|CNN's Gerri Willis shares five tips on how to save for college tuition. (August 10)|
NEW YORK (CNN/Money) -
It's one of the biggest investments you'll ever make: College tuition. With tuition rates increasing every year, parents will need to have over one hundred thousand dollars in the bank by the time they send their child to a four-year public college.
Sound scary? In today's 5 tips we'll to break down the most advantageous savings programs for you.
1. Start early
For families who have the luxury of time, you may want to look into Coverdell Education Savings Account plans. In this savings vehicle, your money grows tax deferred. However, there is a $2,000 contribution limit annually and an annual maintenance fee.
A Coverdell ESA may be part of the college savings solution but it's not the entire answer. You really do need to start early in order to reap any benefits from a Coverdell since $2,000 a year for even a decade won't mean much if your child is looking at a four year private college.
The money is held in the child's name, so this will reduce the student's financial aid eligibility. You can tap into the account if you want to send your child to a private elementary or high school. But contributions also have to stop once the child turns 18 years old and the money has to be used for college by the time that child is 30 years old. Otherwise, there will be a 10 percent penalty and income taxes to fork over.
Kelly Tanabe, co-author of "Sallie Mae How to Pay for College" says that investment choices are more varied with Coverdell and fees are lower than state 529s.
2. Consider 529s
State 529 college plans have been a popular investment vehicle for a lot of parents. But be wary. It's convoluted, it's expensive, it's unregulated and it may not even grow your savings.
There are 92 separate state 529 plans, according to Morningstar. And some states like West Virginia, California and Nevada have up to five offerings. These plans vary wildly and can be very difficult to understand. Right now money grows tax deferred but that is set to expire in 2011.
And the fees can be outrageous. Mark Kantrowitz of online financial aid site Finaid.com says that many time these fees benefit the broker more than the saver. "I've seen fees as high as 5 percent," he says.
The majority of money that goes into these vehicles ends up in high-fee plans sold by advisors. In fact, after you've paid annual fees, management fees (which can be a full percent) and broker fees at .8 percent, there's a real danger your savings will just be eaten away, according to Tanabe. Wyoming's College Achievement 529 plan has fees of 2.4 percent annually. With a $10,000 investment over a ten-year period with an 8 percent return, you would only come out with $16,933.
And if all those fees haven't gotten you cross-eyed yet, the mutual fund provider TIAA-CREF is proposing fee increases for its 529 college funds that would almost quadruple annual costs. You should consider 529s only if you're buying from a low cost provider. Avoid funds offered by brokers. Click here for a look at MONEY's best college saving plans.
And what about oversight? 529 plans are not subject to SEC regulations. In fact, in Utah's Educational Savings plan director was just charged with funneling educational funds into his own personal accounts.
If you do want to use 529 plans, you must do your homework. These plans differ from state to state. Check out www.savingforcollege.com to compare the rules and www.morningstar.com to track performance. Click here to take a look at the SEC's investor guide.
3. Prepay with caution
If you're certain your son or daughter is going to a state school, you may want to consider prepaid tuition. The more time you have before your child gets to college, the better. When you enter into a pre-paid plan offered by the state, you basically lock in tuition costs and offset inflation rates.
For example, if a state school costs $10,000 and you buy $5,000 you already have half of tuition paid for, regardless of how much tuition rises. You may like that certainty, but many state programs charge more than current tuition rates when pricing in the contracts.
And be careful -- if your student winds up not going to a state school, you may lose money. In some states, such as Florida, you would get the initial money you put in, but you may have to pay additional cancellation fees, according to Tanabe. In other states you may only get a small refund of your money.
Right now states like West Virginia, Virginia and Texas have suspended enrollment in their prepaid programs. In Ohio tuition increases of 10 percent annually caused the prepaid tuition plan to be suspended. And keep in mind, prepaid tuition plans reduce financial aid eligibility. These pre-paid programs also don't cover the cost of room and board.
4. Play it safe
If you're more conservative, consider Education Savings Bonds. This is a risk-free investment. And there are tax breaks for parents who meet income eligibility. For single taxpayers your adjusted gross income cannot exceed $74,850 to quality for the exemption.
Since the money is held in the parent's name, the child isn't penalized when it comes to getting financial aid. And don't forget that you can also tap into your home equity or retirement savings too. Most colleges don't count these assets at all.
You need to invest at least $50 in bonds in order to qualify for the exemption. Right now the rate is 3.5 percent. The annual limit is $60,000. For more information, click here.
5. Get your rebate
We all know about frequent flier miles, but how about getting money for college by shopping at McDonald's or Staples? The rebates received from a loyalty program are not subject to income tax or sales tax.
Upromise is one example of a free rebating program that helps families save money for college. Major companies where you can get rebates include America Online, Avis and Borders Books & Music.
You can automatically have your Upromise balance invested in a section 529 plan or you can redeem the rebate for cash. For more information, go to www.upromise.com. Or call 1-800 upromise.
If you buy or sell a home through a Upromise affiliated broker, you can save up to $3,000. But usually the rewards are smaller. If you spend $60 at Sharper Image, you'll see a savings of $1.80.
Tanabe says that you'll need to spend a lot of money to see significant savings and that these programs should be seen as enhancements to college savings, not as a replacement for other savings.
Gerri Willis is a personal finance editor for CNN Business News and the host for Open House. E-mail comments to firstname.lastname@example.org.