College tuition has been escalating at a rapid pace, and with every uptick, parental anxiety about how to foot the bills rises, too.
Now, the State of Illinois is acting to help quell those fears by introducing tax-favored savings plans specifically designed to ensure the money will be there when a child is ready for college.
This means more investment products will be available for college–a plus for parents looking for a savings vehicle compatible with their personal financial profile. But with choice can come confusion, especially since investing in one product can impact or curtail your ability to invest in another.
Here, then, a short primer on options that will debut soon:
– Illinois is re-introducing a popular federal and state tax-exempt “college bond” offering this month, with sales set for just a four-day period next week, from Monday through Thursday.
“These are zero-coupon bonds that are sold at a discount and are then worth $5,000 at the time they mature,” explains Kurt Kauffman, bond analyst with the Illinois Bureau of the Budget.
What bond buyers will pay depends on the exact market conditions for the AA-rated bonds during that four-day period, and what maturity they stipulate.
“For instance, the maximum maturity available will be in the year 2019, and a bond with that maturity date will cost about $1,570,” says Kauffman. “The earliest maturity will be 2001, and given current prices that will cost $4,270.”
Although the exact yields on the bonds can’t yet be predicted, a bond held for 22 years may yield about 5.4 percent and a four-year term may yield 4.3 percent.
If the child that the bond is purchased for decides to go to a public or private college in Illinois, the yield is even bigger, because the Illinois Student Assistance Commission will pay a $20 bonus for each year of the term of the bond, up to $440 per bond.
So why choose the bonds when you can search for a high-flying equity mutual fund?
“If you have a relatively short horizon (before your child goes to college) you don’t want to be chasing a high-growth mutual fund that is going to outdo the bond,” counsels Dr. Robert Weagley, a professor of consumer and family economics at the University of Missouri.
Parents who begin saving early–say, when their child is a toddler–can afford to chase high yields and assume the accompanying risks, because the ups and downs of the stock market will iron themselves out over the long haul, adds Weagley.
On the other hand, parents who start investing when a student is in high school could find themselves at a loss if the Dow Jones takes a downturn just when they have to begin paying for college.
These bonds hold more of an attraction for parents with a relatively short time line, agrees Bryan Malis, manager in the financial counseling services group in the Chicago office of Deloitte & Touche.
The federal and state tax exemptions on the earnings also make these an appropriate choice for families in high tax brackets, adds Malis.
The State of Illinois 1997 General Obligation College Savings Bond issues will be available through the following firms: First Chicago, A.G. Edwards, Edward D. Jones, Everen, Fidelity Capital Markets, Harris Bank, Merrill Lynch, Morgan Stanley Dean Witter, Paine Webber and Smith Barney.
– While the college bonds offer the guarantee of a certain yield, Illinois will begin marketing a “prepaid tuition” plan next spring that speaks directly to the concern of whether there will be enough money there when the tuition bills roll in, at least if your child elects to go to a community college or state university in Illinois.
In a nutshell, explains Randy Erford of the Illinois Student Assistance Commission (ISAC), parents (or others, such as a grandparent) can pay the current cost of one semester of tuition and mandatory fees at public universities in the state (or choose the community college plan) and then be guaranteed that when their child starts school, the tuition and fees have already been paid, no matter how much those costs escalate.
Parents can pre-pay just one semester, or up to nine semesters (some college majors require nine semesters). “We’ve designed our program to be especially accessible to all families,” explains Erford, “because you can pay each semester in installments, too.”
A prepaid tuition contract must be at least three years, explains Erford, meaning that you can purchase them for a child who won’t be attending college for at least three years. If a child then doesn’t want to attend a state university here, ISAC, the administrator of the plan, will transfer the value of the contract, which would be the average current costs of tuition and fees at all of the Illinois public universities, to a school of the student’s choice.
It’s all a bit complicated, which is why parents should really understand all of the provisions before embarking on one of these plans. Still, tuition and mandatory fees for Illinois state schools have increased 55.7 percent over the seven-year period from 1990-1997, reports ISAC.
“The prepaid tuition plans are appropriate for individuals who don’t want to make investment decisions on their own,” comments Amy Coleman, tax manager in the Chicago office of Arthur Andersen. “There is a simplicity to it; someone is actually telling you just how much to contribute so that tuition costs will be covered.”
On the other hand, Coleman notes that as is the case with the college savings bonds, prepaid tuition is probably more appropriate if a child is just a few years away for college. Parents with a long-term time horizon can afford to take greater risks and chase greater yields.
If you choose the prepaid tuition plan, you should be aware that the IRS will forbid you to contribute to one of the new “Education IRAs” for that child the same year that you or anyone else is making contributions to his or her prepaid tuition plan. “Understanding which investments are mutually exclusive is important,” underscores Malis.
Financial planners will probably be busy in the next few years, running scenarios for anxious parents on which plan works best for them. There are other complicating factors that, because of space limitations, can’t be covered here, including how prepaid tuition plans can directly reduce tuition costs, which in turn can reduce financial aid offers.
Aside from the complicated tax issues, though, Weagley says there’s a comforting psychological benefit of saving in an investment specifically earmarked for your child’s college.
“It increases the likelihood that a child will see that the goal of college is something that everyone believes in for him. These investments provide a psychological motivation for the child to get him going in a college direction.”
