Saving for College

Don’t panic! College costs may be increasing at about twice the Consumer Price Index (CPI), tripling over the next 17 years, but you don’t have to save the full amount. Rather, follow the 1/3 – 1/3 – 1/3 rule to save one third of anticipated college costs:

• One third of college costs will come from past income in the form of savings,
• One third will come from current income and financial aid, and
• One third will come from future income in the form of loans.

This will help amortize the cost over an extended period, instead of having to pay the full amount all at once. If you combine the three-fold increase in college costs with the one-third rule, you should set a savings goal equal to college costs the year the baby was born.It is important to start saving as soon as possible. The earlier you start, the more time you’ll have for your savings to grow and the easier it will be to save. If you save $100 a month from birth at 5% interest, you’ll accumulate $32,186 by the time the child enrolls in college, with 36% of the savings coming from interest. On the other hand, if you start saving when the child is a high school freshman, you’ll need to save $605 a month and then less than 10% of the savings will come from interest. Time is your most valuable asset. The more you save, the easier it will be to pay for college. It is literally cheaper to save than to borrow. If you save $200 a month for 10 years at 6.8% interest, you’ll save a total of about $34,400. If instead of saving, you borrow this amount, you’ll pay $396 a month for 10 years at 6.8% interest, nearly twice as much. One of the best ways of saving for college is the section 529 college savings plan. This is a tax advantaged savings plan, where earnings are tax deferred (like a Roth IRA). If you use the distribution for qualified higher education expenses (tuition, fees, room and board), it is also tax free. Many states will even let you deduction all or part of your contributions on your state income tax return. To make it easier to save:

• Start off small and gradually increase the amount. It is more important to get started.
• Save on a regular schedule.
• Make saving automatic, so you don’t have to take any action to save. You can set up an automatic transfer from your checking or savings account into a college savings plan.
• Direct a portion of windfalls, such as income tax refunds, bonuses and inheritances, toward your children’s college savings plans.
• Use credit card loyalty programs like Upromise, which automatically deposit rebates from your everyday purchases in your children’s college savings plans.

Avoid the following common mistakes:

• Save in the parent’s name, not the child’s. Child assets are assessed at 20%, meaning that $10,000 in the child’s name will reduce need-based aid eligibility by $2,000. A portion of parent assets are sheltered – less than 7% of dependent students have any contribution from parent assets – and then assessed according to a bracketed scale, with a maximum rate of 5.64%. This means that the worst-case impact of $10,000 in the parent’s name is $564.
• Avoid advisor-sold 529 college savings plans, as these are often among the most expensive. Look at the fees charged by the 529 plans, and consider only those that have fees of around 1% or less.

Saving for college increases your child’s flexibility to choose the college that best meets their needs and will give you peace of mind knowing that you’ve provided for their future. Copyyright (c) 2007 by FinAid Page LLC (www.finaid.org). All rights reserved. Reprinted with permission.