Chapter 8 Multiple Choice Questions

1. Which of the following statements concerning educational tax

credits and savings opportunities is correct?
a. The Lifetime Learning Credit is equal to 10% of qualified
educational expenses up to a
certain limit.
b. The American Opportunity Tax Credit (AOTC) is only available for
the first 3 years of
postsecondary education.
c. A parent who claims a child as a dependent is entitled to take the
AOTC credit for the
educational expenses of the child.
d. The contribution limit for Coverdell Education Savings Accounts is
applied per year per
donor.
The correct answer is c.
• The Lifetime Learning Credit is equal to 10% of qualified educational expenses up
to a certain limit –
20% up to $10,000 in expenses.
• The AOTC is available for the first 3 years of postsecondary education – first four
years only.
• A parent who claims a child as a dependent is entitled to take the AOTC for the
educational expenses of
the child.
• The contribution limit for Coverdell Education Savings Accounts is applied per year
per donor – per student, not per donor.

2. Mitch and Jennifer have AGI of $125,000 and have not planned for
their children’s education. Their children are ages 17 and 18 and the
parents anticipate paying $20,000 per year, per child for education
expenses. Which of the following is the most appropriate recommendation
to pay for the children’s education?
a. 529 Savings Plan.
b. PLUS Loan.
c. Pell Grant.
d. Coverdell ESA.
The correct answer is b.
It’s too late for the parent’s to begin savings for their children’s education so that
eliminates the 529 Savings Plan and Coverdell ESA. Their AGI is too high for a Pell
Grant.
MULTIPLE-CHOICE PROBLEMS
3. Tan and Chia are contemplating making a contribution to their
grandchildren’s education fund. They are both retired, have a significant
amount of discretionary income and are concerned about estate transfer
taxes. Which of the following education planning techniques would you
recommend?
a. Prepaid Tuition.
 b. Coverdell ESA.
c. UGMA or UTMA.
d. 529 Savings Plan.
The correct answer is d.
529 Savings Plans are a good planning technique for grandparents that want to pay
for their grandchildren’s education. It also allows the grandparents to lower their
gross estate.

4. All of the following statements are true, except:

a. The American Opportunity Tax Credit is only available for the first
four years of postsecondary education.
b. The Lifetime Learning Credit is only available for the first two
years of post-secondary
education.
c. The American Opportunity Tax Credit is awarded on a per student
basis.
d. The Lifetime Learning Credit is awarded on a per family basis.
The correct answer is b.
AOTC is good for the first four years. Lifetime is available throughout your lifetime.
AOTC is per student, lifetime is per family.

5. Which of the following types of aid are not need based?

a. Pell Grant.
b. Plus Loan.
c. Perkins Loan.
d. Subsidized Stafford Loan.
The correct answer is b.
Plus loans are based on a parent’s credit score.

6. The following type of financial aid is awarded to students with a low

EFC, and funds are guaranteed to be available if a student qualifies:
a. Pell Grant.
b. Plus Loan.
c. Work Study.
d. Stafford Loan.
The correct answer is a.
Pell Grants are always available if a student qualifies.

7. Roshan is a freshman at Florida State University where his tuition is

$4,000. Shante, his older sister, is a graduate student at Expensive
University, where tuition is $25,000. What is the maximum tax credit
Roshan and Shante’s parents can take?
a. $2,000.
b. $3,650.
c. $3,800.
d. $4,500.
The correct answer is d.
Roshan is in his first four years of college so he is eligible for the AOTC ($2,500
calculated as ($2,000 x 100%) + ($2,000 x 25%)). Shante is only eligible for the
Lifetime Learning Credit since she is in graduate school ($2,000 calculated as
$10,000 x 20%). $2,500 + $2,000 = $4,500.

8. What is one of the primary differences between a Coverdell ESA and

a 529 Savings Plan?
a. A Coverdell can be used for private elementary, middle, or high
school.
b. A Coverdell does not have a phase-out limit for participation.
c. A 529 Savings Plan has a phaseout limit for participation.
d. A Coverdell allows 5-year proration of contributions.
The correct answer is a.
A 529 Savings Plan does not have a phase-out limit. A Coverdell can be used for
private elementary, middle, or high school, whereas a 529 Savings Plan can only be
used for post-secondary education.

9. Reba has a son, Chad (age 18), a freshman at Tulane University with
tuition of $30,000 per year. Reba’s AGI is $45,000. She takes a withdrawal
of $20,000 from her 529 Savings Plan and pays the remaining $10,000 in
tuition out of her checking account. Which of the following would you
recommend?
a. Take a Lifetime Learning Credit of $2,000.
b. Take a American Opportunity Tax Credit (AOTC) of $2,500.
c. Cannot take AOTC or Lifetime Learning Credit because she took a
529 distribution.
d. Take AOTC and Lifetime Learning Credit totaling $4,500 ($2,000 +
$2,500).
The correct answer is b.
Taking the AOTC is a better choice because it offers a higher tax credit. Reba is
entitled to take an AOTC
because it is paying for different expenses than the 529 Savings Plan distribution. A
taxpayer cannot claim both the AOTC and Lifetime Learning Credit for the same
child in the same year.

10. Peter wants to save some money for his daughter Gwen’s education.
Tuition costs $12,500 per year in today’s dollars. His daughter was born
today and will go to school starting at age 18. She will go to school for 4
years. Peter can earn 11% on his investments and tuition inflation is 7%.
How much must Peter save at the end of each year, if he wants to make
his last savings payment at the beginning of his daughter’s first year of
college?
a. $2,694.56.
b. $2,789.04.
c. $3,167.33.
d. $3,176.43.
The correct answer is d.

11. Kim and Nick are planning to save for their daughter Chloe’s college
education. Chloe was born today and will attend college for 4 years,
starting at age 18. Tuition currently costs $15,000 per year and tuition
inflation is expected to be 6%. They believe they can earn 9% on their
investments. How much must Kim and Nick save at the end of each year, if
they want to make their last savings payment at the beginning of Chloe’s
first year of college?
a. $3,869.03.
b. $3,892.07.
c. $3,965.04.
d. $3,978.53.
The correct answer is d.
Using the Uneven Cash Flow Method:
12. What is the present value of all college education for 5 children ages
0, 1, 1, 3, and 5 if the cost of education is today’s dollars is $17,000 per
year, education inflation is 5%, and the parents expected portfolio rate of
return is 8.5%? The children are expected to be in college 4 years and they
will each start at age 18.
a. $88,775.02.
b. $148,958.22.
c. $192,007.89.
d. $203,085.22.
The correct answer is c.
$192,008 (rounded)
13. What is the present value of the cost of college education for 4
children ages 1, 3, 5, and 7. The current cost of college is $25,000. The
children will begin college at age 18 and be in college for 4 years.
Education inflation is expected to be 6% and the parents portfolio rate of
return is 8%.
a. $294,000.
b. $295,000.
c. $300,000.
d. $305,000.
The correct answer is c.
$299,714 (rounded to nearest thousand)

14. Using previous information, how much do the parents have to save
annually at year end through the education of the youngest child at pay all
college costs?
a. $17,418.31.
b. $29,381.57.
c. $29,921.11.
d. $30,526.52.
The correct answer is c.
$29,921.11

15. Lanie is a single mom who has 3 children, ages 1, 5 and 9. While she
is struggling a bit, she would like to pay for half of their education at a
public college. The annual cost of education is currently $20,000 and has
been increasing at 6% and is expected to continue. Her portfolio that was
established for education has $25,000 in it and earns an average rate of
return of 8%. If she would like to fund half of four years of college for each
of the children, how much must she save each year at the end of the year,
for the next nine years (round to the nearest $100)?
a. $9,400.
b. $10,700.
c. $12,300.
d. $15,800.
The correct answer is b.
Step 1: Determine the education needs for the three children at age 18 for the 9
year old.
PV = $10,000 (half of the $20,000 tuition)
N=9
i=6
FV = $16,894.79

PMT = $16,894.79
N = 12 (4 years for each of the 3 children)
i = ((1.081.06) - 1) x 100
FV = 0
PVAD = $183,311.36

Step 2: Determine how much Lanie must contribute each year.

FV = $183,311.36
N=9
i=8
PV = - $25,000
PMT = -$10,677.53
16. George has been in academia his entire career and wholeheartedly
believes that education is the key to success. He has two daughters, Cindy
and Susie. Cindy is a lingerie and swimsuit model who also believes in
education, as well as fashion. Cindy has two children, Red and Mauve, who
are ages 4 and 2 today. She is also headed to the hospital at this very
moment to deliver her third child, who will be named Olive. Susie is an
engineer, who used to play rugby in college and also believes in education.
Her children, Copper and Mercury, are ages 3 and 5 today, respectively.
George believes that with $100,000, a student should be able to obtain a
great education, even if it is not the exact amount necessary to fund all of
a student’s time in college. George would to provide each of his
grandchildren with the ability to have $100,000 of purchasing power when
they turn 18. Education costs are approximately $30,000 per year at
private schools and about $15,000 at public schools. Education costs have
been increasing at a consistent rate of 7% per year and are expected to
continue, while inflation has been at a steady 3% per year. How much
should he set aside today to fund his goal for his grandchildren if he can
earn a rate of return of 9%?
a. $136,383.
b. $179,983.
c. $212,444.
d. $377,520.
17. CJ is 40 and wants to retire in 25 years. He expects to live until age
95. He currently has a salary of $100,000 and expects that he will need
about 75% of that if he were retired. He thinks he needs to accumulate $1
million (future dollars) and he will be fine. He currently has $150,000
saved for his retirement that is earning 9%. He is able to save $20,000
towards his retirement. However, he is willing to use some or all of this to
fund education for his grandchild, Bob, if and when his retirement
objective appears to be set in terms of funding. Edward, Bob’s dad and
CJ’s son, wants Bob to go to school for six years and expect that it will
cost $50,000 per year in today’s dollars. Inflation has been modest at 3%,
while education has been increasing at 6% per year. Edward would like to
know how much he should save every year to fund Bob’s college expenses
assuming that he can max out his dad’s (CJ) contribution, which would
begin in one year and stop when Bob goes to school. Edward would also
begin contributing in one year and stop when Bob goes to school and
wants to assume he can earn 9% per year. How much does Edward need to
save each year? (round answer to nearest $1,000)
a. $0 - Dad has it covered.
b. $4,000.
c. $9,000.
d. $15,000.
The correct answer is a. The funding for Bob can be handled by CJ.

Step 1: Determine how much CJ can contribute

PV = $150,000
N = 25
i=9
FV = $1,293,462

This means that CJ can contribute the entire $10,000 per year towards education
funding for Bob.

Step 2: Determine the education needs for Bob at age 18

PV = $50,000
N = 18
i=6
FV = $142,716.96

PMT = $142,716.96
N=6
i = ((1.091.06) - 1) x 100
FV = 0
PVAD = $799,499.95

Step 3: Determine how much CJ’s contributions will equal at age 18

PMT = $20,000
N = 18
i=9
FV = $826,026.76

This means that Edward does not have to contribute anything.