A Nest Egg For College Bound
Saving for college is the second biggest financial concern behind retirement planning for parents with children younger than 18.
And there are a whole host of ways to come up with the cash to send your child to college, junior college or trade school, whatever the case may be. The Early Show's Financial Adviser Ray Martin explains some options.
According to an annual survey from Fidelity Investments polling parents of college-bound kids, only half of Americans are saving regularly for a higher education for their children.
The basic advice from parents with kids in college, however, is to start saving now, to do so often and to increase what you set aside whenever possible.
Costs of Higher Education:
The cost of going to college is rising at an annual rate of 5 percent to 6 percent. According to Fidelity, the average cost for a four-year private college in the United States is $19,844 and for a four-year public college, it's $8,106.
If you have a 2-year-old son, by the time he is 18, assuming a 5 percent inflation rate and assuming an annual tuition of $20,000, you will probably pay about $43,700 a year.
College Calculators on the Web:
A number of Web sites calculate how much you're likely to spend on college by the time your child reaches 18.
You simply have to type in some basic information, such as your child's age or the type of school. Some sites even allow you to type in the exact school you want your kid to attend. Web sites include the following: Quicken.com and Parenttime College Planner at Pathfinder.com.
Choosing an Education Savings Plan
You need to consider the following before determining where to put your child's college money:
- The child's age.
- Your preferences when it comes to control over money.
- Your tax situation.
- Whether financial aid is being tapped.
How Americans Save for College:
According to a survey by the College Savings Plan Network, about half of Americans rely on passbook savings accounts to pay for their children's college tuition.
But Marshall Bennett, the network's chairman, stated in a Washington Times article, "Savings accounts are a poor choice for college savings because they are not even keeping up with the inflation rate.
The network study also found the following statistics:
- Thirty-seven percent of those surveyed were investing their kids' college money in mutual funds.
- Sixteen percent of them were using U.S. savings bods.
- Forty-seven percent of those surveyed were using passbook savings accounts.
- Seven percent of those surveyed were using life insurance.
- Five percent of those surveyed were using Educational IRAs.
- Four percent were using CDs.
Savings accounts generally earn about 2 percent. That's less than the cost of tuition inflation, which is about 5 percent. So a regular savings account might not be able to cover your costs.
Types of College Accounts
Personal account: There are two advantages to using your personal account to save for college.
The account is in your own name, and you won't be penalized for using the money on something other than education since there are no strings attached.
The drawback is that if you're not a financial wizard, you may not be putting your money into the right investments.
Custodial account: The big advantage to a custodial account is the tax break. The first $700 is tax-free, and the next $700 is taxed at the child's rate, not the donor's rate.
Custodial accounts are called UGMAs and UTMAs in reference to the Uniform Gifts to Minors Act and the Uniform Transfers to Minors Act. Both have been around for a while.
State-sponsored college savings plans: These plans were made possible under Section 529 of the tax code. They invest your money in structured portfolio plans. If you're lucky enough to have a rich relative, you can put up to $50,000 a year into acollege savings plan.
About 40 states offer these plans, and about half of those states allow nonresidents to invest in them. About half of those 40 states require you go to college in state.
If you've got money left over after paying for college, that extra money is taxed at the parents' rate but is not considered a capital gain.
And these plans tend to invest conservatively, primarily in bonds and cash. These accounts grow federal and state tax-deferred until funds are withdrawn for higher-education expenses. Earnings withdrawn to pay for education are taxed at the child's rate.
Prepaid tuition: Another type of higher education plan available under the 529 tax code is prepaid tuition. The real benefit of prepaid tuition is that parents actually lock in a specific tuition price when they start to invest. It's a way to hedge against inflation.
These accounts are in the contributor's name, not the child's. The disadvantage is that you have to pick a specific school and then must send your child to that school.
Education IRA: The Education IRA, not to be confused with the traditional IRA, first came into being in 1998. An Education IRA is tax-free when the withdrawals are used for higher education.
But, as with the college savings plans, there are penalties for using the money for oher purposes. Those investment gains are taxed at the beneficiary's rate, plus a 10 percent penalty. The Education IRA is self-directed, meaning you get to choose the investments.
Not everyone is eligible for an Education IRA; there are income restrictions. The annual contribution is limited to $500. And you may be penalized when it comes time to apply for financial aid since the assets are considered the child's.
None of the plans are mutually exclusive. You can do a combination But beware, there is a 6 percent penalty charge if contributions are made to an Education IRA and a Section 529 plan in the same year.