It’s no
secret that the cost of advanced education can be very steep.
Outside of buying a home and saving for retirement, probably
no single expense hits families harder.
The average
annual tuition cost alone at a four-year private institution
in 2001-2002 was $17,123, according to the College Board, but
some ran well above that. Tuition at a four-year public
institution averaged $3,754 for in-state
residents.
These costs do not include room and board,
books and supplies, transportation, and miscellaneous expenses
ranging from laundry to Friday night pizza. Total college
expenses can easily run higher than $30,000 a year at some
private schools.
Furthermore, tuition costs have been
rising faster than inflation rates—between 4 and 8 percent a
year. An average annual increase of five percent would push a
$16,000 tuition bill to over $33,000 in 15 years.
The
good news? Excellent, less-expensive alternatives. There are
top-notch state universities and colleges, as well as top
private schools. Tuition at “great value” two-year community
colleges averaged only $1,738 in
2001–2002.
Higher-priced private institutions often
provide significant student aid on an as-needed basis and
sometimes based on merit. Tax laws in recent years have also
helped underwrite costs. Don’t eliminate consideration of
pricier, private schools without looking closely at financial
aid. Careful planning, even if your child is getting close to
college age, can whittle some of the costs down to a
manageable
size.
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Many more strategies for meeting college
costs
Numerous tax breaks and college savings vehicles
have emerged in recent years to help make college more
affordable for more families. However, the mushrooming number
of options—some of which conflict with each other—make the
task of deciding which strategies to pursue a frustrating
challenge. A CERTIFIED FINANCIAL PLANNER™ professional can
help you weigh and select the best strategies for your
situation.
Why save for college?
Before
tackling the task of funding college for your children, first
make sure it’s worth the money and the effort. Not everyone
wants, needs or is qualified to go to college. Some will do
fine in a trade school, perhaps join the military or pursue
other career avenues.
Still, college does, on average,
provide significant financial advantages, in addition to the
direct educational benefits. A college graduate earns an
annual average of 62 percent more than a high school graduate,
according to the U.S. Census
Bureau.
College versus retirement
Many CFP®
professionals believe that parents shouldn't sacrifice their
efforts to save for retirement on the altar of college. Your
children will find a way through college, even if your help is
limited. Parents who fail to save enough for retirement risk
poverty and reliance on Social Security as a sole means of
income.
So, the first step when calculating how much
you can save for college is to be sure you're already saving
enough for retirement. Some trade-off may be acceptable, such
as delaying retirement two or three years. Just be sure to
weigh the costs and benefits in a rational, not emotional,
manner as you make decisions.
Let your children know
what you can realistically afford. They may have to choose a
less expensive school, fund more of it themselves or borrow
more heavily. In general, it’s a good idea to have your
children earn at least some of their own college money, even
if you can afford to pay the entire bill. It increases their
commitment.
Start saving now
Some families assume
they shouldn’t save for college because they think it will
reduce financial aid. Not a good idea, say
planners.
First, the vast majority of financial aid
these days is in the form of loans, which you and your student
must pay back. Thus, it’s better from a financial standpoint
to save money and earn a return on it rather than borrow that
money and pay interest on it later.
Saving also gives
you more flexibility. You are less likely to be forced to pick
a second-choice school because it has a better financial aid
package than your first choice.
Future financial aid
might be tighter or unavailable, or current tax breaks may
have disappeared. Carefully saved or invested money will be
there regardless.
As with any form of investing, time
is your ally. The sooner you start to save, the better off you
are. Consider cash gifts for your newborn as a great way to
jump-start their college fund. If you start early, the power
of “compounding” is on your
side.
How much do I need to save each
month?
As with saving for any goal, you’ll need to
determine the cost of college, how much time you have to save
and what kind of realistic return you can earn on the money
you save.
Keep in mind, the cost is not just for
tuition. Figure in room and board, transportation, books and
supplies, and miscellaneous expenses such as
laundry.
How should I save?
That, too, depends on
your individual circumstances.
Time is a big factor, and
your willingness to take some risk. If your child is entering
high school, you’ll probably want to become more conservative
with your investment strategy by reducing exposure to the
stock market and mixing certificates of deposit (CDs), money
market funds or short-term bonds into your portfolio. Returns
will be lower, but you don’t have the time to weather an
investment setback.
With a younger child, you might
feel comfortable taking more risk, such as investing in stocks
or stock mutual funds. Over time, market based investments
usually offer a better rate of return than fixed ones.
However, the bear market of 2000/2001 reminds us that stock
market values can fall
rapidly.
What are my investment choices?
The
challenge today is that there are so many options for saving,
and one size does not fit all. Some of the vehicles to
implement your college planning strategy include:
- Cash and cash equivalents.
CDs, money market funds, short-term bonds or bond funds, and
savings accounts are good options when you’ll need the money
soon for college, within five years or less.
- U.S. savings bonds. The
interest earned is free of federal tax if the money is used
to pay for qualified college expenses, and if your income
qualifies. Be certain to check about issuing requirements.
- Coverdell education savings
accounts. You can now contribute up to $2,000 a year to
what was formerly called the education IRA, though some
income restrictions remain. Earnings are federal income-tax
exempt as long as they are used for qualified education
expenses, which now include K-12 private school costs.
- Pre-paid state tuition plans.
Some states offer programs in which you pay for tuition in
advance with the guarantee that tuition costs will be
covered when your child enrolls regardless of how much
tuition costs climb between now and then. It’s a good option
for conservative investors or in the event that tuition
costs increase dramatically. Theses plans are usually
limited to schools within the state and do not include
private universities.
- 529 college savings plans.
Individual states administer these plans, while the
investment management is usually outsourced to an investment
firm or mutual fund company. 529 Plans offer some unique
features, which vary by state. Some plans allow:
-
- Up to $10,000 in contributions
annually
- Investor control when the student
reaches the age of majority
- Tax-deferred growth
- No income restriction to open a
plan
- No age-limit to open a plan or to
start or complete withdrawals
- Qualified withdrawals are
federally-tax free through the year 2010
- Taxable investments. You can
invest in anything you choose—stocks, mutual funds, bonds,
real estate—with the potential of earning a higher return
than some other college investment options. Income from the
assets is taxed at your rate. You can minimize any
capital-gains taxes on the investments by gifting the
property to your child when it’s time for college and have
your child sell the property (though you could face gift
taxes).
- Roth IRAs. You can choose your
investments. Earnings grow tax deferred, and early
withdrawals are not subject to penalties if used for college
expenses. Earnings are subject to income tax, however.
Should I save in my child’s name?
Many
families establish custodial accounts in their children’s
name, but most experts advise against this, especially with
the emergence of superior alternatives such as 529 savings
plans. However, the decision ultimately depends on individual
circumstances.
With a custodial account, investments
are held in the name of a minor, but are managed by the
custodian (such as a parent). This arrangement provides tax
benefits, especially for higher-income
families.
However, custodial accounts generally present
two major drawbacks. One, when the child turns 18 or 21,
depending on the state, he or she assumes control of the
assets, which thus may not necessarily be spent on
college.
Second, assets held in a minor’s name
typically count more heavily when it comes to calculating
financial aid. However, some colleges are changing their
policies in this area, which may diminish this drawback in
some cases.
When there is little time to save
Any
savings at this point should be in low-risk vehicles such as
money markets or CDs. Other options include:
- Increase cash flow by creating and
implementing a personal spending plan.
- Take advanced placement classes in
high school or a heavier college load in order to shorten
the time—and thus, expenses—in school.
- Consider less expensive alternatives,
such as community college for the first two years, or attend
a state university.
- Some employers supply education
assistance (some of which is tax free to the employee).
- Consider the military, which provides
education assistance upon completion of active duty.
- Make use of tax breaks. Taxpayers
below certain income levels can claim the (1) Hope
Scholarship, (2) Lifetime Learning credits or (3), through
2005, an education expense deduction.
- Consider borrowing from private
sources.
- The student can work at college,
either in on-campus or off-campus jobs.
- Finally, apply for financial aid.
Tell me more about financial aid
Financial
aid is a broad term that covers financial help through the
college your child attends. Financial aid includes merit and
needs-based scholarships and grants, as well as work study.
However, loans are the most prevalent form of financial aid
today. There are federally guaranteed, private
college-sponsored loan
programs.
How much aid can I get?
That depends on
your assets, income, how many students you have simultaneously
in college, and other factors. In general, schools expect
parents to contribute a maximum of 5.64 percent of assets and
income. Schools tend to exclude family assets and income from
the calculation if they are low.
Students are expected
to contribute 35 percent of their assets and 50 percent of
their income, though some schools are beginning to reduce the
student’s commitment to that of the parent. Financial aid is
designed to make up the difference between what the family can
afford and the cost of the school.
Even families with
relatively high income should consider applying for financial
aid. They may qualify for low-intersest loans or merit
scholarships.
Borrowing options
Students may qualify
for federally backed Stafford or Perkins loan programs. Other
loan options are available to parents:
- Federal PLUS loan
- Private college loans
- Home-equity loan
- Cash-value life insurance
- Retirement accounts
Many planners discourage borrowing from
retirement plans because you are taking away from your
priority retirement efforts, and there is the risk of income
taxes and penalties if you don’t repay on time. Also, the
income from them may reduce financial aid.
Keep in mind
that too much college debt can delay or hurt other family
financial goals, such as retirement, or saddle the graduating
student with debt that might alter plans or career
options.
Teach your student finances
Students can
help minimize the cost of college by managing their finances
wisely. Prepare a realistic budget with your child before he
or she goes off to college. Be clear about which expenses you
will pay for and for which ones they will be responsible. Have
your child track spending, and, together, review the budget
periodically.
Students must be especially careful with
credit cards, which are pushed heavily on college campuses
these days. Students frequently graduate with too much credit
card debt, and in some cases students are forced to quit
school because of debt
problems.
A college education is
achievable
For the majority of families, a college
education is a goal worth the financial effort. Working toward
that goal can be complex and expensive. Yet with careful
planning, families can provide a good, affordable education
for their
children. | | |
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