A Parent’s Dilemma:

How Can I Afford the High Cost of Higher Education for My Children?

Study These Smart Ways to Save

for Your Kids’ College Tuition

By Elizabeth Lewin

t might sound crazy to worry about your child’s college tuition before she has taken her first step. But, there is something to be said for setting up an educational savings plan while the kids are young. It has to do with the magic of compound interest: the more time your money has to grow, the more there will be for your children’s education when the moment of truth arrives.

       With the rising cost of higher education, it’s more important than ever to start early.  Even if you managed to pay your own way through college, your child will probably not be able to follow in your footsteps. The cost of tuition and other education-related expenses has increased at a rate that has outpaced inflation since the early 1980’s. In fact, college costs have nearly doubled every 10 years! Here are the latest College Board figures. During the 2001-2002 school year, the average cost of tuition, books, fees, room and board was $11,976 per year at a public university and $26,070 per year at a private university. Big increases in tuition are expected for the 2002-2003 academic year, because the economy has eroded endowment funds. So, 18 years from now, putting your child through college will cost approximately $250,000, assuming four years of college at $15,000 per year plus inflation.

     Scary? You bet—particularly, if you’re also worried about how you’re going to save money for your own retirement.

What’s a Parent to Do?

         The good news is that there are some very smart savings plans designed specifically for the purpose of saving money to put your kids through college. Better yet, annual contribution limits are rising to meet the rising cost of tuition. And colleges and universities are showing consideration to baby boomers who are feeling the squeeze of saving for their children’s college and their own retirement by not figuring retirement savings into their calculations of who is eligible for scholarships or loans. Below are a few savings options to consider:

      Educational IRAs (also known as Coverdell Education Savings Accounts) have been available since 1997. The annual contribution was raised this year from $500 to $2,000 per beneficiary. However, there is an income limit: an adjusted gross income (AGI) of $220,000 for married couples and $110,000 for singles. Earnings accumulate tax-free and withdrawals are tax-free, too, providing that the funds are used to pay for tuition, fees, books, supplies, room and board.

     Any funds that remain in the Educational IRA after you’ve financed your first-born’s education, or when your first born turns 30, can be rolled over to another child in the family.

    One drawback: Since the account is opened in the child’s name, it could be factored into financial-aid calculations down the road—something that might make it more difficult for your child to obtain loans or grants.

     Section 529 Plans are state-sponsored savings plans. Section 529 plans can be set up for the benefit of any child or adult. These plans are established by individual states, which hire money managers to invest the funds. Most states allow non-residents to invest in their plans, and the future scholars are not restricted to attending colleges in specific states.

     Section 529 Plans have become quite popular, for good reason. Here are a few of them:

1. The maximum contributions vary from state to state, but they can be as much as $250,000.

2. Earnings grow tax-free, and, with the passage of the 2001 Federal tax law, withdrawals to pay for tuition or college expenses are tax-free. In some states, residents can get tax breaks on their state income tax, if they use that state’s 529 plan.

3. Currently, assets in these savings plans will not have a major impact on financial aid. The money in these plans is treated as a "parental" asset. (However, Congress might make changes. If the assets in these plans are considered the child’s eligibility for financial aid will be reduced.)

4. Wealthy parents or grandparents can reduce their taxable estate by gifting to a 529 Plan. The annual gift-tax exclusion has been raised to $11,000 this year (from $10,000 in previous years). You or wealthy grandparents can take five annual gift-tax exclusions in one year, which is a great way to get an account started.

5. Funds not used by the beneficiary by age 30 can be transferred to benefit another family member—even a niece, nephew, or cousin.

     Some caveats: You can’t contribute to both an Education IRA and a Section 529 Plan in the same year, even if there are different contributors. Nor can you control the investment of your contributions. The money managers, hired by the state whose plan you have selected, make the investment decisions. They will be more aggressive in investing your money if your child is young.

     Make sure that you understand how these plans work before you set one up for your child. There are numerous Web sites, including www.collegesavingsplans.org, www.salliemae.com , and  www.sensible-investor.com, which are good sources of further information on the subject.  You can also call the Department of Education (or Department of Higher Education) in the state where you live to ask for advice. A meeting with a financial adviser to discuss your situation and goals before you open an educational savings account wouldn’t be a bad idea, either.

     Prepaid plans offered by colleges and universities, operating on the  “pay-now, attend later” principle, allow  you to prepay your child’s tuition fees. Rather than paying full price for your child’s education down the road, you pay a discounted rate up-front. Basically, the educational institution calculates what it will cost for your child to attend college 15 years down the road, and estimates what type of return it can expect to earn on your money. Then it determines how much it needs to charge you today in order to generate the amount needed when you child is ready to attend that college.

     What if your child decides to go some place else—or doesn’t want to go to college at all? You’ll probably lose all but your original investment. Also, prepaid plans might reduce eligibility for financial aid. Banks also have prepaid plans, in the form of long-term Certificates of Deposits, which you might want to consider.

      U.S. Savings bonds still work! Don’t write off savings bonds as a means to saving for your child’s education. While their rate of return may not be as high as what you could get, long term, in the stock market, savings bonds have some hidden perks. Not only does the Government guarantee the bonds, but the income they generate is tax-free if it is used for tuition and fees, as long as you and your spouse earn less than $86,400; and it’s reduced if you earn between $86,400 and $116,400. If you’re single, the income is tax-free as long as you make less than $57,600, and it’s reduced if you earn between $57,600 and $72,600. If you earn more than the upper limits, then none of the income is tax-free. Learn more about Government savings bonds at www.savingsbonds.gov .

     Whatever savings “curriculum”  you select, don’t wait until your child is a high-school senior to discover that the rules of the game have changed for the worse. Make a point of keeping on top of financial aid and other tax changes that might affect your child’s college fund. Learn about them as they occur and readjust your financial game accordingly. That way, you’ll be sure to be able to make tuition payments when they come due.

     Now, you’ve done your homework. Making the grade is up to your straight-A student.

 ___________________________________________

Elizabeth Lewin is the co-author of the recently published book, “Family Finance” (Dearborn Trade).  She is also the author of “Your Personal Financial Fitness Program,”  “Financial Fitness for Living Together,” and “Kiss the Rat Race Good-bye.”  Elizabeth has written articles for Redbook and Reader’s Digest’s New Choices, among other magazines, and she has appeared on numerous national radio and television talk shows. She is a member of the Editorial Advisory Board of MAKING BREAD Magazine.

MAKING BREAD RECOMMENDS
these books

by the author.