Financial Planning for College

The College Board reports that prices at public colleges have risen more than 30 percent over the past five years, even after adjusting for inflation. For the 2007-2008 school year, average published tuition and fees were up approximately 6 percent at four-year public and four-year private colleges. Increases at two-year colleges were somewhat less, approximately 4 percent.*

Consider this: The average published tuition, fee and room and board for a student at a public four-year institution in the 2007-2008 school year was $13,589. Just five years earlier, the average cost was $9,672. That's a 40% increase. For students at a private four-year institution, the current average cost is $32,307, compared to $24,867 five years earlier, a 30% increase.* Note that these are average estimates that do not include incidentals such as spending money and travel.

These figures might seem daunting, but may not be as insurmountable as they seem. The reality is that the savings needed to send most students to college are below these averages. Student loans, financial aid, scholarships, and grants reduce expenses for many. Students' earnings, and other sources of income, may also reduce the amount you'll need to save.

It helps to set your college savings plan early, preferably as soon as your child is born. Like buying a house, the more you save, the less you'll need to borrow. Save and invest regularly, even if it's just a small amount from every paycheck. Over time, look for ways to boost your college fund savings. Salary increases, bonuses, and money your child receives as a gift are good opportunities to increase savings contributions.

There are many options for college savings plans and investing money for educational expenses, and some provide tax advantages. This article overviews several choices: money market and bank savings accounts, government bonds, stocks, and mutual funds, as well as government-sponsored plans designed to help you build your college expense fund.

* Source: Trends in College Pricing, College Board, 2007.

Once saving becomes part of your budget, money will begin to accumulate. It's important to take advantage of the financial strategies that will help your college savings grow in value. Perhaps the most important thing you can learn about saving is the importance of compounding—given time, compounding makes small investments large. Consider the following hypothetical example:

The week the McMillans had their first child, David, they opened a college savings account. It wasn't always easy, but they managed to put $200 away each month until David was 18 and ready to go to college.

The Rileys' child, Barbara, was born the same month as David McMillan. Since money was tight for them, they decided to delay opening a college savings account until they were earning more. When Barbara turned 9, they opened the account and were able to contribute $600 a month until she was ready to go to college at age 18.

Both the McMillans and the Rileys invested their college savings in the same mutual fund. It earned 8 percent compounded annually. The McMillans' total contribution was $43,200 and the Riley's total contribution was $64,800. Which family do you think had the larger college fund?

You've probably guessed the answer. The McMillans had the larger college fund at $96,657-they accumulated more than $53,450 in compound interest on their investment of $43,200. The Rileys had nearly as much—their fund was worth $95,087 — but they had to invest $64,800 to do it. As you can see, time is a critical component to make investments grow. It's not just how much money you save that counts, it's also how much time you have for that money to work for you. You need to start saving as early as possible.

Note that these are theoretical examples presented to illustrate the power of compounding; they do not take into account taxes, account fees, or inflation. Specific interest rates or conditions used in the examples may not be attainable or desirable.

This article provides an overview of common types of vehicles used to save funds for college. In some cases, you may face complicated tax issues if you plan to pay college expenses with the returns from savings and investments. To realize the full benefit of these instruments, consult with a tax professional before committing your funds.

Savings Accounts

A savings account is a good place to store emergency funds and money for short-term financial goals. Funds are readily accessible and the Federal Deposit Insurance Corporation (FDIC) generally insures savings accounts up to $100,000. The main drawback is low return. The interest rate paid on a savings account is often less than the rate of inflation, so your money may not grow as fast as the rising price of goods and services, making savings accounts inadequate for college savings. On the other hand, if you need to "park" your money for a while until you establish your investment strategy, a savings account might be a reasonable choice.

Money Market Accounts

Money Market Accounts usually earn slightly higher interest than savings accounts but still allow easy access. Some banks and financial institutions require an initial deposit of $1,000 or more and limit the number of withdrawals or transfers you can make during a given period of time. Money market accounts issued by banks are FDIC insured; those issued by financial institutions are not. To get information about FDIC insurance, including whether or not your bank is insured, go to: www.fdic.gov/consumers/consumer/information/fdiciorn.html.

Certificates of Deposit (CDs)

CDs generally earn more interest than savings accounts with equally little risk, but with less liquidity. Like savings accounts, the FDIC generally insures them up to $100,000. CDs provide higher interest rates; in exchange, you agree to keep your money in the CD for a fixed period, usually three months to five years. There is usually an interest penalty for taking money out before the end of the period.

U.S. Savings Bonds (Series EE, Series I)

You need only go as far as your local bank to invest in Series EE or Series I U.S. Government Savings Bonds. The face value of the bonds range from $50 to $10,000. EE bonds are purchased at half their face value. For example, when you buy a $50 bond, you pay $25. The Treasury Department guarantees that new issues of Series EE Bonds will double in value by 20 years from the issue date. This is referred to as the original maturity date. Series EE Bonds earn interest for 30 years. Bonds purchased after April 2005 earn a fixed rate of return, and interest is compounded semiannually for 30 years. I Bonds are purchased at full face value, and also earn interest for 30 years, compounded semiannually. Both EE and I Bonds are exempt from state and local income tax and have certain tax benefits when used for education expenses.

Growth Stocks

Investments in the stock market have the potential to provide better returns than fixed-rate investments (such as savings accounts and CDs), if you have time to let the money ride the ups and downs of the market. The potential for a higher return comes with a higher degree of risk. This is a long-term approach to investing. The word to look for here is growth. When assessing the potential of a particular stock, it is generally a good idea to focus on long-term appreciation rather than dividends. And remember, what the stock market did in the past is no guarantee of how it will perform in the future.

Growth Mutual Funds

A mutual fund is a pool of money, supplied by investors like you, that is invested in various securities such as stocks, bonds, money market instruments, or a combination of these investments. The total investments (holdings) of a mutual fund are called its portfolio. Every share of the mutual fund represents a proportion of ownership of the fund's portfolio as well as a proportion of the income those holdings generate. Typically, the investment portfolios of mutual funds have a professional manager or team of managers making day-to-day and minute-by-minute buy and sell decisions.

Investing in mutual funds allows you to participate in the growth potential of the stock market with lower potential risk. Investing in just a few stocks can be risky, but mutual funds can help you diversify your investments, and while not guaranteed, diversification can help balance risk. Also, you can start investing in mutual funds with a relatively small amount of money.

There are many types of mutual funds, and the amount of risk varies widely. As with stocks, the share value of a mutual fund will go up and down as market conditions change and investors may make or lose money. Mutual funds are not FDIC-insured, even when they are sold through a bank.

Note that mutual fund companies are required by law to provide you with a prospectus before you invest. A prospectus is a legal document providing detailed information about the mutual fund's investment strategy, fee structure, and operations and is available from your registered representative. Carefully consider investment objectives, risks, charges, and expenses before investing. For this and other information about any mutual fund investment, read the prospectus carefully before you invest. Investment return and principal value will fluctuate with changes in market conditions such that shares may be worth more or less than original cost when redeemed. Diversification cannot eliminate the risk of investment losses.

529 plans were authorized by Congress in 1996. They are administered by the states and provide families with tax incentives to encourage saving for college. States implement their 529 plans in various ways, with each having its own conditions, but all 529 plans are exempt from federal income tax.

529 Prepaid Tuition Plans are offered by 19 states. These plans lock in the price of tuition at today's rates, no matter what the rate actually is when your child enters college. Prepaid tuition plans are operated by state governments. If you decide to invest in a prepaid tuition plan, your college savings will go to the state, either in a lump sum or in monthly installments. The state, in turn, will invest the money to earn the difference between what you're paying and the projected cost of tuition when your child reaches college age. Accounts are guaranteed by the state government to at least match in-state college tuition increases. Check with your state's commission on higher education to see if a prepaid tuition plan is available where you live.

Anybody can contribute to a prepaid tuition plan. This is especially good for grandparents, because of the estate planning possibilities. Prepaid tuition plans are exempt from federal income tax, and, in some states, from state and local income taxes.

Prepaid tuition plans are not for everyone. Using this option may jeopardize your chances for state financial aid if you would otherwise qualify. If you're interested, and a plan is offered in your state, determine:

• Whether the plan covers only the cost of tuition, or room and board, as well;
• If you can apply the proceeds to another state school within your state; and
• How your original deposit will be returned if your child does not attend college or attends a private or out-of-state college.

529 College Savings Plans. Unlike prepaid tuition plans, these plans do not lock in tuition rates and make no guarantees. The value of investments in these plans will fluctuate based on the investment vehicles you choose and market conditions; savings may not be enough to cover all college expenses. Most 529 Plans offer a variety of investment options based on the number of years until the funds are needed.

The maximum permitted account balance (per beneficiary) will be specified by the plan you choose and the state in which you live. Some plans have a dollar amount limit — usually $300,000. Limits on others are tied to the projected (future) cost of full-time college tuition for five years. Additionally, most—but not all—will have annual contribution limits.

Contributions may be made by parents or by others (e.g., gifts from grandparents). In 2008, $12,000 per donor for each beneficiary is eligible for the gift-tax exclusion. Note that other gift-tax considerations may apply. To determine specific laws and regulations that affect your situation, consult a financial professional.

Unlike prepaid tuition plans, the monies from the account may be used at any qualified institution of higher learning within the United States. If your child does not go to college, the money can be used for another family member's qualified education expenses or you may keep the money and be taxed at your ordinary income rate plus a 10 percent penalty. Check with your state's commission on higher education to see if a college savings plan is available where you live. If your state does not have a savings plan, many other states have opened their plans to non-residents. You should consider the potential tax benefits (if any) that your own state's plan offers to residents prior to considering another state's plan. A 529 plan locator to determine the plan(s) available in your state is at The College Savings Plan Network.

The federal government encourages educational savings by providing tax breaks. These include tax credits (i.e., you subtract the credit directly from the amount you pay in taxes) and tax deductions (i.e., you subtract the deduction from your income before calculating the taxes). The government will even allow you to defer paying taxes while your income grows, and, in some cases, pay no taxes on interest and earnings used for education. It may be possible to take advantage of more than one of these tax benefits for education saving, but the process is sometimes complicated. Check with a tax professional before committing your funds in anticipation of getting these tax breaks.

Hope Scholarship Credit

The Hope Scholarship Credit may help you reduce your annual tax by up to $1,650 per eligible student, depending on how much you spend on tuition. An eligible student can be you, your spouse, or your dependent. The Hope Credit is only available for the first two years of post-secondary education per student. You cannot claim the Hope Scholarship credit if your adjusted gross income is above $57,000 for single filers, or above $114,000 if filing jointly. There are other requirements you must meet to qualify;
see IRS Publication 970, Tax Benefits for Education.

Lifetime Learning Credit (LLC)

You may use the Lifetime Learning Credit to reduce your tax by 20 percent of the first $10,000 you paid for qualified tuition and related expenses for yourself, your spouse, or your dependent(s) for whom you claim an exemption. The income limits are currently the same as for the Hope Scholarship Credit. Parents with more than one child may claim an LLC for one child and a Hope Credit for a different child in the same year. The two credits, however, may not be claimed in the same year for the same child. You cannot claim the credit if you are married filing a separate return.

Deduction for Qualified Higher Education Expenses

This deduction allows taxpayers to deduct $4,000 of qualified higher education expenses. You cannot deduct higher education expenses on your income tax return if you or anyone else claims a Hope or Lifetime Learning Credit based on those same expenses. The deduction is phased out for joint filers with income between $130,000 and $160,000 and single filers with income between $65,000 and $80,000. Check with a tax professional for the most up-to-date information.

Coverdell Educational Savings Account

You are now able to set up a plan called a Coverdell Education Savings Account (CESA) for the purpose of paying education expenses. The earnings from the account are not taxed and withdrawals from CESAs are tax-free when used to pay for qualified educational expenses. The account may be opened on the day your child is born; and contributions are allowed until your beneficiary reaches age 18.

Contributions may not exceed $2,000 per child, per year. The amount is per beneficiary, and not per contributor. So if you have three children, you could contribute up to $2,000 for each of them, bringing your total to $6,000 annually. Contributions are phased out for joint filers with income above $220,000, and single filers above $110,000. Contributions are made with after-tax dollars.

The CESA allows you to make withdrawals to pay for elementary, secondary, and college expenses. Neither ordinary income tax, nor the 10 percent penalty for premature withdrawals applies if the distribution is used for tuition, fees, books, and room and board. Currently, you may also claim either a Hope or LLC credit in the same year as the distribution. Please note that part of a withdrawal will be subject to ordinary income tax and the 10 percent penalty if you do not use the entire distribution to pay for tuition, fees, books, or room and board.

This discussion of tax considerations provides only a general overview; tax laws are constantly changing. Consult a tax professional or financial advisor before investing, and review investments regularly. In particular, if you move money from one account to another there may be tax implications. If you are unsure of the implications, always seek professional advice.

Here are just a few examples of tax considerations that could affect college funds:

• Loans. Many families find that their savings is not enough to cover the entire cost of a child's education. If you take out a qualified student loan, in your name, to pay for your child's education, the interest on that loan may be deductible as long as the child was your dependent when the loan was received. If a child who is no longer a dependent takes out a loan in their own name, they may be able to deduct the interest. Note that a qualified loan is one used to pay tuition, fees, living expenses, books, supplies, and transportation expenses.

The maximum amount of interest deductible on a qualified student loan is $2,500—per return. There are also certain income restrictions. The deduction is phased out if your modified adjusted gross income is in the range of $55,000 to $70,000 for single filers, and $110,000 to $140,000 for joint filers. Consult a tax professional before planning on this deduction, as other restrictions may apply.

• Custodial Accounts. You can transfer assets to a custodial account for your child under the Uniform Gift to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). Income on assets in these custodial accounts is generally taxed at the child's rate, although some exceptions may apply. Consult a financial professional for information relating to your specific situation.

Note that putting assets in your child's name could reduce the amount of financial aid he or she is eligible to receive. It is also important to realize that unlike 529 College Savings Plans, these custodial accounts belong to the child. The account terminates and becomes the child's property, to do with as he or she chooses, at a specific age (usually 18 or 21) specified by state law.

Even if you start saving early, it may be impossible to completely prepare for paying for college. That doesn't mean, however, that college is out of the question. You have other cost-saving options available.

Student Strategies: Paying for College

Students can follow a variety of strategies to help reduce their expenses prior to entering college and once they're in college. For example, many college students are able to work at part-time and summer jobs to help subsidize their tuition or for entertainment money. Be aware, however, that money earned by the child prior to college may reduce his or her eligibility for financial aid.

Some colleges offer cooperative education programs where students rotate study with periods of career-related work, allowing them to earn money and credits at the same time. However, it may take more than four years to complete a degree through a cooperative education program. Ask the college admissions office about the specifics of their program.

Depending on a child's scholastic ability, he or she may be able to earn college credits by taking college courses or Advanced Placement exams while still in high school. First- and second year college students can also take College Level Examination Program tests for course credit. These options can represent a significant savings over the cost of a course in the classroom. Check with your child's high school guidance counselor or with the college admissions office for eligibility requirements and program specifics.

Another cost-saving possibility is for your child to attend a Community College for the first year or two, then transfer to a four-year college to complete a degree. This can be a more affordable approach to receiving a degree from a prestigious institution. Also, colleges that are highly competitive for freshman applicants are often less competitive for third-year applicants.

Paying for College using Financial Aid

The traditional sources of financial aid include scholarships, grants, work-study programs and government loans. Your child's scholastic record, course of study, athletic ability, and choice of college are just a few of the variables that may affect the availability of these options. The Internet can provide information about billions of dollars of scholarship money available each year. There are several very good scholarship search websites. See For More Information for websites.

If your family meets certain financial criteria, the federal government has a program of low-interest loans with extended payment terms. Relying too heavily on loans, however, can burden graduates with large debts just when they are working to establish financial independence.

A tool to help you determine how much you need to save for your child's education, Monthly Savings Needed to Accumulate $100,000, appears below. To use the tool, you'll need a good estimate of the cost of your child's education, based on the year in which you expect he or she will enter college. To come up with an estimate for specific years and/or specific colleges, you can use the college cost calculator at The College Board website, or another calculator available on the Internet.

Once you've approximated the total cost of your child's education based on the year in which he or she will begin, you'll be able to determine how much you need to save on a monthly basis to reach your goal. The table shows monthly savings for college based on number of years you have to save and projected savings growth.

If you project your savings and investments will earn six percent, and you have ten years to accumulate savings for college, the table shows that you will need to put away $610/month to accumulate $100,000. Returns mentioned are hypothetical, and are not intended to reflect any actual investments.

Assume that instead of $100,000 you want to save $160,000. That amount is 1.6 times as much as $100,000. Therefore, instead of saving $610/month, you would need to multiply $610 by 1.6 to determine how much to save monthly; in this case you need to save $976/month to accumulate $160,000 for college costs.

More examples for adjusting the savings—up or down from $100,000—appear below.

Going Forward

It's true—college is expensive. But as you can see, there's a lot of help available: loans, grants, and tax breaks that can significantly lower the bill. Bear in mind, though, nothing can replace a carefully planned savings and investment strategy, and the earlier you start the more likely it is you'll reach your goal. Given how important a college education is to your child's future, today is the best time to begin.

Consumer Information from the Federal Government

The quarterly Consumer Information Center Catalog lists more than 200 helpful federal publications. Obtain a free copy by calling 888-8-PUEBLO or on the Internet at www.pueblo.gsa.gov.

Helpful Links

The College Board
www.collegeboard.com
The College Board website has a wealth of information on topics such as choosing a college, applying to college, and paying for college There are also financial calculators and a scholarship search tool.

College Savings Plans Network
www.collegesavings.org
The College Savings Plans Network website contains a 529 plan locator to determine what plan(s) are available in your state.

The SmartStudent™ Guide to Financial Aid
www.finaid.org
The SmartStudent™ Guide to Financial Aid website provides links to several free online scholarship databases, as well as on many educational savings opportunities.

Sallie Mae College Answer
www.collegeanswer.com
The Sallie Mae College Answer website has information on many topics relevant to choosing a college and financing a college education.

Internal Revenue Service
www.irs.gov/publications/p970/ch02.html
IRS Publication 970, Tax Benefits for Education

Free Application for Federal Student Aid
www.fafsa.ed.gov
The federal government is a major source of financial aid. Start by filling out the Free Application for Federal Student Aid available on the Internet.

Because the content of newsgroups and websites changes constantly, it is impossible for us to review it all. MetLife is not responsible for the content of any of the above links.