No one disputes the fact that the cost of a college education is high. For the 2004-05 school year, the average annual cost of a four-year public university is $14,640 and for a four-year private university is $30,295 (Source: Trends in College Pricing, 2004). While those prices are sure to increase in the future, that doesn't mean you should just give up and ignore the entire subject. There are a number of strategies to help you fund that college education:
- Start investing as much as you can now.
The sooner you start saving, the more time you will have to let those savings grow. Figure out how much you need to save annually to meet your goal. Don't panic if you can't afford to save the entire amount. There are other sources to help fund a college education, such as borrowing and financial aid. Your goal may be to save 30%, 50%, or some other percentage of the total cost.
- Adjust your investment mix over time.
For years, college costs have been increasing by more than the overall inflation rate. Just for the 2004-05 school year, tuition at four-year public colleges increased by 10.5% compared to overall inflation of 2.2% (Source: Trends in College Pricing, 2004). Thus, you should select investments likely to stay ahead of increases in college costs. However, as your child nears college age, take steps to protect your principal by shifting to more conservative investments.
- Become familiar with the financial aid system.
If you think you will qualify for financial aid, learn about the system now, no matter what your child's age. Calculate your expected family contribution to get an idea of how much aid you might receive and research what types of aid are available. Many families are surprised to find out a significant portion of most aid packages comes in the form of loans.
- Decide whether to save in your name or your child's name.
If you expect to qualify for financial aid, you may want to save in your name, since only 5.6% of your assets are considered available for college costs, while 35% of your child's assets are considered. If you don't expect to qualify for aid, you can make annual gifts, up to $11,000 in 2005 ($22,000 if the gift is split with your spouse), to your child without paying federal gift taxes. Those assets are then removed from your taxable estate and any income becomes taxable to your child.
- Look into section 529 plans, which include prepaid tuition programs and college savings plans.
Prepaid tuition programs guarantee funds to cover tuition at your state's public colleges and universities, although some private colleges also offer these plans. College savings plans invest your money in stocks, bonds, or mutual funds. You can use distributions to pay higher-education expenses at any college or university. Qualified distributions taken before 2011 are tax free.
- Examine Coverdell education savings accounts (ESAs).
You can make annual contributions of $2,000 per beneficiary under age 18. While contributions aren't tax deductible, earnings grow tax free as long as proceeds are used for qualified education expenses. In addition to college expenses, proceeds can be used for elementary and secondary school tuition and expenses and computer technology and equipment. Eligibility to make contributions is phased out at adjusted gross income (AGI) levels of $95,000 to $110,000 for single taxpayers and $190,000 to $220,000 for married taxpayers filing jointly. If your income exceeds those limits, however, your child or other relatives can make the contribution.
- Consider using a Roth individual retirement account (IRA) to help fund college costs.
However, only consider this strategy if you have other means to save for retirement. Your contributions to a Roth IRA can be withdrawn at any time without paying federal income taxes or the 10% early withdrawal penalty. If you are under age 59 1/2 when distributions for qualified education expenses are taken, you will have to pay ordinary income taxes on earnings, but not the 10% federal income tax penalty. If you are over age 59 1/2 and opened the Roth IRA at least five years before the distribution, you may not have to pay federal income taxes on the earnings.
- Realize that education credits and deductions may reduce the cost of college.
- Investigate borrowing options.
Borrowing can put a significant strain on your finances, usually at a time when you should be concentrating on saving for retirement. However, if you need to borrow, there are a variety of loan options available, with the federal government offering several attractive alternatives to students and their parents.
- Encourage your child to participate in the process.
Maintaining good grades and participating in extracurricular activities may make your child a more desirable candidate for college. He/she may then be eligible for a wider range of grants and scholarships. You may also expect your child to work part time to fund part of his/her college education.