12,155 in four years. Her son will be in the 12% marginal tax bracket in all relevant years. Given these assumptions, should Margaret participate in the qualified tuition program?

Answer 1

Margaret can accumulate $11,948 by investing her funds for 4 years, but then she must pay the actual tuition. Alternatively, if she invests the $10,000 in a qualified tuition program, the tuition will be paid in 4 years, regardless of the amount. The amount of tuition less the $10,000 will not be subject to tax. Thus, the after-tax future value of the qualified tuition fund is $12,155 ($12,155 – $0), which is greater than the alternative accumulated value.

Therefore, it appears that Margaret should participate in the qualified tuition program