If your son or daughter is getting ready to go off to college, you’re probably experiencing an array of feelings on many different levels. You’re no doubt happy for your child, but a little anxious and worried, as well.
She’s really going away—maybe far away—and you might not see her again for months. You wonder if she’ll be okay without you. Will she get along with her roommate? Will she eat right? Will she be able to keep up with all the work involved? Will she be happy?
After you finish considering your child’s well being as it relates to college, the next thing to enter your mind may well be the cost. College is expensive, that’s for sure.
Hopefully, you’ve been stashing away money that’s earmarked for college costs for years. Unfortunately, however, some people are unable to save much, and many of us don’t save as much as we should. That might mean that we’ll need to get creative when it comes time to send our kids to college. College costs are a major financial issue for many, many families, so don’t feel like you’re on your own here. In this chapter, we’ll look at different possibilities for paying for your kids’ educations, and how you might be able to get some help with those costs.
Yearly costs at Harvard University in Cambridge, Massachusetts, have topped $34,000 a year, while students at Georgetown University in Washington, D.C., pay about $33,000. An education at the University of Pennsylvania in Philadelphia costs approximately $32,000 a year, Tulane University in New Orleans is about $31,000, and students at Rice University in Houston hand over about $23,000 a year. Of course, not all colleges and universities cost as much as these prestigious institutions, but college these days is an expensive venture.
Tuition at Utica College in Utica, New York, cost $4,014 for the 1980–1981 school year. The cost for the 1999–2000 year was $16,150. This kind of increase is not unusual on a national basis.
The cost of college has significantly outpaced inflation since the early 1970s. Nationally, the cost of college tuition has quadrupled since 1980.
As you can imagine, and may well know firsthand, paying for a college education (not to mention two or three of them) can be a tremendous strain on a family’s finances. The problem is that we realize how important college is to our kids’ futures. Many of us consider college to be a necessity, not a luxury or an option.
Census Bureau data points out a clear link between education level and finances. Both male and female college graduates earn significantly more than high school graduates, and it’s been shown that income rises faster among people who have higher education.
So how does the average family find the cash to send its kids to college, and still meet all its other expenses? If you’ve become extremely discouraged from reading the first part of this chapter, cheer up. Not all colleges are nudging at the $30,000 a year or over mark. There are still some educational bargains out there.
Community colleges come at a much lower cost—averaging roughly $3,000 a year. State-owned colleges and universities generally are affordable for state residents. And many schools offer financial aid to deserving students.
Even if you find a bargain, however, you’ll face significant expenses. In addition to tuition, room, and meals, there are costs for books, fees, and transportation. Add to that the cost of phone cards, a microwave, computer, and one of those little refrigerators for the dorm room, and you’ve got yourself a bill that may look to you like the national debt.
So how do we go about paying for college? Let’s have a look.
If we all started to save for college the day our children were born, we’d probably be in pretty good shape by the time that baby reached 18 or 19 years old.
Unfortunately, most of us don’t do that. Life and daily bills get in the way, meaning that all too often, the college fund is the last account on the deposit list each month.
If you’re not convinced that it’s important to start saving early for college, consider these figures from the T. Rowe Price investment firm. These numbers are the amounts parents need to save per month and per year at 10 percent return in order to have $100,000 saved when it’s time for college.
Unless you hit the lottery when your kid’s 15, it’s easier for most people to pay a manageable amount over a long period of time than a huge chunk each month for a shorter time. If your children are still young and you’ve decided you’d like to start saving for college early on, you’ve got some choices as to how to do so.
You could invest money in a uniform gifts to minors account, an educational IRA, 529 plans, EE bonds, or just accumulate money in your name that’s designated for your child’s college expenses. All of these methods have some pros and cons.
Parents who invest $100 a month for 18 years at a modest 6 percent total return would have $39,000 when their child is ready for his freshman year at college.
Putting money aside in an account in your name that’s designated as a college fund for your child is what financial advisers call a traditional college account. The money in that account is yours, which means you can use it in case of a real emergency.
If your child for some reason doesn’t go to college, you simply use the money for something else. All income and capital gains from the account are yours, and must be reported on your annual income tax returns. This means that there isn’t any compounding on the funds, and you won’t earn interest on your interest. If your precious decides that he’d prefer to work on a shrimp boat in Louisiana instead of head off for college, however, all the money in the account is yours. This means of saving doesn’t have any tax benefits, which has made it less popular as other, more tax-friendly methods of saving for college have been introduced.
Another tactic for funding a college education is to use proceeds from appreciated stock. Grandma, or whoever it is that owns the stock, can give it to the student, who can then sell it and apply it toward his first semester’s tuition. He’ll still have to pay capital gains on the stock, but they’ll be based on the child’s tax bracket, which is much lower than Grandma’s.
Many colleges and universities offer payment plans and incentives to try to entice future students to their campuses. If you’re interested in a particular school, see if there’s a payment program you can get into early on.
You also can pay money directly to an educational institution for the cost of your child’s education. There isn’t any limitation to the amount you can give, except it must be earmarked for tuition. The funds must be paid directly to the college, not channeled through the student. Be sure to tell Grandma that she shouldn’t pay any tuition funds to the college until she sees a bill, though. If she hands over tuition money to Cornell, for instance, and then your child decides to tour Europe instead, the money can’t be returned. It becomes a charitable gift to the college.
Traditional methods of saving for college are still popular, but there are some newer and more creative methods of saving, as well.
You really should sit down with a financial advisor, who will assess your financial situation and recommend a plan that best suits your situation.
So you know what the advisor is talking about, some information about other options for saving for college is given in the following sections.
A method of saving for college that’s gaining in popularity is utilizing EE Bonds. These bonds are special because the interest accrues on them from the time the bonds are purchased until they are cashed, with the proceeds used toward college exempt from federal income tax liability. This is a beneficial tool, but you should know that it’s not available to everyone.
A person over the age of 24 must purchase the bonds in the name of the parents of the child for whom the money is earmarked—not in the child’s name. And the bonds must be held for at least five years before they can be used for college costs. That means you can’t go out and buy them when your child is 17 and expect to use them to pay for college costs.
When you cash in the bonds to pay for educational expenses, the entire interest amount is tax free, provided your joint household income is less than $79,650. The amount is pro-rated up to a maximum of $109,650 of family income, and, once you’re over $109,650, the accrued interest is taxed.
EE bonds can be a nice supplement to your college savings, but not a practical means of funding an entire college education. If your child doesn’t go to college, the bonds remain in your name.
In order to cash in on the income tax exemption of EE bonds, they can only be used for educational expenses for you, your spouse, or your dependent children. The bonds can be used to pay for tuition, room and board, and books.
These are older style accounts that are set up to lower the income tax liability that individuals pay for funds in their children’s names. Funds set aside for college, or given as gifts to your children, are placed into an account in the child’s name under the Uniform Gifts to Minors Act. The funds belong to the child. Since the child is a minor, however, the funds must have a custodian—usually a parent. The funds accumulate and are invested, with the child earning investment income. The nice thing about these kinds of accounts is that the first $750 of investment income the child earns is not taxed, and the next $750 is taxed at the lowest tax bracket. After that, the rate increases and is paid at the parents’ tax rate. After age 14, the rate is always taxed at the rate of the child’s tax bracket.
A possible downside of these funds is that the money belongs to your child. If Rob decides to buy a motorcycle and ride through Europe instead of going to college, as long as he’s no longer a minor, you can’t stop him from taking his “college” money with him. It’s a good idea to only invest enough in these types of funds to get the income tax advantage, and put the rest of your child’s college money somewhere else.
Don’t Go There
Life insurance is not a good investment for a college account. Neither are limited partnerships or tax deferred annuities. These are long-term investments that aren’t suitable for college savings. If your financial advisor recommends any of these investment tools, run and find another advisor.
The custodian of a UGMA account can set it up as a savings account in the local bank, and change it to a brokerage account as the account grows. You can even buy stocks or bonds with the money, but not unless you know what you’re doing.
Gift tax limitations dictate that a maximum of $10,000 a year can be placed in a UGMA account. That amount can be doubled if a couple is gifting.
The recent tax law change will increase the annual limit on contributions to an education IRA from the current $500 per year to $2,000 per year. Thank goodness! It was hardly worth the hassle of setting up one of these accounts for a measly $500 a year. With a $2,000 limit, however, you can reach, or get close to your college goal if you start saving as soon as your child is born.
As with all IRAs, the income and capital growth are deferred within an education IRA until the funds are withdrawn for college.
Education IRAs have income limits for the parents, but you can change the beneficiary designation to another child if your first child decides not to go to college. One of the problems with education IRAs is that you can only use the funds for your children, so if none of your children go to college, the funds become taxable to the last named beneficiary when they reach 30 years of age. Unfortunately, you can’t roll the unused education IRA over into a personal IRA, the accumulated capital gain and income are taxed to the beneficiary.
There are two tax credits that may be available to you during the time that your children are in college. As with so much of the income tax code, these tax credits are not cut and dried, but depend on your annual income and some other stipulations.
As you know, there are tax deductions and then there are tax credits. The difference is where they can be used on your tax return. A deduction is listed on Schedule A of your income tax return, and if your deductions are large enough to exceed your standard deduction, you can subtract the deductible sum from your adjusted gross income. After you’ve subtracted out your exemptions, this figure is called your taxable income and used to calculate your tax.
A tax credit is usually better because you don’t have to itemize your deductions to use the credit. You can file your return using a standard deduction and still use a credit. Once you’ve calculated your tax, a credit is subtracted from this tax to lower what you owe the IRS.
The HOPE (Higher Opportunities for Performance in Education) credit has been available since 1998. It’s a tax credit for qualified tuition and related expenses during a student’s first two years of college. The student must attend college or other post-high school courses at least half time.
The credit is for 100 percent of the first $1,000 of qualified expenses paid during the year, plus 50 percent of the next $2,000, for a maximum of $3,000.
A Lifetime Learning Credit is a credit for expenses that don’t qualify for the HOPE credit. The Lifetime Learning Credit is available for any school year for courses aimed at acquiring or improving job skills. The credit may be for undergraduate, graduate, or professional degree courses.
The Lifetime Learning Credit is equal to 2 percent of expenses up to $5,000, for a maximum credit of $1,000 per year. After the year 2003, the credit will rise to 20 percent of $10,000, for a maximum credit of $5,000 per year.
The Lifetime Learning Credit is for you, your spouse, and your children or other dependents. It’s intended to be used for tuition and related fees—not room and board, commuting, or other expenses. And, of course, there are income limits.
What the IRS giveth, the IRS taketh away. The credit begins to phase out with adjusted gross income over $80,000 per year and is completely gone if your income is more than $100,000 per year (for married filers, the figures are halved for single filers). We’re not talking about $80,000 in taxable income, we’re talking adjusted gross income—the total of all your income, with some adjustments.
If you qualify (by attending a college or post-high school at least half time), you could use the HOPE credit for your child’s freshman and sophomore years, and the Lifetime Learning Credit for her junior and senior years.
There are two types of qualified state tuition plans, both of which are 529 plans. That means they fall under section 529 of the tax code, which permits investing for college in a tax-deferred vehicle. One type of qualified state plan is known as a Prepaid Tuition Plan or Tuition Assistance Plan. The other is simply called a 529 Plan.
Adding It Up
Tax-deferred income is earned, but not taxed until the income is used. Tax-free income is never taxed.
The 529 Plan was revised in 1997 and again in 2001. This plan is the newest way to save for a child’s college education. Basically, it’s an account that’s set aside for a child’s education, and is tax deferred until it’s used. The money, however, can’t be accessed by the child. If Rob buys that motorcycle and takes off for Europe, he can’t grab the money from the account on the way out.
A 529 Plan is even more appealing under the most recent Tax Act, which will in 2002 make all earnings within a 529 Plan tax free, not just tax deferred. And, up to $50,000 can be contributed to a 529 Plan each year by an individual, or up to $100,000 by a couple. Contributions to these plans are considered gifts. The person setting up the account and depositing money is called a contributor, and remains in control of the money. If the child for whom the money is intended does not go to college, the money can be passed along to another beneficiary (within the large family unit—nieces and nephews rather than just brothers and sisters like an education IRA), or retained by the contributor.
At that point, if the contributor retained the money, it would become taxable, and there would be a 10 percent penalty. The penalty is meant to be a deterrent to people using a 529 Plan as a convenient way to stash away tax-free money, never intending to use it to pay for college.
The Prepaid Tuition Plan is intended to fund tuition expenses only. Money in these plans can’t be used to prepay room, board, books, fees, and so forth. It’s strictly for tuition. That means you’ll probably need to have another college investment vehicle, as well.
The governments of various states normally set up these Prepaid Tuition Plans, which are guaranteed against losses in the stock market. You probably will need to be a resident of the state in which you set up a plan.
A Prepaid Tuition Plan guarantees that your tuition credits will pay for your child’s tuition. No matter what happens to tuition costs, your purchase “locks in” the cost of future tuition. The plan can be used for tuition at any accredited, public or private college or technical school in the United States.
This plan may keep you eligible for financial aid, since it only covers the cost of tuition. You’ll still need to come up with the money for room and board.
The funds you contribute to a Prepaid Tuition Plan are used to buy tuition credits that equal credit hours paid at different types of institutions. You’ll need more credits for a four-year college or university, for instance, than you would for an area community college. You’ll need to purchase more credits if your child is interested in a university, while you’ll need to purchase less if your child is interested in a community college.
If your child doesn’t use all the tuition credits you’ve purchased, you may be able to get a refund.
The staff of many colleges will advise you to identify the schools in which you and your child are interested, and then worry about how you’ll pay for it. They encourage you to consider their schools by telling you there is financial aid available. We hear them, but there’s a basic problem with that philosophy.
If the cost of a particular school is so great, it may be that even after financial aid you won’t be able to afford it.
The cost for one year of tuition, room, and board at Lehigh University in Bethlehem, Pennsylvania, is $32,000. That doesn’t include books, or expenses such as transportation, phone, and so forth. If your child receives $16,000 a year in financial aid, you’d be thrilled, right? That is, until you realized you’d still have to shell out $16,000 a year, plus expenses.
At the end of four years, you’d have paid more than $64,000, and that’s only for your first child. If a school offers a financial aid package for your son or daughter, make sure the college is within the framework of what you can afford, even with the package.
To get an idea of the financial aid for which you might qualify, check out www.FinAid.org. You then can compare the aid package to the total costs for the school in which you’re interested.
Regardless of how much money you’ve managed to put aside, you’ll still need to take a good, hard look at what expenses will be involved with the college you choose. If you’ve saved $80,000 and are feeling great about it, consider that you could spend that money in two years if your child goes to one of the most prestigious schools, and encounters heavy additional expenses.
We’d all like for our kids to go to a great college, but chances are, if your child is motivated, he or she will do well in a state school or a less expensive private school. Most kids don’t go to Yale or Harvard, and they turn out to be just fine.
And there’s nothing that says your child shouldn’t, or can’t contribute to her college fund. Many, many students work while they’re attending college, either for extra money or to help with the costs of tuition, books, and so forth.
Decide how much you can pay for your child’s college before she applies to a particular school. That way, you’ll have an idea if the school is affordable, with or without a financial aid package. College is a matter that affects the finances of an entire family, and all sides of the issue should be considered.
Besides tuition, fees, room and board, your child will have other expenses while at school. Decide before she leaves in late August what you’ll pay for, and what costs she’ll be responsible for. Fraternities and sororities are wonderful social experiences, but if you and your child are accumulating tens of thousand of dollars in debt, maybe another $1,000 per term or year in frat fees might not be necessary.
Some schools lower the cost of room and board if a student houses in a fraternity or sorority house, but even if your child stays in the dorm, frats cost money.
Be prepared to discuss spring break. Will your child come home for the break or will he fly directly on to the Florida beaches? If so, who will pay for the flight and other costs, such as a motel, meals, and beer? Most parents leave paying for the fun stuff up to their kids.
Once you’ve worked through the financial aid worksheet on the finaid.org Web site, or determined in another way that you should qualify for some financial aid, you’ll need to complete a College Scholarship Service (CSS) PROFILE. You do this during your child’s senior year of high school.
You can get a copy of the Free Application for Federal Student Aid by logging on to the FAFSA Web site at www.fafsa.com.
PROFILE is a program through the financial aid division of the College Board, a national, nonprofit association of schools and school systems, colleges and universities, and educational organizations. The College Board uses the information you supply to help it award nonfederal student aid funds. It forwards your information to the colleges in which you are interested, so that staff there can determine whether there’s aid available for you.
To apply for federal financial aid—which includes federal grants, loans, and work-study money—you’ll need a form known as the Free Application for Federal Student Aid (FAFSA). There are some basic requirements for these federal programs. The requirements are as follows:
The following programs are included under federal financial aid:
Basically, grants are aid that you don’t have to repay. Loans must be repaid. A work-study program pays students for campus jobs.
Don’t Go There
Be careful that you don’t get a financial aid advisor who is out to sell you a loan on which he’ll receive a commission. Ask how the advisor is paid, and ask for recommendations from several families with comparable financial situations. Check to see if those families are satisfied.
Because filling out these federal application forms can be complicated, you may want to consider using a financial aid advisor. These advisors are available in most areas; you can check your phone book to locate one.
There also are books and online information to help you apply effectively for financial aid. Once you know what your financial situation will be, you can begin looking realistically at different schools.
If your college savings are slim, and your son or daughter doesn’t qualify for enough scholarships or financial aid to cover the cost of an education, don’t despair. There may be another way for you to come up with money for Bobby’s tuition.
Over the years, you’ve probably built up equity in your home. Equity is part of your net worth, and it can be used to help pay for your children’s education. You can utilize this equity by taking a second mortgage or obtaining a line of credit.
A second mortgage is an additional loan to your primary mortgage, and it increases the amount that you’ll need to repay. Not all financial institutions offer second mortgages.
A line of credit is approval for a designated loan, up to a pre-approved limit. Your home is used as collateral against that loan.
You can use as little or much of the approved amount of the loan as you need. If you get a line of credit for $25,000, for instance, and find that you end up needing only $18,000, you don’t need to use the entire amount. The funds are available and usually accessed by writing a check for a portion of the limit. Interest charged is usually variable, with repayment calculated on the amount of the loan, and the current interest rate.
An equity loan is a fixed-rate loan for a designated amount. It uses your home as collateral. Fixed-equity loans are usually issued for between five and seven years.
You should consider these factors when deciding which type of home equity loan makes the most sense for you:
If you don’t own a home, or haven’t built up sufficient equity in it to qualify for a second mortgage, equity loan, or line of credit, you may have to get creative in order to fund a college education.
Adding It Up
A fixed interest rate means that the rate charged for the loan is fixed for the entire term of the loan, whereas a variable interest rate “varies” or changes based on some predetermined interest rate, i.e., the prime lending rate. A fixed rate allows you to know what your monthly cost of the loan will always be. Variable rates enable your monthly payment to go up or maybe go down.
You could get a second job, or have your child find a job to help pay for his or her college expenses. If your parent or parents are still living and have assets that they’ll pass along to you or your child at the time of their deaths, you could consider asking them for a gift now. We’ll get into that topic in much more detail in Part 6, “Preparing for the Future.”
Many families have come up with creative ways to finance children’s educations. If you can’t afford to pay outright for college, it doesn’t mean that you’re not a good parent. Be frank with your son or daughter about your financial situation, and see if he or she has any ideas. And, remember that the price of an education varies tremendously from school to school.
It’s very common for students to earn their spending money themselves. Your son worked at summer accumulating $2,500 and this should tide him over until he comes home next summer. If you’re generous and can send him a check in addition to all the other costs of college, congratulations.
But earning it and spending it wisely over the course of the school year is a wonderful learning experience. If your child earned $2,500 and is in school for 9 months, he has $275 per month to spend, including Christmas and birthday gifts. You might need to help him by sending him only what he can spend each month, or he might need to watch it carefully himself. If he overspends one month, he needs to get a job until next month.
You’ll need to decide if your child can take a car to school, is a car really needed at school, or are they just used to having a car at their disposal. Are you comfortable with them being miles away in case there is an accident or breakdown and you need to go get the car?
Many colleges don’t permit freshman to have cars on campus, while other schools don’t have any restrictions. You should receive an auto insurance discount when your child is away at school and their car is at home, so know a car on campus will increase your car insurance costs, plus most colleges charge parking fees. Using the car increases daily gas expenses. Do you really want them to have a car?
The greatest problem with college students is credit card debt. The average amount of credit card debt accumulated by college graduates keeps mounting to new heights with each new graduating class. Current college seniors have over $7,500 in debt.
If you want your child to have a credit card, have the card company (a local bank) set a low enough limit so your child can’t keep borrowing. Credit card interest is not deductible and the rates are prohibitive. The credit card companies send the cards to your child’s college address. Many of the companies are borderline predatory. Discuss with your child the uses of a card and maybe have them use their debit card rather than having a need for a credit card.