Making the grade: straight As for education funding

Dec. 1, 2000
How do you begin saving for your children`s college expenses without jeopardizing your own financial future?

How do you begin saving for your children`s college expenses without jeopardizing your own financial future?

Kathleen Adams, RDH, BS

Today you send them off to school with a "superhero" lunch box or a Barbie backpack. Before you know it, you`re loading the car with real luggage and about every piece of clothing they own - it`s time for college! You send your dreams with them; they bring back the clothes (in need of laundering) ... and the bills. Are you ready? Perhaps you remember only too well the costs of your dental hygiene education, and possibly the ongoing cost of paying off a student loan. Your parents most certainly remember. But the costs were well worth it. For those of you who are now playing the role of parent, rather than child, the question is: How do you begin saving for this expense without jeopardizing your own financial future?

What every parent should know

> Times have changed. College isn`t always a four-year experience anymore. Because of class-size limitations, the infrequency of course offerings, or the need to work while in college, some students don`t complete their studies in four years. Also, a bachelor`s degree now is not universally considered the "standard" for many occupations; a graduate degree may be necessary. Therefore, parents may want to consider underwriting college as a five- or six-year obligation. And there`s more. Besides tuition, parents also must consider the "other" costs of college: books, supplies, travel, and room and board.

> Student loans can be expensive. Usually called financial aid, student loans often sound like the only alternative, especially for families who have delayed planning. But, no matter how reasonable the loan rate, it`s not uncommon for financial aid to increase the cost of a college education by thousands of dollars.

> Ultimately, you will pay. Despite the wide availability of scholarships and grants, nearly 80 percent of college expenses are paid for by the family and/or through loans, according to the 1993 Fiscal Year Federal Budget.

Multiple choice

So what type of college-savings program should you have? That depends on factors such as your personal situation and your education-funding strategy. Let`s take a look at several alternatives and review some of their pros and cons:

* The Education IRA. You (or anyone else) can contribute up to $500 per year to an education IRA for each child under age 18. While your contributions aren`t tax-deductible, they generally can be withdrawn tax-free if used to pay for qualified higher-education expenses (tuition, fees, books, supplies, and equipment at any eligible postsecondary educational institution ... and room and board if the student is enrolled at least half-time). Simply establish an IRA account in your child`s name and make your contribution. If your child wins a scholarship or doesn`t go to college, the funds can be rolled into a younger child`s education IRA.

(Note: Contributions are phased out as your adjusted gross income (AGI) rises, so you may qualify only for a partial contribution ... or you may not qualify at all. In addition, if college is just a few years away, this may not be the best choice for your family due to the $500 annual contribution limit.)

* Traditional and Roth IRAs. Contributions to a traditional IRA may or may not be tax-deductible, depending on your income, but earnings grow tax-deferred until their withdrawal. Contributions to a Roth IRA are not deductible and are phased out as your AGI rises, but qualified withdrawals can be made tax-free if you meet certain requirements. Withdrawals from both types of IRAs now can be used to pay for qualified higher-education expenses, without incurring the 10 percent IRS early-withdrawal penalty (although regular income taxes may apply). However, it`s generally not a good idea to reduce the earnings potential of your retirement savings. Tap into other college-funding sources first.

* Regular Investment Program*. You can start an investment program and choose from a wide range of mutual funds that meet your risk tolerance and investing time frame. You won`t receive any tax advantages. But you`re funding the program with after-tax dollars and paying taxes on earnings each year. You will pay capital-gains taxes when you sell your shares; however, you won`t have to worry about finding money to pay taxes on withdrawals. (*Such a program does not assure a profit and does not protect against loss in declining markets.)

* UTMA/UGMA Account. Under the Uniform Transfers to Minors Act or the Uniform Gifts to Minors Act, you can establish an UTMA or UGMA account in your child`s name. An individual can give up to $10,000 tax-free every year; a married couple can contribute up to $20,000. Until the child is 14, a portion of the earnings is taxed at the child`s rate, with the remainder taxed at the parents` marginal tax rate. After age 14, it is all taxed at the child`s rate. If this is much lower than your rate, your family saves on current taxes while saving for college. As custodian, you oversee the funds for your child`s benefit until he or she reaches legal age, usually 18 or 21, after which time your child will have full control over the assets. (Note: If you plan to apply for college financial aid, be aware that money in your child`s name can reduce his or her qualification for such aid.)

If you have a college-bound child or grandchild, remember that it`s never too late or too early to start. Yes, the power of compounding will work better if you begin early, but the most important step is: just get the college-savings ball rolling!

FYI: More than $1 million. That`s the gap in earning potential over a lifetime between those with a college degree and those with a high school diploma, according to The College Board`s 1999 Trends in College Pricing. On average, college graduates with a bachelor`s degree earn 75 percent more than those with only a high school diploma. That`s why it`s so important to focus on the high cost of not sending a child to college, instead of focusing on the college expenses.

Kathleen Adams, RDH, BS, is a financial adviser with Waddell and Reed ( She is currently trying to initiate money-management workshops for hygiene students and specializes in working with dental professionals. She can be reached at (800) 210-1357.