Life Advice About...Financial Planning For College

Life Advice

This Life Advice pamphlet about Planning for College was produced by
the MetLife Consumer Education Center with assistance from the
National Center for Financial Education and the Department of the Treasury.

If you're good at planning ahead...

You may have thought about it before your child was even born, perhaps while you were shopping for a bassinet and teddy bears. At any rate, you probably started thinking about it when your child was very young. After all, it's one of the major responsibilities you face as a parent: your child's college education.

Personal growth and expanded horizons are reason enough to send a child to college, but there are more practical considerations, too. College graduates have more jobs to choose from, and they generally make more money than people who have a high school education. That makes a college education very important for your child's future.

Start Early, Early, Early

As a parent with an eye to the future you should start early to save for your child's college education. College costs have risen consistently for the past 10 years, and there's little reason to think this trend will reverse itself. Most cost estimates predict annual increases of 5% or more. What's more, many people take more than four years to finish college and some go on to postgraduate studies, so you may need to save even more.

To see just how expensive college is likely to become, take a look at the chart below.

A child born in 2003 will probably start college in the year 2021, when a private college education could cost over $69,940 a year! Of course, these are only average estimates. If you have a specific school in mind, you may wish to contact the school - now and when the anticipated date draws closer -for information on tuition costs, how they have changed and the trend for future increases.

Clearly, it helps to begin saving early, preferably as soon as the child is born. The idea is to earn interest on as much money as you can and pay interest on as little as possible. It's like buying a house: the more you've saved ahead of time, the less you'll need to borrow. Set aside or invest as much as you can, even if it's just a small amount from every paycheck.

Increase your contributions to the fund as your salary increases. Add extra cash from raises or yearly bonuses, as well as some of the money your child receives as gifts. Money that comes unexpectedly and has not been budgeted will not be missed. Also, if your older child has a part-time job, encourage him or her to put some of those earnings into the fund.

Strategies for Funding College Tuition

Growth Stocks and Growth Mutual Funds.
Good investments in the stock market have the potential to provide better returns than fixed-rate investments (such as savings accounts and CDs, which are generally FDIC insured) - if you have time to let the money ride the ups and downs of the market. This is a long-term approach to investing. And remember: What the stock market did in the past is no guarantee of how it will perform in the future.

The word to look for here is growth. When assessing the growth potential of a particular stock, look for long-term appreciation rather than dividends. Growth stocks also allow you to postpone paying taxes on the capital appreciation realized until you sell the stock.

Investing in just one or two stocks is always risky. If you'd like to participate in the growth potential of the stock market with less risk, consider a growth mutual fund. Money invested in such a fund is professionally managed and is usually diversified over many stocks, which helps reduce risk. Also, you can start investing in mutual funds with a relatively small amount of money.

U.S. Savings Bonds (Series EE, Series I).
You need only go as far as your local bank to invest in Series EE or Series I U.S. Government Savings Bonds. The face values of the bonds range from $50 to $10,000. EE bonds are purchased at half their face value. For example, when you buy a $50 bond, you pay $25. I bonds, however, are purchased at face value. The interest rate paid on these bonds varies. EE bonds reach face value in a maximum of 17 years and earn interest for up to 30 years. I bonds also earn interest for up to 30 years, which is paid when the bond is redeemed.

These bonds can offer substantial tax savings if they're used to pay qualified higher education expenses. If all requirements are met, no federal income tax is due on the interest. To get this important advantage, you'll need to follow certain guidelines. Among them: The savings bonds must be issued in 1990 or later and be purchased in one or both parents' name(s)-not the child's. Married taxpayers must file a joint return. The owner must be at least 24 years old before the bond's issue date. The bonds must be redeemed by the owner in the year they're used to pay for qualified higher educational expenses. Qualified higher educational expenses generally include tuition and fees and exclude room and board. Talk to your tax advisor and the person selling you the bond to be sure you've set up the purchase properly. Also, there are income restrictions on who can take advantage of this benefit. You'll need to call the Internal Revenue Service or your tax advisor to verify your eligibility.

Life Insurance.
You shouldn't purchase life insurance unless you need protection. If you have a permanent life insurance policy paid with fixed annual premiums, you generally have the option of borrowing against its cash value. Of course, the amount of cash value available to borrow against varies, depending on the specific policy. The death benefit will be decreased by the amount of the outstanding loan. The interest rate charged on such loans is often reasonable, and in many cases you can pay back the loan on a flexible schedule. Talk to your financial services representative about the advantages of life insurance when planning your child's college education.

Prepaid Tuition Plans (529 Plans).
Certain states, such as Alabama, Alaska, Colorado, Florida, Massachusetts, Michigan, Ohio, Pennsylvania, Tennessee, and West Virginia offer various types of prepaid tuition plans, generally for students attending state schools. Residents of these states can buy a contract or bonds at a fixed price, based on the rates of college tuition today. Payments can be made in lump sums or monthly installments. The state, in turn, invests the money to earn the difference between the amount you are paying and the projected cost of tuition at the time your child reaches college age. Those who sign up are fully protected, as the state assumes all the risk of the investments. Check with your state's commission on higher education to see if a prepaid tuition plan is available where you live.

Prepaid tuition plans are not for everyone. They mostly attract middle-income families who tend to be more conservative in their investments. Lower-income families using this option may jeopardize their chances for state aid and forfeit money needed for immediate essentials. If you're interested and a plan is offered in your state, you'll want to know if it covers only the cost of tuition, or room and board, too. Also, check to see if it applies to other than state schools. Finally, confirm that your original deposit will be returned if your child attends a private or out-of-state college, is not accepted at a state school or chooses not to attend college at all.

College Savings Plan (529 Plans).
Certain states such as Connecticut, Iowa, Kentucky, Louisiana, Massachusetts, New Hampshire, and New York offer college savings plans. These plans, also known as 529 Plans for part of the United States Code that governs qualified state tuition programs, allow the contributor to save as little or as much as they like on behalf of a designated beneficiary's qualified education expenses. Contributions, considered gifts by law, may be as little as $25 or as much as $50,000 ($100,000 for joint filers) in one year, of a five-year period, without incurring gift taxes, assuming no gifts are given to the same beneficiary within five years. These accounts vary from state to state. Some may guarantee a minimum rate of return, others offer tax incentives, and most generally provide tax-deferral and favorable tax treatment upon withdrawal.

Currently, money withdrawn for qualified education expenses is taxed at the child's rate. Beginning in 2002 the law will allow tax-free distributions from state plans for qualified education expenses. Unlike pre-paid tuition plans, the monies from the account may be used at any qualified institution of higher learning within the United States. If your child does not go to college, the money can be used for another family member's qualified education expenses or you may keep the money and be taxed at your rate plus a 10% penalty. Check with your state's commission on higher education to see if a college savings plan (529 Plan) is available where you live. If your state does not have a savings plan, many states have opened their plans to non-residents. Several private plans have also been developed.

Hope Scholarship Credit.
Generally, this credit will reduce your tax up to $1,500 per year of the cost of tuition and fees paid during the first two years of post-secondary education for joint filers with adjusted gross incomes of up to $80,000 and single filers up to $40,000. This credit phases out as you adjusted gross income increases and you are not eligible for this credit if you joint income is above $100,000 and single income is above $50,000.

Lifetime Learning Credit (LLC).
Generally, this credit will reduce your tax up to $1,000 of college tuition and fees per year through the year 2002 and $2,000 each year afterward. To qualify for the full credit, a taxpayer would need to spend $5,000 on qualifying expenses through 2002 and $10,000 each year after. Parents with more than one child may claim a LLC for one child and HOPE credit for a different child in the same year. The two credits, however, may not be claimed in the same year for one child.

Deduction for Qualified Higher Education Expenses.
The new deduction, available in 2002, allows taxpayers to deduct $3,000 of qualified higher education expenses. The deduction, scheduled to increase $4,000 before being eliminated in 2005, is phased out for joint filers with incomes between $130,000 to $160,000 and may not be used in the same year as the Hope Scholarship Credit and Lifetime Learning Credit.

Educational Savings Accounts.
You are now able to set up IRAs for the purpose of paying college expenses. Contributions are allowed until your child reaches 18, and contributions may not exceed $2,000 per child per year. The $2,000 limit is phased out for joint filers with income above $190,000, and single filers above $95,000. Contributions are made with after-tax dollars. There is no tax deduction. This type of IRA allows you to make withdrawals for elementary, secondary and college expenses. Neither ordinary income tax nor the 10% penalty for premature withdrawals applies if the distribution is used for tuition, fees, books, and room and board. Currently you may claim either a HOPE or LLC credit in the same year as the distribution.

CDs and Bank Accounts.
Bank Certificates of Deposit (CDs) and bank savings accounts are two other places to put college savings. Although CDs and bank savings accounts are generally FDIC insured, they generally offer a lower return potential than other investment vehicles and are most appropriate for those with short-term goals.

Tax Considerations

Even if you invest wisely and defer the tax liability on savings for your child's college fund, you'll have to come up with the taxes when you liquidate those investments. Chances are you'll be faced with taxes at a time in the future when you are likely to be in a higher tax bracket and have other additional expenses. You'll need to be sure your investments earn enough to cover the anticipated taxes.

It's important to note, too, that tax laws are constantly changing and this discussion of tax rules provides a general overview. Consult your tax advisor before you begin investing, then check back regularly. If tax law changes negatively affect your college investments, you may want to move the money. How and when you move the funds also can affect taxes, so be sure to talk to your tax advisor first. In particular, some of the tax provisions discussed above are due to expire after December 31, 2010.

Here are just a few examples of tax considerations affecting college funds:

• Loans. If you plan to take out a loan to help pay for your child's college expenses, the interest may be deductible. Generally, if the taxpayer's adjusted gross income is below $130,000 for joint filers and below $65,000 for single filers the following interest may be deductible. The deduction is phased out ratably from $50,000 to $60,000 for single filers and from $100,000 to $130,000 for joint filers. Students may claim this deduction only if they are not claimed as dependents on parents' returns.

• UGMA accounts. You can put assets in a Uniform Gift to Minors Act (UGMA) custodial account for a child. However, if the child is under age 14, all income earned by these assets above a certain level (determined annually by the IRS) is taxed at the parents' income rate, whether or not the parent is the custodian. For children 14 years old and older, the income on assets in a UGMA account is generally taxed at the child's rate. You should keep in mind that putting assets in your child's name may reduce the amount of financial aid he or she is eligible to receive. It is also important to realize that unlike college savings plans (529 plans); UGMA accounts belong to the child. At age 18 the account becomes the child's property, regardless if the child attends college.

Other Avenues for Revenue

Even if you start early, it may be impossible to save enough for your child's college education. That doesn't mean, however, that college is out of the question. You have other cost-saving options available.

Student Strategies.
While they may not be options you should rely on, there are some strategies students can follow to help reduce their expenses prior to entering college and once they're in college. For example, many college students, particularly those who commute to a local school, are able to work part-time and summer jobs to help subsidize their tuition or simply for entertainment money. Be aware, however, that money earned by the child prior to college may reduce his or her eligibility for financial aid. Some colleges offer cooperative education programs where students rotate study with periods of career-related work, allowing them to earn money and credits at the same time. However, it may take more than four years to complete a degree through a cooperative education program. Ask the college admissions office about the specifics of their program.

Depending on a child's scholastic ability, he or she may be able to earn college credits by taking college courses or advance placement exams while still in high school. First- and second-year college students can also take College Level Examination Program tests for course credit. These options can represent a significant savings over the cost of a full-semester course in the classroom. Check with your child's high school guidance counselor or with the college admissions office for eligibility requirements and program specifics.

Another cost-savings possibility is to attend a community college for the first year or two, then transfer to a more expensive four-year college to complete a degree. This can be a more affordable approach to receiving a degree from a prestigious institution that you may have been unable to afford for four years or which may have been more competitive to gain entrance as a freshman.

Financial Aid.
Think of this in broad terms. You needn't be the sole source of funding for your child's higher education. For example, when your child receives a gift of money, put it into a college fund. When grandparents ask what to give for birthdays, suggest college fund contributions.

And don't forget the traditional sources of financial aid: scholarships, grants, work-study programs and government loans. Your child's scholastic record, course of study, athletic ability and choice of college are just a few of the variables that may affect the availability of these options.

If your family meets certain financial criteria, the federal government has a program of low-interest loans with extended payment terms. Relying too heavily on loans, however, is costly and can burden graduates with large debts just when they are working to establish their financial independence. Also, you should be aware that government financial aid programs are subject to change.

Home Equity.
If you bought your home when your child was small, you're likely to have built up a significant amount of equity by the time college is in the picture. You can tap that resource for your child's education with a home-equity line of credit. Interest payments may be tax deductible.

How to Calculate Estimated Four-Year College Costs

If you want to start saving regularly for your child's education, the following steps will help you estimate the amount that you will need to set aside. Tables 1 and 2 will be used in making your calculations.

Table 2
	Investment return, after taxes, of:
Years Until College	4%	6%	8%
1	.981	.971	.962
2	.481	.471	.463
3	.314	.305	.296
4	.231	.222	.213
5	.181	.172	.164
6	.148	.139	.131
7	.124	.116	.108
8	.106	.098	.090
9	.093	.085	.077
10	.082	.074	.066
11	.073	.065	.058
12	.065	.058	.051
13	.059	.051	.045
14	.054	.046	.040
15	.049	.042	.035
16	.045	.038	.032
17	.041	.034	.029
18	.038	.031	.026
Source: College Costs, 2000-2001 ed., reprinted with permission from LIMRA International, Inc., Hartford, CT 06141.

 

A Step-By-Step Worksheet for Determining College Costs

(1) Your child's age	____________________
(2) Enter the number of years until your child begins college.	____________________
(3) Enter the estimated current annual cost of college, selected from the here:	____________________
(4) Multiply this by an inflation factor selected from Table 1	____________________
(5) This equals your child's future annual college cost.	____________________
(6) Multiply this by 2 for a two-year college or 4 by a four-year college	____________________
(7) Your child's estimated future college cost	$___________________
(8) Select from Table 2 the investment factor for the investment return that you expect to acheive after taxes.	____________________
(9) Multiply the estimated cost in Step 7 by the investment factor in Step 8. This is the amount of money that you need to put aside regularly each year to fund your child's education; divide this amount by 12 to obtain the monthly figure, and by 52 to obtain the weekly figure.	$____________________
Yearly savings = Monthly savings = Weekly savings =	$____________________ $____________________ $____________________

 

For More Information

REFERENCE MATERIALS

Paying for Your Child's College Education
Marguerite Smith, Warner Books
$9.99

Financial Aid for College: A Quick Guide to Everything You Need to Know
Pat Ordovensky, Peterson's
$8.95

The Best Way to Save for College: A Complete Guide to 529 Plans
Joseph F. Jurley, BonaCom Publications
$26.95

PAMPHLETS

The quarterly Consumer Information Center Catalog lists more than 200 helpful federal publications. For your free copy write Consumer Information Catalog, Pueblo, CO 81009, call 888-8-PUEBLO or find the catalog at www.pueblo.gsa.gov

ADDITIONAL INFORMATION

www.collegeboard.com
A 100-year-old, not-for-profit membership association. The mission of the College Board is to prepare, inspire, and connect students to college and opportunity. Its members include more than 3,800 schools, colleges universities and other educational associations.

www.savingsbonds.gov
The official sources for savings bond information

www.collegesavings.org or 877-CSPN4YOU
College Savings Plan Network

www.finaid.org
The Financial Aid Information page on the World Wide Web. You'll find a variety of free information including a datbase of 180,000 private sector scholarships, fellowships, grants and loans.

The federal government is a major source of financial aid. Start by filling out the free Application for Federal Student Aid (FAFSA), available from your child's high school counselor or by calling 800-4-FEDAID.

Revised: 2003