College Saving 101: Sorting through the choices

John W. Schoen Senior Producer • Profile • E-mail

As college freshmen begin heading off to school, their entry in the Class of 2009 represents the culmination of years of hard work and study, stress and sacrifice, anxiety and confusion. And the students worked hard, too.

But for their parents, sending a child to college is one of the biggest financial challenges out there. And it’s not getting any easier.

Last year, the average annual published price of tuition, fees, room and board for a private four-year college came to $27,516 -- up 6 percent from the year before, according to the College Board. A year at a four-year public colleges cost $11,354 – up 8 percent.

Aside from the burden of setting aside all that cash –- on top of saving for retirement –- parents today face a mind-boggling set of investment choices, each offering various features, fees and tax savings.

‘The best strategy for one family is not necessarily going to be the best for another.’ — Joseph Hurley Savingforcollege.com

“You have so many options out there that it does become somewhat of a task to compare those options and put together a strategy that works in your own circumstances,” said Joseph Hurley, a Rochester, N.Y.-area accountant who has written about college savings and publishes savingforcollege.com, a Web site devoted to the subject. “Because the best strategy for one family is not necessarily going to be the best for another.”

The road to college starts with a savings plan. If costs continue rising at roughly 6 percent a year -– the average increase for the past 10 years -– the total cost of a private four-year college a child born today, entering the Class of 2027 in 18 years, will hit roughly $325,000 -– assuming costs increase at about the same rate as they have for the past 10 years. For a public four-year college, in your state, figure more like half that amount.

So the first step for your plan is to take a deep breath. You won’t necessarily end up paying the full sticker price: some $122 billion in financial aid was available last year, according to the College Board. More than half of that was in the form of loans. So most families combine savings with college-funded financial aid packages, current income and loans to pay the bills.

Once you’ve decided to start saving, you still need to figure out how to make your savings work hardest by sheltering as much of your college fund as you can from taxes. The good news is that there is a nearly endless variety of savings options: From taxable accounts to to Education Savings Accounts to so-called 529 plans, set up specifically for college savers.  In general, these plans offer the biggest tax savings to those who use the money specifically for college. So if you’re not sure college is the goal, you may be better off waiting until your plans –- and your child’s intentions –- become clearer.

Taxable accounts
The simplest form of college savings is a taxable account: You set aside money in whatever savings investment you like — with no restrictions on how the money is spent. You retain full control of the money, but you’ll pay taxes — at your rate — on any capital gains or income generated by the fund.

To cut your tax bill, you may want to look at a so-called UGMA (Uniform Gift to Minors Act) or UTMA (Uniform Transfers to Minors Act) account. Here’s how they work:

Instead of keeping the money in your name, you set up the account in your child’s name, with you acting as custodian until the child reaches adulthood (defined, state by state, as anywhere between 18 and 21.) You'll get a tax break on the first $1,500 of investment income until your child reaches 14, at which point investment and income is taxed at the child’s tax rate, which is usually lower than yours. If you have investments that have appreciated in value, you can probably substantially cut your capital gains tax by giving them to your child's account (up to $11,000 a year per parent), and then applying your child’s lower capital gains rate when those investments are sold. 

There is one major drawback to this strategy: You can’t take the money back if your child decides not to go to college. Once they reach adulthood, the money is legally theirs — to do with as they wish. So, again, if your child’s higher education plans are up in the air, you may wish to retain control of the money.

Funding an account in your child’s name could also hurt their chances of collecting financial aid. That’s because assets held in a student’s name have a greater impact on the formula for calculating financial need than do assets held in the parents’ name.  

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