A College Education for Children Still One of Biggest Burdens for American Families

When Winthrop Smith’s baby was born last month, Smith took out his calculator and figured out how much it would cost to send little Cameron to Harvard when the time came.

“I’m a little pessimistic about educational inflation,” he said. “The thing that concerns me is that faculty salaries are so low relative to others right now.”

Since college costs have been increasing at 9% a year over the last decade, Smith guessed they may continue to rise at about 8%.

“When I look at it like that, I figure my 1-month-old baby is going to cost me roughly $260,000,” he said.

Paying for college education is one of the biggest financial burdens most families face. Unlike other costly goals, such as buying a home or preparing for retirement, it must be paid for without any real encouragement from Uncle Sam.

The government makes mortgage interest deductible to make home owning easier, and helps workers prepare for retirement through tax-deductible Individual Retirement Accounts.

No Government Support

But there is no similar support when the time comes to send Junior off to Princeton.

“Educating the next generation is evidently not as much in the national interest as buying a vacation house or taking a customer out to a $150 lunch,” complained an Ohio father of four who has financed his offspring through six advanced degrees.

Since the cost of college is not deductible, a couple in the 50% bracket would, in effect, have to earn $10,000 in order to pay a $5,000 college bill.

“This is one of the biggest interruptions in capital accumulation for the middle-income family,” said Lewis Wallensky, a Los Angeles financial planning consultant. “And if you have two or three children in college at the same time, it really becomes a killer.”

The cost of a college education, of course, can vary wildly, depending on whether the child goes to a public or private school, a community college or a four-year university. Living at home may save money although that isn’t inevitably the case. A youngster living in a dormitory, for instance, needs no car.

Winthrop Smith, who did the Harvard calculations, is director of emerging investor business at Merrill Lynch, and in the business of encouraging parents to put away money for their offsprings’ future education. But other estimates are not much more encouraging.

The average cost of one year of college now is about what four years cost in 1963. A study by the American Council of Education put the average cost of attending college in 1984-85 at a little over $6,000. Public schools cost about $5,000, while independents required more than $9,500 to pay for tuition, room and board, books and expenses.

“In 20 years, the average cost of a college education is going to be $140,000 or more,” predicted Alexander Bove, a Boston tax lawyer.

Bove’s new book, “Nearly Free Tuition,” describes strategies for getting tax breaks on college payments. The book, published by Viking, is aimed at parents in higher tax brackets, where sheltering college-earmarked savings from the IRS is a priority.

People lose opportunities to save money, he claimed, by failing to plan. “Any kind of planning takes positive steps. Your lawyer and accountant aren’t lying awake nights thinking about financing your child’s education.”

Strategies for coping with college costs are radically different for a couple just celebrating the arrival of their first child and one that becomes uncomfortably aware the twins have just turned 16.

Start Young

“Start when you’re young,” advises Wallensky. “I can’t emphasize that strongly enough.”

One of Wallensky’s favorite tactics is to get new parents to begin putting a set amount into a mutual fund every month. That system, known as dollar-cost averaging, takes the emotion out of playing the stock market by investing a set sum at regular intervals. Most financial planners believe that on the long run, the system will produce substantial growth.

“It works. We have people who began in 1967, putting away $100-$200 a month. When the time comes to pay for college, they just breeze through,” Wallensky said.

If investors prefer the security of a regular savings account, Wallensky advises them to make sure the passbook is marked “For College” in large letters. “I know it’s simplistic, but it works. You don’t have a tendency to pick it up and say, ‘Gee, we can use the money.’ ”

Zero-Coupon Bonds

A favorite college savings device for parents these days is zero coupon bonds, in which the investor pays a small amount for a bond and receives the face value when it matures, but no interest in between.

“For early planners, zero coupon bonds are the ideal arrangement,” Bove said. “For a very low initial outlay they can ensure a given amount is available for child when child enters college.”

Merrill Lynch’s TIGRs, stripped-down Treasury, are now yielding 11.25% to maturity at 18 years. A TIGR purchased for $1,000 now would produce about $6,800 in 18 years. A parent who could afford to plunk down $32,500 when baby was born could get enough TIGRs to take care of Smith’s estimated Harvard bill in 18 years.

Although the holder receives no payment until the bond matures, he or she is taxed each year for the interest that has accumulated. Therefore, Bove advises, the bonds be put in a simple trust for the child.

“It shouldn’t be in the name of the minor directly,” he added. “Securities in the name of a minor can’t be negotiated, and you might find yourself having to go to court to have a guardian appointed.”

Financial experts have come up with any number of ingenious ways to shelter college funds from the tax man. Most of them involve turning over income-producing assets to the child, so the money will be taxed at a child’s lower bracket.

Some of these schemes can be extremely complicated, and many are useful only to parents with a large lump of money to set aside in trust and a tax bracket high enough to make the savings meaningful.

“Some families are in such low brackets there’s not a hell of a lot you can do for them,” Bove said.

Best-Known Device

The best-known such device is a Clifford Trust, named after an unhappy taxpayer who tried to shift income from some securities to a relative and lost. As a result, the Supreme Court set up some guidelines for shifting income that are still used 40 years later by parents hoping to shield college funds from the IRS.

Through a Clifford, parents can shift assets to a child for a period of at least 10 years, during which all the income will be taxed at the child’s low rate. The money is administered by an independent trustee until it reverts back to the donors when the 10 years expires.

“One advantage to a Clifford Trust is you can borrow money to finance it,” Bove said.

In his book, Bove detailed a strategy he used to finance a $10,000-a-year college education for the Greenfields, a family with a high income but no assets except their home:

- Dr. Greenfield took out an $80,000 loan from his bank, using his home as collateral.

- He established a Clifford Trust for his daughter, Cindy, and made it a gift of $80,000.

- After investing the money briefly in short-term Treasury bills to establish how much interest he could make on the open market, the trustee loaned the $80,000 to Dr. Greenfield at 14%, with payments of interest only.

- Dr. Greenfield used the $80,000 to repay the bank.

- Each year Dr. Greenfield pays $11,200 interest to the trustee, and the trustee uses the money to pay Cindy’s college expenses. Since the $11,200 is taxed at Cindy’s bracket, she pays a federal tax of about $1,100, leaving $10,000 for school.

- Dr. Greenfield takes an $11,200 tax deduction on his income tax return for interest payments. In his 50% bracket, that means the net cost of the interest payments are really only $5,600.

Such arrangements may well be endangered if Congress ever gets around to passing the Treasury Department’s proposed tax simplification plan. Bove argues, however, that even if the arrangements do lose their tax advantages, those already in existance may be allowed to continue until they expire.

“In all probability, the final version would grandfather existing trusts,” he said “I’m advising my clients to do this type of planning now.”

Some banks are now offering to set up college trusts for their clients. Citibank, for instance, has a program called University Trust that can be opened for $10,000.

Bank Charges

The bank charges $250 a year or 1% of the trust’s assets to administer it. If the customer does not have the $10,000, Citibank says it will structure a loan, once normal credit requirements are met.

The simplest and most frequently used sheltering device is the Uniform Gift to Minors Act, which allows gifts to a minor to be made to a custodian on the child’s behalf.

The disadvantage to the system is that the money becomes the child’s when he or she reaches the age of majority. In theory, the funds are supposed to finance college, but there is no legal way to stop the youngster from spending it as he or she likes.

“You have no idea what a kid may turn out to be when they’re ready to go to college,” Wallensky said. But on a practical basis, he admitted, it is not unusual for parents to “forget” to tell their children the money is not absolutely restricted to paying for education.

For families that have no property or money to put into a college trust, and no time left to start a savings plan, there is always a college loan. But they are becoming increasingly difficult for middle-class families to obtain at affordable rates.

In general, Wallensky counsels families against going deeply into debt to finance college costs.

“Under those circumstances, the kid’s better off going to local school and working part time,” he said. “The kids have to become realistic.”