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Finance 101 for parents
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September 15, 1998: 12:33 p.m. ET
It's never too early to start saving for the costs of college
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NEW YORK - A hint of autumn, football games and long financial aid lines can only mean one thing: college is in session.
Parents who got a jump start on stashing cash away for their child's college education may not be standing in those financial aid lines.
So, parents of the members of the Class of 2016, listen up: Scholarships are great, college work-study jobs are free and financial aid is attainable. But, by saving early, some college freshmen may be able to walk on campus with enough money for tuition, dorm fees, books, meals and pocket change without asking for a dime from the school or the government.
Tuition climbing quickly
The College Board, an association of schools that strives to ease the transition from high school to college, tracks tuition and says while the rate of increase has slowed, tuition is still climbing at twice the inflation rate.
"But, we see a continuing effort by schools and the federal government to keep tuition costs down,'' said Jack Joyce, manager of communications and training services.
Indeed, tuition at private and public schools has increased between 5 percent and 13 percent each year since 1980, according to the U.S. Department of Education.
Whether tuition levels off or increases, the key to financial planning is growth and starting early, advised Stan DiLiberto, a certified financial planner based in Seal Beach, Calif.
Start saving at birth
How early? Think bottles and diapers.
"Start putting money away in growth-oriented investments in your name," said DiLiberto, "and when the child turns 15, switch it to their name so that he will only be taxed at a marginal rate -- if any rate at all." Using this schedule, parents can contribute up to $10,000 per year as a gift -- tax free.
Whatever the savings plan, remember the college fund will have to outpace the rate of inflation by more than 7 percent -- the current annual increase in college costs -- advised some financial planners.
Also, when thinking savings, think mixed nuts: a diverse portfolio can create a buffer during bear markets. Divide assets among equities (stocks and mutual funds), bonds and cash.
The choices
The Wall Street Journal Guide to Personal Finance lists a few tried-and-true investments:
- Mutual funds -- they emphasize long-term gains. Parents can transfer riskier funds into safer ones as the child gets closer to college age.
- Zero-coupon bonds -- schedule them to come due on a staggered basis during the years the money is needed so an investor can calculate the amount that will be available. Also, some bonds are tax-free.
- Certificates of deposit -- they carry a guaranteed return on investment, but the yield may be low. The long-term yield is unpredictable due to changing rates.
- U.S. Savings Bonds -- if an investor's income is less than $63,450 per year, the interest is tax-free if the money is used to pay for education.
Who holds the money?
Financial planners often get asked the $60,000 question: should parents put the investment in the child's name?
It depends on the parent's income, DiLiberto said.
"If you're wealthy -- and we're talking an income over $120,000 and assets totaling $500,000 excluding IRAs and 401(k)s -- go ahead and put it in your child's name," DiLiberto said. "But if you have a relatively modest income, don't put it in your child's name."
In some states, there is one drawback to signing over the money to the little one: the parents will lose total control of the money once the child turns 18 or 21. Also, the strategy can backfire if the child applies for financial aid. Most aid formulas require students to contribute 35 percent of their savings, while parents only need to account for 5.6 percent of theirs.
Only one purpose
Calvin Brown, a Washington-based certified planner and accountant, said having the child's name on the investment helps to "clarify the child's decisions about their education.
"Some people have a problem with dedicating their savings and investments toward specific goals. It puts saving for college in perspective -- that money is there for that purpose only."
Brown said he's heard horror stories about high school college advisors suggesting that parents can access the child's account at any time -- "that's illegal, because that money is an irrevocable gift to the child," and to do so would mean the parent would be required to pay back taxes.
Search out sources
Brown has advised some clients to consider tapping into their individual retirement account, but only after clearly weighing which life event is more of a priority: paying for the child's college or squirreling away for retirement.
"It boils down to which investment will have the greatest return," he said.
Other college nest eggs include a whole life insurance policy, which will pay for college expenses if either parent dies before the child has graduated. It also features a cash value that increases over time, and can be borrowed against in a pinch.
Financial aid
Financial aid is available for middle-class families, those with incomes less than $100,000, Brown said.
"Middle-class parents seem to be under a false notion that they can't qualify for financial aid," he said. "There are legal ways to obtain free money such as grants and college work-study."
Roughly $55 billion in financial aid is available each year to college students from both public and private sources with schools contributing about $6 billion, according to the New York-based College Board association.
"When I speak to groups of parents of young kids, they mostly want to develop strategies for qualifying for financial aid and the unfortunate part is if they haven't saved anything, they may discover that aid will mostly be in the form of loans," Joyce said.
Prepayment plans
Some states have prepaid tuition programs which allow parents to start saving for college in one lump sum or in installments. In exchange, tuition will be covered in full at state schools. Room and board costs aren't included. The downside is that if the child chooses to go to school in another state or not at all, the payments are returned, with interest -- but the interest is small potatoes compared to interest on a growth mutual fund.
Homeowners who have garnered equity may consider a home equity loan, but should tread carefully, Brown advised.
"Before I do a home equity loan, I would want some type of cost-sharing agreement between me and the child to make sure he contributes something towards his college expenses," he said. "It seems when the child know he's footing some of the bill, he's going to take college that (much) more seriously."
With all the investment choices available, DiLiberto advises parents to start thinking about what type of school their child will attend: private or public school, in-state or out-of-state. As soon as the child is a freshman in high school, start calling different schools to find out what the tuition costs are.
"It helps to see the numbers in front of you and it won't be such a shocker come high school graduation," DiLiberto said.
Joyce said the College Board conducts workshops for high school guidance counselors each fall on how to plan and pay for college. Counselors pass the information on to students and parents.
"One of the problems we've experienced is dealing with parents who want to start paying for their child's education when they're juniors and seniors in high school," Joyce said. "The College Board has tried to develop, through our web site, extensive planning tools such as a free scholarship locator and current college tuition costs." 
-- by Bank Rate Monitor for CNNfn
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