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		YOUR CHILD'S COLLEGE EDUCATION:  How To Finance It
		How can you properly fund your children’s education without draining your current cash flow? What should you do if they are a few years away from college and your education fund won’t be enough? How can you increase your chances of getting financial aid? What tax benefits might be available to you? This Financial Guide answers these questions.

TABLE OF CONTENTS

Savings And Investment Strategies
If You're Caught Short
Sources Of Financial Aid
Planning Techniques
How To Reduce Taxes
INFOSOURCES

With the costs of a college education rising every year, the keys to funding your child’s education are to plan early and invest shrewdly. However, there are steps you can take if you get a late start. Moreover, there are a number of effective techniques for increasing financial aid opportunities and reducing taxes.

SAVINGS AND INVESTMENT STRATEGIES

The thought of funding your child’s education—the cost of which has grown at about 6% a year—can be staggering. However, proper planning can lessen the financial squeeze considerably, especially if you start when your child is young.

Here are some guidelines--geared to parents whose children are no older than elementary school age--for funding your child’s education.

Start Saving Early

We cannot emphasize enough that getting an early start is basic to funding your child’s education. The earlier you start, the more you’ll benefit from the compounding of interest.

When should you start saving? This depends on how much you think your children’s education will cost. The best way is to start saving before they are born. The sooner you begin, the less money you will have to put away each year.

Another advantage of starting early is that you’ll have more flexibility when it comes to the type of investment you’ll use. You’ll be able to put at least part of your money in equities, which, although riskier in the short-run, are better able to outpace inflation than other investments after time.

Find Out How Much You’ll Need To Save

How much will your child’s education cost? It depends on whether your child attends a private or state school. In the late-90s, the total expenses--tuition, fees, board, personal expenses, and books and supplies--for the average private college are about $21,000 per year and about $10,000 per year for the average public college.  However, these amounts are averages: the tuition, fees, and board for some private colleges can cost more than $25,000 per year, whereas the costs for a state school can be kept under $10,000 per year.

Don’t forget to add the costs of graduate or professional school to the amount your child will need.

Choose Your Investments

As with any investment, you should choose those that will provide you with a good return and that meet your level of risk tolerance. The ones you choose should depend on when you start your savings plan—the mix of investments if you start when your child is a toddler should be different from those used if you start when your child is age 12.

The following are often recommended as investments suitable for education funds:

Series EE Bonds are extremely safe investments. For tax treatment of redemption proceeds used for college, please see the Financial Guide: HIGHER EDUCATION COSTS: How To Get The Best Tax Treatment.

U.S. Government Bonds are also safe investments that offer a relatively higher return. If you use zero-coupon bonds, you can time the receipt of the proceeds to fall in the year when you need the money. A drawback of such bonds is that a sale before their maturity date could result in a loss on the investment. Further, the accrued interest is taxable even though you don’t receive it until maturity.

CDs are safe, but usually provide a lower return than the rate of inflation. The interest is taxable.

Municipal Bonds, if they are highly rated, can provide an acceptable return from the tax-free interest if you’re in the higher income tax brackets. Zero-coupon municipals can be timed to fall due when you need the funds and are useful if you begin saving later in the child’s life.

Stocks contained in an appropriate mutual fund or portfolio can provide you with a higher yield at an acceptable risk level. Stock mutual funds can provide superior returns over the long term. Income and balanced funds can meet the investment needs of those who begin saving when the child is older.

Deferred Annuities provide you with tax deferral, but the yield may not be acceptable because of the relatively high cost of these investments. Further, amounts withdrawn before you reach age 59-1/2 may be subject to a 10% premature withdrawal penalty.

IF YOU’RE CAUGHT SHORT

If you have insufficient savings for your child’s education when he or she is close to entering college, there are ways to generate additional funds both now and when your child is about to enter school:

1. You can start saving as much as possible during the remaining years. However, unless your income level is high enough to support an extremely stringent savings plan, you will probably fall short of the amount you need.
2. You can take on a part-time job. However, this will raise your income for purposes of determining whether you are eligible for certain types of student aid. In addition, your child may be able to take on part-time or summer jobs
3. You can tap your assets by taking out a home equity loan or a personal loan, selling assets or borrowing from a 401(k) plan.

4. You (or your child) can apply for various types of student aid and education loans (discussed below and in InfoSources).

SOURCES OF FINANCIAL AID

Here is a summary of the possible sources of financial aid. The types of aid and tax implications change frequently, so consult your financial advisor for specifics when you’re approaching the time to seek financial aid.

Grants, the best type of financial aid because they do not have to be paid back, are amounts awarded by governments, schools, and other organizations. Some grants are need-based and others are not.

• Pell grants are federal aid based on need.

• State education departments may make grants available. Inquiries should be made of the state agency. Employers may provide subsidies.
• Private organizations may provide scholarships. Inquiries should be made at schools.
• Most schools provide aid and scholarships, both needs-based and non-needs-based.
• Military scholarships are available to those who enlist in the Reserves, National Guard, or Reserve Officers Training Corps. Inquiries should be made at the branch of service.

Loans may be need-based, and others are not. Here is a summary of loans:

• Stafford loans (formerly guaranteed student loans) are federally guaranteed and subsidized low-interest loans made by local lenders and the federal government. They are needs-based for subsidized loans; however an unsubsidized version is also available.
  
• Perkins loans are provided by the federal government and administered by schools. They are needs-based. Inquiries should be made at school aid offices.
  
• Parent loans for undergraduate students (PLUS) and supplemental loans for students are federally guaranteed loans by local lenders to parents, not students. Inquiries should be made at college aid offices or by calling 800-333-4636.
  
• Schools themselves may provide student loans. Inquiries should be made at the school.

Work-Study Programs. This is a program that is federally funded and based on the family’s financial need. The student works on-campus and receives partly subsidized pay. The receipt of work-study funds does not affect the level of "need" for purposes of need-based grants and loans.

To make a thorough investigation, you should fill out the financial aid application, which you can obtain from the school’s financial aid office. You will have to provide tax returns. The amount you are determined to be eligible for depends on your income, the size of your family, the number of family members currently attending college, and your assets.

PLANNING TECHNIQUES

There are a number of techniques that you can use to try to increase the amount of financial aid or to reduce tax on the income being accumulated.

How To Increase The Amount Of Financial Aid

Here are some strategies that may increase the amount of aid for which your family is eligible:

1.  Try to avoid putting assets in your child’s name. As a general rule, education funds should be kept in the parents’ names, since investments in a child’s name can impact negatively on aid eligibility. For example, the rules for determining financial aid decrease the amount of aid for which a child is eligible by 35% of assets the child owns and by 50% of the child’s income.

2. Reduce your income. Income for financial aid purposes is generally determined based upon your previous year’s income tax situation. Therefore, in the years immediately prior to and during college, try to reduce your taxable income. Some ways to do this include:

• Defer capital gains.
• Sell losing investments.
• Reduce the income from your business. If you are the owner of your own business, you may be able to reduce your taxable income by taking a lower salary, deferring bonuses, etc.
• Avoid distributions from retirement plans or IRAs in these years.
• Pay your federal and state taxes during the year in the form of estimated payments rather than waiting until April 15 of the following year.
• Since a portion of discretionary assets is included in the family’s expected contribution from income, reduce discretionary assets by paying off credit cards and other consumer loans.
• Take advantage of vehicles which defer income, such as 401(k) plans, other retirement plans or annuities.

3. Detail your financial hardships. If you have any financial hardships, let the deciding authorities know (via the statement of financial need) exactly what they are, if they are not clear on the application. The financial aid officer may be able to assist you in explaining hardships.

4. Have your child become independent (if feasible). In this case, your income is not considered in determining how much aid your child will be eligible for. Students are considered independent if they:

• Are at least 24 years old by the end of the year for which they are applying for aid,
• Are veterans,
• Have dependents other than their spouse,
• Are wards of the court or both parents are deceased,
• Are graduate or professional students or
• Are married and are not claimed as dependents on their parents’ returns.

HOW TO REDUCE TAXES

As noted above, education funds should generally be kept in the parents’ names because of financial-aid considerations. However, in specific cases, it may be better to keep the investments in your child’s name since the tax rate on the income will be less than if they are held in your name. Professional advice should be sought in making this decision.

In the past, parents would invest in the child’s name in order to shift income to the lower-bracket child. However, the addition of the "kiddie tax" mostly put an end to that strategy. Now, investment income over $1,600 for 2005 (the same as for 2004) of children under the age of 14 is taxed at the parents’ rate. (This threshold is indexed annually for inflation.) Once the child reaches age 14, however, all income is taxed at the child’s rate. Of this $1,600, one-half probably won’t be taxed due to the availability of the standard deduction while the other half would be taxed at the child’s rate.

Note: These rules apply to unearned income. If a child has earned income, this amount is always taxed at the child’s rate. If you decide to invest in your child’s name, here are some tax strategies to consider:

1. You can shift just enough assets to create $1,600 in taxable income to an under-14 child.
2. You can buy U.S. Savings Bonds (in the child’s name) scheduled to mature after your child reaches age 14.

   Caution: Buying in the child’s name forfeits tax relief otherwise available where bonds are redeemed to pay college expenses.

3. You can invest in equities that pay small dividends but have a lot of potential for appreciation. The income earned when your child is under 14 will be minimal, and the growth in the stocks will occur over the long term.
4. You can, under The Uniform Gifts/Transfers to Minors Acts, establish a custodianship for your child. Gifts to children under these acts are irrevocable, so you run the risk that your child will use the money for non-educational purposes once he or she reaches the age of majority—a determining negative factor for many parents.
5. You can set up a trust for your child.
6. If you own a family business, you can employ your child in the business. Earned income is not subject to the "kiddie-tax," and is deductible by the business if the child is performing a legitimate function. Additionally, if your business is a sole proprietorship and your child is under 18, then he or she will not pay social security taxes on the income.

There are also a number of tax incentives that you might be able to take advantage of. Please see the Financial Guide: HIGHER EDUCATION COSTS: How To Get The Best Tax Treatment.

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Related FGs

• INVESTMENT BASICS: What You Should Know
• ANNUITIES: How They Work and When You Should Use Them
• HOME EQUITY LOANS: How To Shop For The One That's Best For You
• HIGHER EDUCATION COSTS: How To Get The Maximum Deduction

Financial Calculators

• How do colleges rank?

Books and Other Publications

• The College Board’s College Cost Book (available through high school guidance counselors or libraries).
• The ACT’s College Planning/Search Book (available through high school guidance counselors or libraries).
• Guide To Scholarships And Fellowships For Math And Science Students (Prentice Hall, 800-643-5506)
• College Student's Guide to Merit and Other No-Need Funding: 1998-2000 Reference Service Press. 
• The Student Access Guide to Paying for College (Random House, 800-733-300, cost: about $16).
• Don’t Miss Out: The Ambitious Student’s Guide to Financial Aid (Octameron Associates, 703-836-5480, Cost: about $7). (Octameron has other titles relating to college admissions and financing available.)

Government And Non-Profit Agencies

• U.S. Department of Education (for information on financial aid): 800-433-7327

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