By Rosilyn H. Overton, CFP, CRPS
As you watch your child head out the door for school, that gnawing feeling in the pit of your stomach isn’t last night’s pizza and garlic knots — it’s your anxiety about how you are going to pay for all the education he or she needs. And, unless your child is a star athlete, don’t count on much in the way of scholarships. Most scholarships these days are based not on academic excellence, but on financial need with only minimal academic standards.
Let’s face it, you won’t be considered poor enough. The percentage of your income that the financial aid officers think should be available for your child’s education is staggering, particularly if you have other children for whom you are struggling to pay private school tuition. Your child is going to have to rely on what you have saved and can pay out of current income, student loans, and what he or she can earn while going to college.
The part that you can handle, the savings, can be a double-edged sword, cutting your child out of available financial aid and loans unless you handle it correctly. Fortunately, the latest version of the tax code has some provisions that can make saving a bit more effective, letting your savings and investment grow without taxes, and even allowing you to never pay taxes on money used for qualified educational expenses. The trick is to start as early as possible, put away money systematically every pay period, and use the tax provisions wisely.
First off, figure out what you will need. The Motley Fool, that quirky online financial site, has a pretty good explanation of how to figure it out, including an online calculator, www.fool.com/csc/csc01.htm.
But you can do some quick and dirty calculations without a computer. According to the College Board, in today’s dollars, if your child plans to attend a state or city school, you need to have about $50,000 set aside to pay for tuition, room and board for four years. For a private institution, you need about $110,000. If he or she will live at home, tuition runs a little less than half that. (Apparently, the massive quantities of food that will disappear from your refrigerator during the college years are considered free!) At a 5 percent after-inflation rate return, a rate that should be achievable with a combination of mutual funds and bank accounts, over 10 years a monthly savings of $320 should come out close to $50,000, and a monthly savings of $710 should allow you to reach the $110,000 needed for a private school.
These are hefty numbers for parents who are also paying current living expenses for themselves and their kids and trying to save for their own retirement. For many, it represents not buying a new car for 10 years, and banking the payments anyway. And, we didn’t even allow for income taxes. However, with these numbers as a target, you should start saving today, and put aside as much as you can. It is hard for students to make good grades and learn well while working, so maybe you can pay some out of then current income, and keep the student’s time working to a minimum.
However much you save, there is a reason for ignoring taxes. Between Section 529 plans and Coverdell accounts, paying taxes on savings used for education just means you aren’t paying attention. Let’s briefly examine these plans work.
The old Education IRA has rid itself of its misnomer and is now called a Coverdell Education Savings Account. If you have Adjusted Gross Income of less than $95,000 if single, or less than $190,000 if married, filing jointly, then you can contribute $2,000 per year into a Coverdell ESA for any child. If you make more than that, simply give the money to the child and twist their arm until they put it into a Coverdell for themselves. Money from the Coverdell can be used for most bona fide education expenses, even for secondary and elementary school, not just college, without taxes on the earnings. The money must be used by the time the beneficiary is age 30, but it can be transferred to a relative’s name if the little guy has ditched school, dyed his hair purple and is trying to make it as a rock star. You can open Coverdell accounts at banks, brokerage firms and mutual fund companies.
The next most popular college plan is the 529 plan. The 529 plan can be of two types, prepaid tuition plans and college savings plans. The prepaid tuition plans are state specific, and New York does not offer one. The 529 College Savings plan allows much larger contributions (more than $200,000 in some plans), and is limited to specific investments at specific providers, most of which are mutual fund or insurance companies. They can be purchased over the telephone from telemarketers at the company or through your broker. You don’t have to use the New York State plan, although you do get a tax-deduction worth up to slightly more than $600 if you do. Every state’s plan is different, and they vary wildly in their provisions. At the Savings For College Web site, www.savingsforcollege.com, you can compare plans until you find the one that is right for you, or you can consult a financial planner or stockbroker.
Performance, investment flexibility and expenses are three major characteristics you should consider. One great thing about 529 plans as a parent or grandparent is that you retain control even after the child is age 18, so you can make sure that the funds are used for what they should be. For persons with substantial assets, the money is removed from your estate, while you still retain control, protecting the money from estate taxes. Like the Coverdell, you can change beneficiaries, but there is no age limit on when the funds must be used. If you are thinking about going back to school, you might consider opening a 529 plan for yourself. Contributions into 529 plans are subject to the Unified Gift and Estate Tax provisions, so you do not want to exceed more than $11,000 per year per person ($22,000 for a married couple), unless you take advantage of a special provision that allows you to spread your larger contribution over several years.
Whatever you do, do it now, and do it steadily. As with most financial objectives, planning and consistency are key. Don’t allow yourself to become paralyzed because the amounts needed seem so large. Anything is better than doing nothing.
Rosilyn H. Overton is a Certified Financial Planner and Chartered Retirement Plan Specialist who owns the Mid-Atlantic Securities, Inc. (Member, NASD & SIPC) office in Little Neck. She can be reached at 631-4000.
