When it comes to paying for college, Leslie McNamara likes to startle parents with an analogy.
She tells them to think about what it costs to buy a new car.
Then she tells them to imagine doing it for four years straight.
“The numbers are intimidating, but people shouldn’t let them throw them,” says McNamara, a vice president specializing in college financing at CoreStates Financial Corp. “If they save $225 a month and they have a two-year-old, (by the time the child is 18) they’ll have $107,000.”
“If” they have the spare $225 a month - and if they get the 10 percent return on the investment she assumes.
The fact is, saving for college “is” intimidating - and the cost is growing currently at an annual average of 6 percent. A year’s tuition at a private four-year college will average $29,794 in 2010, based on the current rate of increase. Harvard could run $66,085.
How do you tackle this?
The first thing, experts say, is to estimate the cost. But don’t panic or become paralyzed into inaction. Remember, you won’t need to save the total amount: half may be fine, with the rest coming from loans, scholarships, grants and student jobs. In any case, save “something,” advisers counsel, if only to show financial-aid offices you’re serious.
Whatever amount you save, “start early and keep at it,” says Gerald Krefetz, author of the College Board’s “Paying for College.”
Rethink some of your assumptions about investing for college. Your grandparents may have given you savings bonds for your education, but that was before college costs rose so rapidly.
Now, you have to be crafty. Think of it as any other investment, Krefetz and others advise, but try to harness a few special quirks that apply only to college saving.
Following are some specific suggestions:
Go for high growth. Parents of young children should concentrate their investments in stocks or mutual funds composed of stocks, which historically have better rates of return than bonds and CDs but that require more time for riding out the ups and downs of the market, planners say.
As children get closer to college, savings should be gradually shifted to safer investments that provide steady income.
For parents who want to guarantee a part of future tuition, Krefetz likes zero coupon bonds, which sell for a fraction of their face value and promise to pay the full face value at a specific date, in lieu of interest.
Taxes. One of the most common mistakes young parents make, says Barry Sullivan, a vice president and financial consultant with Merrill Lynch, is to avoid building up their tax-advantaged savings accounts - such as 401(k) plans - until they’ve saved a full college fund. In fact, he and others say, retirement savings provide an indirect way of investing for college while deferring taxes.
Sullivan tells clients to check the rules of their 401(k)s to see if funds can be withdrawn from them or borrowed later without penalty for college costs.
If they can, he advises the clients to “max out” on the 401(k)s because they are tax-deferred and, hence, grow faster than ones that aren’t. Later, the clients can just borrow the funds in these plans for college, then slowly repay themselves, he says.
“The No. 1 rule is always save the ‘before’-tax dollar first” in a 401(k), says Brinker, a certified financial planner.
The same principle applies to your home: You can build up equity in a home, deduct the mortgage interest, and then use an equity loan to help finance college later.
Another plus: If you think your child might qualify for financial aid, financial aid officers often exempt retirement savings and home-equity loans from calculations of parents’ worth - so putting money into those is, in a sense, a way to shield it from the prying eyes of financial-aid officers.
Put money in your child’s name. Children under 14 get the first $650 in investment income tax-free, and the second $650 taxed at the children’s rate of 15 percent. (The rest is taxed at the parents’ rate.) For many parents, that’s reason enough to put money in a child’s name - the money will grow faster if it isn’t taxed highly.
Sullivan at Merrill Lynch does this for his own four children, with a neat twist: He gives them stock that has risen in value; they sell it, but they don’t have to pay capital-gains tax on the first $650 and just 15 percent on the next $650. Then Sullivan reinvests their proceeds in a growth mutual fund for them.
Even after a child turns 14, the money is still taxed at a lower rate: 15 percent.
But Sullivan and others caution that there are down sides to putting money in your child’s name. Colleges consider up to 30 percent of children’s money fair game for college costs when calculating financial aid; parents’ savings, particularly retirement savings, are much more exempt. So, if there’s a chance of financial aid, you may be better off keeping the savings in your name.
Prepaying for college. If you have cash in hand, you may be tempted to prepay your child’s education through a variety of public and private programs. Financial advisers warn against this, though. Prepaying your child’s education locks your child into attending a school he or she may not get into or want to attend. You will get a refund, but it might not equal what you would have made on another investment.
The College Savings Bank, in Princeton (800-888-2723), offers another type of prepayment plan, under which savings are compounded to keep up with the rising cost of tuition. But it, too, is probably a poor investment, financial planners say, in that the current rate of increase for college costs is just 6 percent, so your savings will earn only 6 percent, less than the return on many safe bonds.
The college savings bond. The old savings tool is still worth checking out if you’re going to be in a lower tax bracket when your children go to school. Currently, couples who make less than $60,000 a year - and single parents who make less than $40,000 a year - are exempt from paying taxes on the interest of U.S. Treasury Series EE bonds if they apply the principal and interest toward their children’s tuition. (This applies only to bonds issued starting in 1990.)
You must be 25 or older when you buy the $1,000 and $5,000 bonds, and you cannot use the money for room and board.