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A Get-Real Guide to Saving for College

college fund

Paula Hible

If you've got a 3-year-old, financial planners will tell you that you need to save somewhere between $140,000 and $470,000 so you can send him to college.

No, we're not joking.

That means if you'd like your child to go to a top private college, you should be putting away about $1,500 a month starting -- well, starting about three years ago. If you're planning on sending him to a good state school, that's only -- gag! -- about $450 a month.

With numbers like those, how can any parent even think about saving for college -- especially right now, when those credit-card bills from your holiday shopping are starting to pile up on your desk? To get a reality check, we put that question to a group of financial experts -- and the good news is that, while daunting, it's not a lost cause. Here's what you need to know before you abandon the idea of saving for college altogether and decide to steer your child toward a career that doesn't require a degree.

baby in Harvard sweatshirt

Paula Hible

Over the past two decades, as competition for college admission has become increasingly fierce, the price of higher education has spiraled out of control. "Annual increases for average tuition and fees have consistently outpaced the rate of inflation, rising at a rate of roughly 6 percent a year," says Margaret Atkins Munro, a tax accountant in Essex Junction, Vermont, who specializes in college costs. As a result, paying full tuition for college has become beyond the reach of most middle-class Americans. In fact, a new survey estimates that parents nationwide will save enough to pay for only 24 percent of the total cost of their children's college education. "So you shouldn't beat yourself up if you won't be able to do for your kids what your parents did for you," Munro says. "It's a whole different ball game today."

But before you give up trying to save, there are a few things to keep in mind: First, those staggering savings requirements mentioned at the beginning are based on the assumption that you'll need to accumulate the full amount for college -- something that many American families aren't able to do and, in fact, may not even have to do. (More on that later.) Second, those sky-high numbers are also based on the prediction that college costs will continue to increase at the same rate as they have in the recent past -- and the reality is they may not. (More on that later too.)

But while you can breathe a little easier, that doesn't mean you're completely off the hook: Financial planners advise socking away money for your child's education as soon as you can -- even if it's only $20 a month. To get started, open a college fund for each of your children. Having a dedicated account will put you in the mind-set of saving and will ensure that you have a place to add extra money that you might hope to see in the years ahead. (Think salary increases, gifts from Grandma, possibly even an inheritance.) "The sooner you start saving, the more time your funds will have to grow. And the more money you have, the more choices your child will have when it's time for him to head off to college," Munro says.

Thanks to a recently passed tax law, the best way for families with young kids to save for college is through a 529 plan, named for the section of the Internal Revenue Code under which the plans were created. These investment accounts -- similar in many ways to a 401(k) -- allow you to put money into mutual funds, where it can grow and compound tax-free. "Then, when it comes time to pay for college, you can use the money, tax-free, for qualified education-related expenses," explains Joseph Hurley, CEO of Savingforcollege.com, a Web site that provides information on investment options. (Another bonus: Money in a 529 plan will not affect a child's eligibility for financial aid when he's in college. Funds in his name in a regular savings account or a trust fund, by contrast, may.)

The 529 plans are offered by 48 states and the District of Columbia, though they are usually run and administered by brokerage firms like Wells Fargo, Vanguard, and T. Rowe Price. No matter where you live, you can invest in any state's plan, though 29 states and the District of Columbia now offer extra tax advantages to their own residents. So be sure to investigate your home state's plan first. (Different plans have varying structures and fees.)

Some states also offer another type of 529 known as a "prepaid tuition plan," which allows you to pay for your child's future education (usually at a state university) at today's prices. Some families swear by these, but there are some potential drawbacks: When your child is in preschool, it's hard to know what the best college for her will be, and this type of savings plan can limit her options. While the plans usually have provisions for transferring the funds to out-of-state or private schools, you may have to pay extra fees to do it.

Also, most prepaid plans only cover tuition -- not room and board, which is usually a big chunk of college fees -- so you probably would need another 529 account to cover those. Talk to a financial advisor to determine what's best for you (make sure it isn't someone who will get a fee for steering you in a specific direction), or go to savingforcollege.com, where there's a tool for comparing various options.

Another tax-free college savings plan that you may have heard about is a Coverdell account. But the Coverdell tax benefits are set to expire in 2010, and at this point it's unclear whether Congress will extend them. So it's a safer bet to go with a 529 plan.

Don't get discouraged if you crunch the numbers and realize you'll never save enough to foot those staggering bills by the time your child turns 18. The fact is, about half of middle-class families don't pay the actual "sticker price" tuition that you hear from financial planners and see cited in college brochures -- and yet their kids still get a degree. How do they do it?

Believe it or not, more than 75 percent of full-time undergraduate students today get some kind of financial aid to cover college costs. Some of that comes in the form of scholarships that schools offer to attract high-achieving kids. Colleges seeking to increase their prestige, for example, will lure top students by giving them big tuition breaks, regardless of family income. Many schools with large endowments (think Ivy League) also promise assistance for any kid who's admitted but who can't afford to pay. (That's why encouraging kids to maintain good grades from the get-go is a smart component to any college plan.)

Another big chunk of financial assistance comes from loans. In fact, the percentage of full-time undergraduate students who borrowed for their higher education increased from a third in the early 1990s to about half today, says Kevin Walker, CEO of SimpleTuition.com, a comparison-shopping Web site for student loans. At present, there are three federal loan programs: the PLUS, Stafford, and Perkins loans, all of which have varying qualifying criteria, interest rates, and repayment plans. Another option for many families is using a tax-deductible home-equity line of credit to help defray college costs.

Finally, many parents use their regular income to help pay for college. When you're cash-strapped because of diaper, daycare, and preschool expenses, it's tough to imagine ever having extra money from your paycheck for college tuition. But remember that you're not in your peak earning years when your kids are young. In 15 years, your salary will likely be higher than it is today; some child-related costs will have gone away; and you'll have more disposable income to help with those tuition bills.

Here's something else to remember when you read about those sky-high college costs: They are projections of tomorrow's prices based on what's happening today. But experts say the cost of higher education has gotten so outrageous that it will likely be reined in before today's 2-year-old graduates from high school. For example, some demographers think that the number of applicants may decrease in another couple of decades, so colleges may have to compete for students by discounting their fees. Also, if higher-education costs remain out of reach for lower- and middle-income families, look to the government to come up with new loan and grant programs to help students out.

At this point, there's no way to predict for sure what the future landscape of college costs will look like. But you can give your child a good head start right now by planning wisely and saving as much as you possibly can -- and trying not to take those staggering numbers too seriously.

Think you're too strapped to put away any extra cash for college? Think again! Here, Margaret Atkins Munro, author of 529 & Other College Savings Plans for Dummies and mother of a 12-year-old son, shares five secrets for finding "hidden" money.

  • Tip #1 Stash away pretax earnings through a "Dependent Care Account" at work. Many companies allow workers to deduct up to $5,000 in pretax dollars from their paycheck and use the money to cover childcare expenses, such as day camp, preschool tuition, and after-school care. Not only does this save you money on taxes, but it also can be an easy savings vehicle for college. How so? Once you get reimbursed for your eligible expenses, just deposit the check (or the portion of it you don't need to pay bills) into your 529 college plan.
  • Tip #2 Reallocate childcare expenses and preschool tuition to a college savings account when your child starts elementary school. Some families pay more than $1,000 a month for daycare and more than $850 a month for preschool. But when your child goes to public kindergarten, those fixed expenses will go away -- and you can stash most of it into a college savings account. Just make sure you're fully funding your retirement first.
  • Tip #3 Use "rewards" credit cards. Get a card that gives you a "point" for every dollar you spend. Charge most of your household expenses and big-ticket items so you build points superfast. Rather than redeeming them for prizes, take the cash back for your child's college account. You can also use a credit card that's affiliated with a so-called "affinity program" -- such as Upromise.com or BabyMint.com -- that contributes money toward a college fund when you buy qualifying products at participating stores.
  • Tip #4 Bank your coins. If you spend only bills and put all your change in a jar, you'll save up to $400 a year. Set aside one day a month to take your kids to a bank that has a free coin-counting machine. This is also a good way to teach them about money and simple math.
  • Tip #5 Ask grandparents to help. Have a frank talk with your parents or in-laws about the high cost of college. Then, suggest they reduce the number of presents they give your child and instead deposit some of the money into her college account. Your daughter won't notice if she gets one fewer stuffed animal or DVD on her birthday -- but cash contributions over a 10- to 15-year time period, no matter how small, can really add up.



Copyright © 2008. Used with permission from the February 2008 issue of Parents magazine.