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College Savings-Not Just for the Kids Anymore

Saving for college will always be an issue for parents, but as people change careers, it’s an issue for everyone. A planner can help you look ahead to what your child’s education will cost and whether you’ll need to upgrade your skills at some point.

Tim Wyman, a Certified Financial Planner professional from Southfield, Michigan, stresses the importance of thinking about higher education as a family issue, not just something for the children.

“If you look over the lifetime of any worker, the difference in wages between college graduates and high school grads is very dramatic, but it’s also going to become a greater issue in future years as mid-career education becomes more common,” said Wyman.

college savings

College savings

A planner can help you negotiate the triangle between college savings for your kids, college savings for yourself, and your retirement. “In 17 years, a four-year public university education will cost well over $100,000, and a private school over $300,000. After I pick people up off the floor, we start breaking down those numbers into a monthly goal. And I stress how important it is to start immediately, because the cost of waiting is substantial.”

Wyman also points out that today and in the future, parents will need to be aggressive about negotiating tuition, room, and board at colleges where either they or their children have been accepted. “Planners can have an important role in training parents and individuals to understand what college costs will be in the future and how to meet those obligations through savings, financial aid, and other funding sources.”

He stresses that people can’t ignore their retirement goals to meet the high cost of education. “You can always borrow money for college, but you really can’t borrow for a 30-year retirement. Most of us will need help to meet those goals.”

Starting Early

Two hundred dollars a month. Focus on that figure for a moment. The day your child is born, you begin setting aside $200 a month until his or her eighteenth birthday. Assuming investment gains based on a compounded rate of 8 percent, by the end of 18 years, you’ll have $97,071.03. That’s assuming you never add another dime and the rate never changes.

The above example assumes that you built a diversified portfolio that meets that return. Of course, it’s possible to build a portfolio that exceeds that return or at least protects you from serious dips in the market.
The prevailing wisdom still holds-the earlier you start saving for a college education, the better.

An 18-year Job

The College Board estimated that in 2005-2006, annual average tuition and fees were $5,491 at four-year public colleges and $21,235 at four-year private colleges. And for room and board, the cost was $6,636 at four-year public colleges and $7,791 at four-year private colleges.

So for tuition, fees, room, and board, at 2006 levels, you would be paying an average of $48,508 for four years of public college, and $116,104 for private school. Fast-forward to 2024, when the College Board estimates that four-year public school number will be $129,845 and private school will be $314,674.

Some people might ask the question, “At these prices, is college really worth it?”

The answer is a resounding “yes.” Your kids can’t afford not to go to college. For that matter, you can’t afford not to upgrade your skills over the length of your career. In December 2000, the U.S. Census Bureau reported that the average income for students with a bachelor’s degree is $45,678, almost twice the $24,572 income of a student with just a high school diploma. That’s a difference of almost $1 million in lifetime earnings. Here’s the most important point: you get that bump even if you don’t send Junior to Harvard.

The One-third rule

Most agree that the days of parents footing the full bill for college are over, even for upper-income parents. Today, there’s a discussion about what’s right for parents to pay and what’s right for students to pay. It’s called the “One-third Rule; and it means the following: parents save enough to pay for one-third of the total expected cost; they pay one-third out of their income and add it to financial aid while the student is in school; and the student borrows or somehow funds the rest.

What’s the principle behind the One-third Rule? That you’ll be spreading the total cost of college over an extended period of time, which is a more efficient way to save. It also allows you to distribute assets in a way that will maximize the student’s chances of obtaining the best financial aid package.

To figure out a savings and investment strategy that truly fits our situation, you consult with a financial adviser such as a Certified Financial Planner professional. Affording college and retirement requires a strategy because though they might be tempted, a parent can’t sacrifice retirement savings for their child’s education.

The College savings reality gap

A March 2006. WSJ.com/Harris Interactive personal-finance poll showed that nearly one-third of parents who expect to pay for some or all of their kids’ college costs haven’t saved any money for that purpose.

Over two-thirds of parents who expect their child to attend college say they plan to pay a portion or their child’s college costs. according to the poll. While another 12 percent plan to pay for all of their child’s education. At the same time, about 69 percent of those parents who expect their child to attend college say they expect financial aid or scholarships to pay all or a portion of college costs.

Of those who plan to pay some or all of their child’s college costs, about a quarter expect to pay between $10,000 to $19,999 annually for their child’s education, including room and board, and 17 percent expect to pay $5.000 lo $9,999 a year. Another 16 percent expect expenses of about $20,000 to $30,000 a year.

Despite these expectations, about 68 percent of these parents say they’ve saved money to help pay for college. About a quarter of those polled say they have saved less than $5,000, and nearly a third of those polled say they haven’t saved any money specifically for college.

The poll which surveyed 579 parents or legal guardians of children aged 18 or younger, found that about 97 percent of the parents expect their child or children to attend college.

Great Ways to start saving with small amounts

One of the biggest challenges for families saving for their children’s college education is that there arc so many options for saving, and one size does not fit all. Which options are right for you depend in part on the age of your child, family income, potential for financial aid, and the expected cost of college.

Here are the major college-savings options to consider while you’re getting help to make the right choices. In 2006, there were plenty of important changes in education savings instruments.

529 college savings plans. President Bush eliminated the 2011 expiration date on the popular tax-free features of these accounts, and experts were already pointing to cheaper and more diverse choices for parents investing in these plans for the future. Here is what these popular state run plans provide:

• Investments grow tax-deferred and withdrawals for qualified college expenses are free of federal tax
• Some states give tax breaks on the contributions
• Over $200,000 can be invested in many plans, and as much as $110,000 at one time
• Investor retains control and can change beneficiaries
• No income restrictions
• Their impact on financial aid is smaller than many alternatives

The bottom line is that 529s can be an especially good alternative for high-income families wishing to save a substantial amount for college, investment options usually are limited, and management fees are sometimes high.

Coverdell education savings accounts. This type of account got bad news in 2006; its tax-exempt treatment was reset to expire at the end of 2010. Given the amount of pressure exerted to. make tax benefits permanent on 529 plans, there is reason to hope that these may ultimately be made permanent as well. You can contribute up to $2,000 a year per child, but there are income restrictions ($190,000- $220,000 for married couples in 2006). Earnings are federal income tax-exempt if used for qualified education expenses including private elementary and secondary schools.

Coverdells can be a good option for people who can save only a small amount each year, or who may want to fund a Coverdell before moving on to other alternatives. Their impact on financial aid is now the same as that of 529 plans-the account is considered the parent’s asset instead of the student’s, resulting in more aid.

Other characteristics of Coverdells:

  • Account ownership. Coverdell accounts may be owned by the student or the student’s parent.
  •  Contribution age limit. Contributions may be made until the beneficiary reaches age 18.
  • Withdrawal age limit. The money must be used by the time the child reaches age 30, or the earnings will be taxed as ordinary income plus a 10 percent penalty.
  • Rollovers. Coverdell accounts may be rolled over to the Coverdell account of a family member of the previous beneficiary income restrictions.
  • Contributions arc phased out for incomes between $95,000 and $110,000 (single filers) or $190,000 and $220,000 (married filing jointly). These phase-outs may be bypassed by giving money to the child through UGMA/UTMA and having the child contribute to his or her own Coverdell account.
  • Corporations may contribute to your account. Corporations, including tax-exempt organizations, may contribute to an individual’s Coverdell account, regardless of income level. Contributions must be in cash. Contributions must be in the form of cash. Stocks, bonds, or other investments are not permitted as contributions.
  • How they affect financial aid. Amounts are treated as assets of the account owner, but it’s better to have the assets in the parent’s name.
  • Income tax implications. Contributions are not deductible on feder¬al or state income tax, but earnings accumulate tax-free. Qualified distributions are exempt from federal income tax. This may change at the end of 2010, when these tax advantages are set to expire. Contributions may be made until the due date of the contributor’s tax return (normally April 15 of the following year). Non qualifled withdrawals are taxed as ordinary income at the donor’s rate and subject to a 10 percent tax penalty. (Non qualified distributions remain tax-free in cases of death or disability of the beneficiary.)
  • Estate tax implications. Contributions are removed from the donor’s gross estate hut included in the beneficiary’s gross estate.
  • How the funds can be used. Primary, secondary, and postsecondary education expenses, including tuition, fees, tutoring, books, supplies, related equipment, room and board, uniforms, transportation, and computers.
  •  How they coordinate with 529 plans. You can contribute to both a Coverdell account and a section 529 plan in the same year, but there may be gift tax implications if you give more than $12,000 per beneficiary.
  • How they coordinate with education tax credits. You can claim a Hope Scholarship and/or Lifetime Learning tax credit in the same year as you withdraw funds from a Coverdell account, so long as the credits are claimed using different qualified education expenses than those paid from the Coverdell distribution. You can’t use the same expenses to justify two different programs.
  • Elementary and secondary payments. Coverdells not only pay for higher education expenses such as tuition and fees, but also for tuition and fees in elementary and secondary school.

Prepaid tuition plans. Under these plans, you can buy part or all of a school’s future tuition bill at today’s prices. Once offered only by some states, a coalition of nearly 200 private schools now offers prepaid tuition plans through a program called the Independent 529 Plan. Earnings from either private or public plans are tax-exempt.

It’s a good option for conservative investors who want to lock in tuition costs and who know what college their children will likely attend (there are penalties for changing your mind about a state school, but there’s more flexibility under the private plan). Also, under current rules, prepaid plans reduce financial aid dollar-for-dollar.

Custodial accounts. Investments are held in the name of a minor, but are managed by the custodian (such as a parent). This arrangement provides some tax benefits, especially for higher-income families because they shift capital gains taxes to their lower-income children. Unlike some other college funding alternatives, there are no income restrictions. But contributions over $12,000 a year per parent (as of 2006) are subject to gift tax, and the assets remain in the parent’s estate in some instances.

Custodial accounts present three major drawbacks. One, the gifts are irrevocable. Two, the child assumes control of the assets when he or she becomes a legal adult (legal age is set by the resident’s state), and thus may spend the money on something other than college. Three, the assets typically count more heavily against financial aid, though some colleges are changing their policies in this area.

Series I and EE U.S. Savings Bonds. The interest earned from these bonds is free of federal tax as long as it is used to pay for tuition and fees, the parents hold the bond title, and parental income isn’t too high. But the benefits may be reduced by other education tax breaks such as the HOPE Scholarship.

Taxable investments in the parent’s name. The advantages include nearly unlimited investment options, no income restrictions, retention and control of the assets, and the flexibility of using the assets for something other than college if necessary. The major disadvantage is the taxes on earnings. You can minimize that by gifting the assets to your child when it’s time for college and having them sell the assets, though you could face gift taxes in such a situation.

Individual retirement accounts. Money taken out of a traditional IRA is free of the 10 percent early withdrawal penalty (but not ordinary taxes) if it’s used for qualified education expenses. Withdrawals of Roth IRA contributions are tax-free, and even the earnings may be tax-free in some situations. Yet, pulling money out of retirement funds is always very risky and should be considered a last resort.

Boost your bargaining power

Nearly one-third more high school graduates are applying to college than there were 25 years ago. Yet colleges and universities feel the pressure of magazine and other college rankings as part of their overall marketing plan, so their competition for top graduates has gotten cutthroat. That’s good news for parents and prospective students.

How do you get your student into a good school with the best chance of affordability? It pays to negotiate, but only if you have something to negotiate with. Here’s what you’ll need:

  • A child with great credentials. It helps if your child is a bright student, with a high grade point average, high SAT and ACT test scores, and extracurricular activities that help top schools take notice. They want the best and the brightest to keep their image golden. Increasingly, schools are banding out scholarships based on merit instead of need, a controversial issue, but beneficial nonetheless if you have one of those bright students.
  • The right school. Even if your kid isn’t a National Merit scholar, pick a school with a good reputation where your student’s grade point average and test scores rank above the average of incoming freshman (these scores are often published in various college-rating guides). The school will be more prone to offer you a better deal.
  • Acceptances at several schools. Have your child apply to several similar schools where you think he or she stands the best chance of getting in (as well as one or two “safety” backups and a couple of “long shots”). That way, if the child is accepted by more than one school, you can use the financial aid package of one school to barter with another school. Aid packages vary widely from school to school.
  • An eye on the endowment. Some schools, particularly private, simply have more money-called an endowment-to offer for grants and scholarships. That’s aid you don’t have to pay back. Dividing the number of students into the school’s endowment fund provides one rule of thumb.
  • A firm guarantee on aid. Some schools offer freshmen what amounts to “teaser” aid. The package is great in the first year, but those discounts, grants, and scholarships turn to straight loans in succeeding years when students are reluctant to leave. Try to get a four-year commitment to the aid package.
  •  An application strategy. While grant and scholarship money generally goes on a first-come, first-served basis, talk to other parents with children at that school to find out what they know about the aid application process. Earlier is better at some schools and not at others.
  • Extenuating circumstances. Make sure the financial aid officer knows of additional reasons your student will need aid, such as a job loss, other children in school, and so on. The officer may beef up the package accordingly.

Ultimately, the most important thing to remember is to pick the right school for your child and then worry about the money.

 

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