Parents’ Guide to Taming Tuition

With higher education costs rising faster than the rate of inflation, saving for college has become one of the biggest financial challenges facing American parents. But parents who plan carefully can handle the cost of college without bankrupting themselves or sentencing their children to a lifetime of student loan payments.

The following is an excerpt adapted from Times staff writer Kathy M. Kristof’s new book, “Taming the Tuition Tiger: Getting the Money to Graduate” (Bloomberg, May 2003).

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There’s a certain amount of gallows humor that goes with having a college-bound child.

One parent I know proudly noted that, thanks in part to her reading and studying with her kids every night, two of her offspring already had been accepted at Stanford and the younger three were headed in the same direction.

“I could kick myself!” she said, contemplating the big tuition bills in her future. “What was I thinking?”

Another parent noted that the good news and the bad news was that his son had been accepted at Princeton.

They’re great schools, to be sure, but the $25,000 to $40,000 annual price tag can make a parent queasy -- particularly a parent of five.

The good news: Although getting the kids through college is likely to be a challenge, both practically and financially, it is possible with the right combination of savings, aid, loans, tax breaks, work and planning.

However, each family must formulate an individual plan, based on its financial resources and the age of the children and their desires.

Here’s an abbreviated guide to preparing for college costs, based on the age of your offspring:

Up to Age 13

Save: When your children are young, you’ve got plenty of time to let your money work for you. Take advantage of that by socking away set amounts at regular intervals.

How much good will it do? That depends on the amount you save, how well you invest and how long you’ve got until the child needs the money. But by putting away $100 a month, the parent of a 2-year-old can reasonably expect to have $35,000 by the time the child completes high school, assuming the investments earn about 8% a year, on average. (That may seem high, given the stock market’s poor performance the last three years, but it’s still below the market’s historical average total return of about 10% a year.)

Use tax-favored accounts: There are two types of tax-favored savings accounts specifically designed for college: Coverdell education savings accounts and so-called 529 plans. Donors don’t get federal income tax deductions for their contributions, but as with a Roth IRA, the money grows on a tax-deferred basis and, if used for college, is completely tax-free.

For the parent with the 2-year-old, using a tax-favored account would save at least $3,400 in federal capital gains taxes.

Which type of tax-favored account should you choose? If you’ve got big educational aspirations and plenty of money to finance them, use both. If your resources are limited, consider the pros and cons of each.

Coverdell pros:

* Money in a Coverdell account can be used to pay private high school and grammar school expenses without triggering taxes or penalties. Money saved in a 529 account can be used only for college.

* Those who like to trade individual stocks will prefer a Coverdell account because it allows personal control of the investment process. By contrast, 529 plans have limited investment choices, much like a 401(k) account.

Coverdell cons:

* The maximum amount that can be contributed each year to a Coverdell account is $2,000.

* Money saved in a Coverdell account is considered the child’s asset, which could make it more difficult for the child to qualify for need-based financial aid.

529 pros:

* These accounts are among the easiest to set up and use, allowing small, regular investments in simple, well-diversified options. Parents usually can choose among aggressive, moderate and conservative portfolios, or they can choose to have the account provider mix the investments based on the age of the college-bound child.

* Maximum investment amounts are set by the individual states that sponsor the plans. But these limits typically are much higher than for Coverdell accounts. Total maximum contributions can be $100,000 to $300,000 per child, depending on the 529 plan. Annual contribution amounts are restricted only by federal gift tax rules that discourage giving more than $11,000 to any one recipient in a single year.

* In addition to federal tax breaks, 23 states offertax deductions for residents who contribute to their state’s 529 plan. (California, unfortunately, isn’t one of them.)

* The donor retains control of 529 assets. That helps the child get more financial aid, and it allows parents or other contributors to reclaim their money if the need arises or if the child proves more interested in buying a Hummer than going to Harvard.

529 Cons:

* As with almost any tax-favored account, if the money isn’t used for qualified expenses -- in this case, higher education costs -- taxes and penalties usually are assessed when the money is withdrawn.

Spend-to-save programs: There are three rewards programs that pay rebates into the college coffers designated by participating individuals who charge purchases on certain credit cards or who buy from specific merchants. That college account can be for the benefit of the cardholder or a friend or relative.

Details about all three -- Upromise, BabyMint and EdExpress -- are found easily on the Internet. Just add “www.” to the beginning and “.com” to the end of the name.

It doesn’t make sense to change your spending patterns to get a few pennies back for a loved one’s college tuition. But for things you planned to buy anyway, getting a kickback doesn’t hurt.

Ages 13-17

Emphasize grades: Your children’s high school grades and curriculum can have a direct effect on college costs in two ways.

Students who take numerous advanced placement classes can “test out” of their first year of college, leaving parents to finance three years of higher education instead of four.

Better grades also improve a student’s chances of getting academic scholarships and grants.

Assess investment risk: As your children approach college age, you need to shift their education-savings portfolios to more conservative investments, reducing the chances of large losses just when you need the money to pay tuition. By the time a child is a high school freshman, at least 25% of the assets should be invested in some sort of fixed-income account, and that percentage should rise as the child gets nearer to graduation.

Consider aid: Calculating financial aid for college students is tricky. The amount of aid available will depend on a variety of factors, including a child’s income and assets, the parents’ income and assets and the cost of the college the child has chosen.

In general, the family’s resources will be a factor in the so-called expected family contribution, or EFC. That’s the amount the parent and child are expected to pay from their own resources before they can qualify for need-based aid.

The difference between the EFC and the total cost of college, including room, board, tuition, fees, books and miscellaneous expenses estimated by the school, is the student’s “need,” which can be addressed with scholarships, grants, loans and work-study awards.

However, the way the family’s savings are structured can affect this formula because certain types of savings weigh heavily in the formula, while other types of savings have no effect at all.

For the best chance of getting aid, parents’ savings should be predominantly in tax-favored retirement accounts and in their home equity. Children’s savings should be predominantly in 529 accounts.

Parents with savings in other types of accounts may want to shift some assets into aid-favored vehicles such as retirement plans while the child is a freshman or sophomore in high school. Aid formulas generally look at family assets held in the child’s junior year of high school.

Figure your EFC: To find out how much you’ll be expected to contribute to college costs before financial aid kicks in, figure your expected family contribution at www.collegeboard.com. Click on the EFC calculator.

This site also is invaluable for parents who want to price-check colleges. A prompt on the left of the page allows visitors to look up almost any accredited college and get a glimpse at everything from activities to tuition.

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Times staff writer Kathy M. Kristof welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012; or e-mail kathy.kristof@latimes.com. For past columns, visit The Times’ Web site at www.latimes.com/perfin.