A client couple at IDS Financial Services has a baby called Chance who hasn’t been conceived yet. Chance’s parents already have money set aside for the unborn’s college education.
Exaggerated planning?
Not really.
Over the last 10 years, private four-year colleges have raised their tuition an average of 8.4 percent each year and public four-year colleges have hiked theirs 8.5 percent, according to figures from the College Board’s 1992 Annual Survey of Colleges.
Including room and board, a year of college now costs roughly $15,073 at a four-year private school and $5,841 at a four-year state school.
If you fall in the vast group of middle-class families who are too rich to qualify for full financial aid but too poor to just write out a college-expense check without selling the house, be prepared to add savings to any scholarships or government-backed student loans your child might get.
Chance’s parents may set a tough standard, but the earlier you start to save, the more flexibility you will have in choosing a school.
“Most people procrastinate,” said Mark S. Ryan, a certified financial planner with IDS in Delray Beach, Fla. “About 50 percent wait until the child is 8 to 10 years old, about another 50 start earlier, but the real smart ones start as soon as the child is born.”
How much you’ll need in savings depends in large part on what school your child will attend. Tuition and fees for the middle 50 percent of private four-year colleges ranged from $5,940 to $11,150 in 1992-93 and from $1,560 to $2,812 at public institutions.
With the drop in interest rates, financial planners favor mutual funds to set aside money for college.
For parents with a child who is 10 years or more away from college, financial planners generally recommend mutual funds that invest heavily in common stock; over the long run, they are considered to yield the greatest return.
“Primarily, we’ll use both growth and income funds,” Ryan said. If the child’s already in high school, he said, “we wouldn’t go with a growth fund because you don’t have so much time to go through the growth cycle. We would go more with corporate or government bond funds.”
Most of Ryan’s clients invest $100 to $300 a month and increase the monthly amount each year by the inflation rate, he said. They also use dollar cost averaging-investing a fixed dollar amount periodically in a fund over a period of time, thus buying more shares when the price is low and fewer shares when the price is high.
The Uniform Transfers to Minors Act allows you to put the fund in your child’s name, which has a tax advantage: If the child is under 14, the first $500 of earnings on the fund is tax free, and the second $500 is taxed at 15 percent; earnings above that are taxed at the parents’ rate. If the child is over 14, all earnings are taxed at the child’s rate.
Keep in mind that if you transfer the assets to your child, your transfer is irrevocable and the child can legally decide how to spend the money when he or she reaches legal adult age.
Florida is among several states that offer a pre-paid tuition plan for the state’s four-year universities and two-year community colleges. The program lets you pay today for your child’s education years from now.
For example, for a child going into the 6th grade, $5,297 now will pay for four years of tuition at any of the state’s nine public universities, starting in the year 2000, when the child would begin college. You also could pay $77 a month until 2000. A third option is 55 monthly payments of $114. The average annual tuition at Florida’s nine state universities now is $1,705.
The program has its critics and its advocates.
Critics say the plan ties up an amount of money that you could invest elsewhere. “I just think over the long period of time, an investment should have a better rate of return than the inflated cost of college,” said Ben Tobias, a certified financial planner in Pembroke Pines, Fla.
But others say the potential loss of interest is a fair price for locking in college costs. “It’s inexpensive,” said Robert Moring, a certified financial planner in Miami. “And if people think they’re going to keep their kids in Florida, it’s a no-lose transaction.”
What Illinois offers
A proposal to implement such a plan in Illinois was vetoed by Gov. Jim Edgar in 1991 and failed to get through the state legislature the last two years, according to Ross Hodel, deputy director of the Illinois Board of Higher Education, but the state does have a savings bond program to help with college tuition.
Maturity dates on Illinois bonds range from 2 to 20 years. The bonds are bought at deep discounts of $1,000 to $3,500, depending on the date of maturity and the yield, and are structured like zero coupon bonds, which means no interest is paid until they reach maturity. At maturity, each of the bonds is worth $5,000. Depending on the supply, purchasers can buy as many bonds as they want.
The proceeds of the bonds are exempt from federal and state income tax, and up to $25,000 is exempt from the state student financial aid needs test administered by the Illinois State Scholarship Commission.
In addition, the tax-free earnings don’t have to be used at Illinois colleges-or even at any college.
“If a purchaser wants to take a vacation to Hawaii (with the money), that’s OK,” said Hodel. “There was some talk of having a penalty for those who did not use it for college, but that was considered too cumbersome administratively. So, the legislature decided to take the reverse tack and have incentives for those who do use it for tuition at an Illinois college.”
The incentive is that the state will contribute an extra $20 directly to the school for every year a bond is held until maturity-so, it can range from $40 to $400 per bond-for the first seven bonds purchased.
But what if you saved and your child got scholarships and loans, and you still fall short a few hundred or a few thousand?
Borrowing from your 401(k) retirement assets is an option. You pay yourself back according to repayment terms set by your plan’s administrator. Typically, you will pay less interest than if you borrowed from a bank, and you would be repaying yourself.
“I usually tell folks, `Would you rather borrow money from the bank and pay 10 to 12 percent, or borrow money from yourself and pay yourself 8 percent interest?’ ” Ryan said.
Borrowing from your 401(k) is a better alternative than withdrawing early from a flexible or variable annuity, which would be taxable and would carry a 10 percent penalty if withdrawn before age 59 1/2, Ryan said.
T. Rowe Price offers a free, step-by-step college-planning kit. To order one, call 800-638-5660
