The cost of college. Four simple words that strike fear in
the hearts of parents everywhere. However frightening the
skyrocketing costs of sending a child to a top-tier private
college, there's good news. The growth of college costs is
finally cooling down, and even better, a little planning goes
a long way towards contributing to this expense. In this section
we'll discuss:
- Why you should start saving for college expenses as early
as possible
- Special savings plans for education
- How to choose the best investment plans with an eye towards
financial aid applications
- Tax breaks for parents with kids in college
Regardless of the method you choose, saving for your child's
college education is like any other investment. The time to
start is now. The sooner you start, the better the chances
your money will increase substantially and enable you to pay
for your child's education with ease. Use a Saving
for a College Education Tool to help you plan how much money to put aside for the colleges you are interested in.
Understanding Savings Plans
Parents can choose between several different saving and investment
plans designed to help save for their children's future education.
Choosing the right plan depends largely on your income and
your ability to save. Below you'll find a summary of the available
plans.
UGMA - Uniform Gifts to Minors Act
is a custodial account placed in your child's name and Social
Security number, with a parent named as custodian. While this
plan offers financial benefits, there are some drawbacks in
terms of ownership and qualifying for financial aid.
The Education IRA has been given a new moniker: the Coverdell Education
Savings Accounts. The Coverdell ESA allows for a maximum annual
contribution of $2,000 per student. The earnings in the account grow
tax-free as long as distributions are used for eligible expenses, which are
not limited to college costs. See http://www.fool.com/csc/csc02.htm for more
details.
Roth IRA Accounts - This is a good
investment strategy that works for parents who will be at
least 59 ½ years old when their kids are in college. You can
invest up to $4,000 a year, 4 times the amount of an education
IRA allowing for accumulation potential.
Section 529 College Savings Plans -
There are numerous advantages to the 529 Qualified Tuition Savings Plan,
including the fact that the federal tax advantages can save you thousands.
They are currently offered by various states, through the help of a
professional money manager or a State Treasurer's Office. The plans can be
extremely different, and so it pays to ask questions.
Investing for College
Once you've surpassed contribution limits to these special
savings programs, there are other investing strategies that
help pay for college.
 While
these separate investments may not have special tax-advantaged
status, there are ways to minimize the effect of capital gains
taxes. For example, if you have made long-term investments
in the stock market, you can give your child enough stock
to pay for their tuition bill. When your child sells the stock,
they pay the long-term capital gains taxes at their lower
tax rate.
What kind of investments should you make? There are a number
of things to keep in mind when designing a portfolio to pay
for a future college education:
- Choose a diversified mix of stocks.
- Stocks with dividend reinvestment plans are ideal.
- No-load mutual funds are good choices.
- The younger your child, the more aggressive you can afford
to be.
Ted Miller, editor of Kiplinger's Personal Finance
magazine, recommends the following course of action: 4 years
before freshman year, sell enough stock (and bank the money)
to pay for the first year, repeat this practice for the next
four years so that by the time your child is ready to start,
you have the money cashed out and waiting.
Education Tax Credits
Once your child is grown and attending college, there are
currently 2 options that offer a measure of relief:
With the Hope Scholarship, families can receive a tax credit
of up to $1,500 a year for the first 2 years of college. This
credit applies against college costs like tuition and fees--books
and room and board do not qualify. There are income restrictions
on using this tax credit: single filers can earn up to $42,000
before the phase-outs begin (they end at $52,000) and joint filers can earn up to $85,000, with phase-outs at $105,000.
The Lifetime Learning Credit offers a $2,000 tax credit taken
for the third school year and beyond. It is per family not per student. The credit can be used by both college
students and adults to offset the cost of professional seminars
and adult-education courses. The income limits are the same
as those for the Hope Scholarship: $42,000
before the phase-outs begin (they end at $52,000) and joint filers can earn up to $85,000, with phase-outs at $105,000.
You can only claim one of these credits on any given tax year, but during
years in which you make withdrawals from an Education IRA, neither of these
credits may be claimed. For current information visit the U.S. Department of
Education website on HOPE Scholarship and Lifetime Learning Credits at
http://www.ed.gov/inits/hope/.
Their College vs. Your Retirement
Trying to save for your children's college education and
your own retirement at the same time seems like a recipe to
shortchange both. What to do? Pay yourself first. Financially,
it usually makes more sense to fully fund your 401(k) or other
tax-deferred retirement plans and grow that money tax-free.
Why? These plans reduce your taxes, grow tax--deferred, and
if your employer offers matching funds, you get a substantial
return right away.
When you have college bills to pay, you may be able to borrow against your
retirement plan to pay for some of your kid's education. Many 401(k)s and
profit-sharing plans let you borrow up to half of the funds in your account,
to a maximum of $50,000. But the requirements for these plans vary widely;
make sure to investigate the particulars surrounding your retirement plan.
Should You Borrow from your 401k? Use this calculator to learn that it could cost you 1/3 more to replace the funds you took out of your 401k because their were pre-tax dollars and the funds you will be returning back to the 401K (after borrowing them) are post-tax and based on your effective tax rate. Visit http://www.401khelpcenter.com/ for an unbiased
information on 401k's.
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