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A Primer On Saving For College

As a parent, your thoughts inevitably settle on the time when your child will graduate from high school and go off to college. And as a parent, you’ll probably have mixed feelings as that day approaches—pride, sadness, joy and concern. The only consolation, if you’re a parent of young children, is that it’s a long way off. Unfortunately, the need to start looking at how you will finance your child’s college tuition may not be. Because of the high cost of a college education, it’s never too early to begin to save for this expense. Next to a home purchase, it is probably the single largest investment that you will ever make. To make matters tougher, college costs are rising faster than inflation.

College costs today
According to the College Board, the cost (tuition, room, board, books, supplies, transportation and other related expenses) of attending a four-year private college in 2006-2007 averaged about $33,300 a year. For out-of-state residents attending a four-year public college, costs totaled $26,300 annually. Even for residents attending a four-year public college in their home state, tuitions averaged about $16,300.

Even if your child qualifies for a scholarship or another form of financial aid, you’ll still need to factor in other costs (such as clothing, travel, entertainment, student activity fees not included in tuition, enrichment/supplementary education opportunities, etc.) that may significantly add to the total cost of sending your child to college.

The cost of college tomorrow
Moreover, for the past several years, college costs have been increasing at a rate faster than the overall inflation rate. While it is impossible to predict what will happen in the future, here is a chart that demonstrates what could happen if the annual cost of college increased by a modest 4%.

College Annual cost 2006-2007 Annual cost in 5 years Annual cost in 10 years Annual cost in 15 years
Private $33,300 $40,514 $49,292 $59,971
Public, in-state tuition $16,300 $19,831 $24,128 $29,355
Public, out-of-state tuition $26,300 $31,998 $39,930 $47,364

And these are only annual costs. If your child attends and graduates from college in four years, you must multiply these totals by four. If you have more than one child…. well, you get the picture. It is a huge investment which requires thoughtful planning and a focused and purposeful saving strategy. Fortunately, as a parent of a young child, you have time to save. In addition, there are several ways that the income tax laws make saving easier.

Funding college education
For decades, parents have used custodial accounts to transfer funds to their minor children to help build assets for college costs. However, the 2001 tax law has enhanced the tax benefits of other types of asset ownership that should also be considered, including Coverdell Education Savings Accounts (Education IRAs) and Qualified Tuition Programs (Section 529 Plans).

Custodial accounts

The Uniform Gifts to Minors Act (UGMA) or Uniform Transfer to Minor Act (UTMA) account provides ways to transfer the ownership of assets to a child. With a UGMA or UTMA account, the parent creates a custodial account on behalf of the minor child. Assets are transferred into the account and the custodian, usually a parent, manages the account until the child reaches legal age. The concern for most parents is that, at that point, the child can do whatever he or she wishes with the assets and the deposits into these accounts are irrevocable.

Coverdell Education Savings Accounts and Education IRAs

Coverdell Education Savings Accounts provide parents and others with the opportunity to save for a child’s education in a tax-sheltered account. Although, there are income limits for those making the contributions, the 2001 tax law increased the annual limit for contributions from $500 to $2,000.

In addition, earnings within the accounts are tax deferred and withdrawals are not subject to tax if used for qualified education expenses. The new law also expanded what was considered “qualified education expenses” to include costs for elementary and high school. Withdrawals not used for qualified education expenses are subject to regular income tax and a 10% penalty. Withdrawals must also be completed before the child reaches age 30.

Education IRA accounts function like regular IRA accounts and are available from most banks, credit unions, brokerage firms and mutual fund companies. Investment options vary and there is usually considerable flexibility with these self-directed accounts.

Start early
The temptation to put off saving for college, especially if your children are young, is always there. But if you do start early, even a small amount can make a large dent in what you will need. You can always increase the savings amount as you earn more. By starting early, you make time your ally. Get a late start and you end up working against time.

Savings accumulation table

Monthly savings Accumulation after 5 years Accumulation after 10 years Accumulation after 15 years
$50 $3,400 $7,764 $13,364
$100 $6,801 $15,528 $27,729
$150 $10,201 $23,292 $40,093
$200 $13,601 $31,056 $53,458

Assumes earning 5% annually and no income taxes

Conclusion
One of the greatest gifts you can give your children is a strong educational foundation that will provide them with an enriching experience and prepare them for a successful and productive life. However, the costs can be daunting. Starting early with a sound long-term plan can make the process easier, and turn your dream of seeing your children attend the college of their choice into reality.