A Consumer Guide to Saving for College Costs

Saving for College – Easing the Financial Burden

The total cost of sending your child to college over the next four years, assuming a 6% rate of inflation applied to tuition and fees, room and board, books and supplies, transportation, and other miscellaneous expenses, averages over $80,000 for a private college and over $40,000 for a public college. Using the same assumptions, the cost in 18 years will exceed $240,000 for a four-year private college and $110,000 for a four-year public college. CPAs recommend that you prepare yourself for these costs by starting a savings plan now.

Invest today for tomorrow

The high cost of a college education makes it necessary for you to make sound investments. CPAs advise that you thoroughly research all available investment options. In addition, they suggest that you rely on a combination of investment vehicles, rather than just one.

Keep in mind that investing is not just a matter of following a strategy that worked for someone else. No two situations are alike.

Investments have varying degrees of risk, potential for capital appreciation and income. Furthermore, some are federally insured while others are not. If you need help in selecting investments, seek expert advice.

Investment options for children under age 14

In 1995, if your child is under age 14 and has unearned income over $1,300, the excess amount will be taxed at your marginal tax rate. To minimize your tax liability, consider the following investments.

  • Series EE U. S. Savings Bonds–EE bonds may provide an acceptable rate of interest, are generally not subject to state and local taxes, and can provide tax deferral until the earlier of when the bonds mature or are cashed in. If you purchase bonds in the child’s name, you can plan to have them mature after the child is 14, and possibly lower the tax cost. If the bonds are purchased in your name, interest accumulated on bonds purchased after December 31, 1989, may be tax-free if the proceeds are used to pay for your own or your child’s higher education expenses. Since there are restrictions (including income limits), make sure you get all the facts before using this strategy.
  • Municipal Bonds–You are not required to pay federal taxes on these bonds. Municipal bonds may be exempt from state and local taxes as well. Keep in mind that municipal bonds yield less income than taxable bonds, but generally have less risk.
  • Zero-Coupon Bonds--These bonds can be purchased at a deep discount and redeemed for the face value at maturity. Although interest is paid at maturity, you are taxed as if interest were paid annually. Instead, you may want to opt for tax-exempt municipal zero-coupon bonds because interest is exempt from federal taxes and possibly from state and local taxes as well.
  • Nondividend-Paying Growth Stocks–Consider purchasing nondividend-paying growth stocks in your child’s name. Since the appreciation won’t be taxed until the shares are sold, you can sell them after your child turns 14, and the gain will be taxed at his or her lower rate.

Investment options for children age 14 and over

If your child is almost ready to go to college and you haven’t put sufficient funds aside, you may want to consider the following investments.

  • Certificates of Deposit–CDs are ideal for investors who are looking for a safe place to keep their money for a few months or a few years and still earn a modest yield. However, you will have to pay a withdrawal fee if you take out your money before the CD term ends.
  • Treasury Bills–T-bills are backed by the credit of the U.S. government and have short-term maturities. They can also be sold before maturity at current market rates. Federal tax can be deferred until the year the T-bill matures or is sold.
  • Money Market Accounts–These accounts are tied into market interest rates. Therefore, if prevailing interest rates rise or fall, the rate on the account will follow. One advantage to this investment is that you will have ready access to the money in your account at all times.
  • Mutual Funds–A mutual fund is a pool of money, drawn from both small and large investors, which is invested in securities. Since they are managed by full-time professionals, you will usually achieve better results with mutual funds than if you managed your investments yourself. In addition, mutual funds are diversified to reduce risk, and you can easily liquidate your investment.

When it’s too late to save

If you don’t have any savings accumulated and you own a home, consider financing your child’s education by taking out a home equity loan. You may deduct the interest on home equity loans of up to $100,000, or the equity in your home, whichever is less. Other benefits are a large credit line, payment flexibility, and reasonable interest rates.

Consider borrowing against your company’s 401(k) plan if it has a loan provision. Although you repay the loan with after-tax dollars, you pay interest to yourself. Thus, your account continues to grow.

Additional ways to finance an education include borrowing money via personal, private or governmental loans, and financial aid. Check with the college of your child’s choice or your state financial aid office for details.

Plan a course of action

Though planning for college seems to be an undertaking meant for wizards, there’s no magic involved. All it requires is estimating college costs as soon as possible and planning a course of action. Investment decisions should not be dictated solely by tax advantages. You need also to consider the non-tax advantages of investments. A professional adviser, such as a CPA, can help you analyze the tax and non-tax advantages of investments, and assist you in developing an investment strategy that will help you achieve your education funding goal.

The information in this publication is for general purposes only. You should consult your CPA for specific recommendations appropriate to your individual situation.

Age makes a difference

Your child’s age determines the types of investments to consider. Basically, if your children are under age 14, you’ll use different investment strategies than if they are 14 or older. Following are some general guidelines you may want to consider.

  • With children up to 14 years old, invest on a regular basis over a long period of time. Consider choosing growth-oriented investments, such as individual stocks, growth funds or bonds.
  • With children age 14 or older, investment stability is crucial. In this case, CDs, Treasury bills and money market funds would be appropriate. These all ensure stability and can continue to earn income during your child’s college years.

What you should know about the “kiddie tax”. . .Your child’s age also has an impact on the tax consequences of your investments. Under a provision known as the “kiddie tax,” in 1995 a child under 14 can accumulate up to $1,300 annually in unearned income (i.e., interest and dividends) at a tax advantage. The first $650 of unearned income is tax-free, the second $650 is taxed at the child’s rate (usually 15%). However, the remainder is taxed at the parents’ top marginal rate. When the child turns 14 years old, the first $650 of his or her unearned income is tax-free and the remainder is taxed at the child’s generally lower rate.

A word of warning . . . To reduce tax liability, parents are often advised to shift assets into their child’s name. Beware that if you follow this strategy, you are handing over full control of the assets to your child. (It also may affect financial aid eligibility.) Even if you shift income through a custodial account, your child will have unrestricted access to the money at age 18 in most states.

Setting up a trust fund for minors enables you to avoid this drawback of shifting income. With a properly established trust, you can decide at what age the child will receive the funds, and you can impose conditions as to how the money is to be used and disbursed. However, be aware that there are certain costs in setting up and maintaining a trust, the tax rates are high and the rules can be complex.

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