Save for college

Imagine your child coming to you with an acceptance letter from the college of his choice.  The one that perfectly matches his career aspirations.  Perhaps even your own alma mater.

Only one thing could make you prouder --- knowing that you have done your homework too.  That no matter where your child is accepted or what financial aid is offered, you have the resources to afford the college of your choice.

Your child's college tuition could be one of the largest expenditures you ever make.  And if you have more than one child, the financial commitment is even greater.

Fortunately, families with a desire to save for future college expenses now have more options than ever before.  Traditional investment options, such as savings accounts, taxable investment accounts, annuities, and U. S. Savings Bonds, are now joined by powerful investment vehicles including Section 529 college savings programs and Coverdell education savings accounts.

New investment programs bring new opportunities, but they make decisions more difficult for people who want the best education possible for their children.  Proper planning and saving can put the cost of any college within your reach.

If you start early enough, there are many options available to help families save money, tax-free, to help pay for college.

For example, under some conditions, parents can withdraw money from a retirement account without paying taxes or an early withdrawal penalty. Additionally, Coverdell Education Savings Accounts and 529 plans allow parents to deposit money into special savings accounts which are set aside to pay for future education expenses. Funds accumulate tax-free, and no taxes are due upon withdrawal as long as you use the money to help pay for college.

Check with a financial advisor to determine which of the many savings programs is right for your family.

Putting Your Plan Together

Establish a savings budget.  One of the first steps you should take in planning for your child's future college expenses is to establish a savings goal.  Start saving the day the baby is born, if not earlier, and save as often as you can.  The sooner you start, the more you can take advantage of compounding to watch your savings grow.  It will also get you into the habit of saving.  There are many very useful college costs calculators on the internet and we encourage you to use them.  The following list should be helpful:

• The Savings Growth Projector illustrates how regular contributions to an interest-bearing bank account or investment fund can grow due to compound interest.   
• The Savings Plan Designer shows you how much money you must save in an interest-bearing account or investment fund each month in order to reach your savings goals.  It is a useful tool for deciding how much to save.  
• The Annual Yield Calculator computes the annual yield required to achieve a given total return over a specified number of years.  
• The Compound Interest Calculator computes the effective interest rate for an investment compounded at different intervals.  It illustrates the effects of compounding on the effective interest rate. 
• The Savings Plan Yield Calculator computes the annual interest rate required to reach your savings goal given the present value of your savings, the value of your regular contributions, and the amount of time available.  

 Invest windfalls, don't spend them.  If you should get a windfall, such as an inheritance, winning the lottery, a large income tax refund, or a bonus from work, put it in the college savings fund.

Increase the amount you save each year.  Increase the total amount you save each year by at least 5%.  So, if you save $100 a month this year, you should save at least $105 a month next year.  This will help you  keep up with the college tuition inflation rate.  When you get a raise, increase the amount of money you save.

Minimize taxes.  Take advantage of the fact that your child can receive up to $850 in investment income each year without paying federal income tax.  By gifting income-generating assets into a UTMA account now, or gifting appreciated assets later, you can effectively shift income and capital gains out of your higher tax bracket.  The opportunities for tax savings may be even better if you can employ your child in the family business.  Remember that any assets gifted to your children are theirs to control when they reach a certain age under state law, and that a students's assets and income are counted more heavily under financial aid formulas.  Speak with your tax advisor before making any tax-related decisions.

Consider 529 savings programs and education savings accounts even for older children.  Just because your child is already in high school doesn't mean you can't benefit from tax-advantaged college plans.

Invest tax-free whenever possible.  If your child will be attending a private or religious elementary or secondary school, consider opening an ESA and contributing up to $2,000 per year.  There may be no better way to invest tax-free.  If your child still has money in the ESA after high school it can then be used tax-free for college.

Put the right person in control.  Grandparents using a 529 plan to save for a grandchild's college education should open the account in their names if they want to maintain control and retain the ability to change the beneficiary to another grandchild.  However, if the grandparents prefer that the parent control the account, they can simply make a contribution into the parents' 529 account.  Another way to gift a 529 plan contribution into an account for a grandchild is to make the check out in the name of  the 529 plan and hand the check to the parent who can make sure it is contributed on behalf of your grandchild.  For tax purposes, the grandparent is still the one making the contribution.

Consider professional assistance.  We suggest you consult with experienced and knowledgeable financial, tax, and/or legal advisors.

Be flexible with your college planning.  Programs and investments will continue to evolve.  Tax laws will change and so will your circumstances.  Review your financial situation periodically and make adjustments whenever necessary.

 College Savings Plans

There are about a dozen different college savings plans available and choosing among the many options can be confusing.  The complete list of college savings plans are listed below:

• Section 529 Plans.  These include Section 529 College Savings Plans and Section 529 Prepaid Tuition Plans.  The Virginia College Savings Plan offers three Section 529 investment options:
  • Virginia Education Savings Trust (VEST) .  The Virginia Education Savings Trust offers a section of 11 investment funds.  Students of all ages can participate wherever they live.  You can use VEST to pay for all major college expenses.  These include tuition, fees, room and board, textbooks, required computers, and supplies.
  • Virginia Prepaid Education Program (VPEP).  The Virginia Prepaid Education Program locks in future college costs for today's students in the ninth grade or younger.  VPEP covers full tuition and mandatory fees at Virginia public colleges.  Benefits can also be used at Virginia private colleges, as well as colleges and universities throughout the country.  Your VPEP investment comes with a guaranteed rate of return for other types of colleges nationwide.
  • AmericanFunds, one of the oldest and largest mutual fund companies in the Country.
• Credit Card Rebate and Loyalty Programs.  Loyalty programs, also known as affinity programs, provide a rebate to the consumer in exchange for shopping at particular retailers or purchasing particular products or services.  They are similar in nature to airline frequent flyer programs.  Typically, such programs do not require you to show a membership card to get the rebates.  Instead, you register your credit cards with them and they track the purchases you make at participating merchants using the cards.  You can also earn rebates by shopping online through the company web sites.  Affinity programs with a college savings emphasis include:
  • BabyCenter.  BabyCenter is a MasterCard credit card with no annual fee that provides rebates to help families save for college.  In addition to a 1% rebate on every purchase (5% for purchases from the BabyCenter store), there are rebates of up to 30% at participating merchants.  Rebates can be deposited in a section 529 college savings plan, money market account, mutual fund, or a banks savings account.  
  • BabyMint.  BabyMint members earn rebates by shopping at the BabyMint network of retailers and service providers, purchasing particular products, or using the BabyMint MasterCard.  Rebates range from 1% to 20%, depending on the retailer or product.  The rebates can be deposited directly into the member's section 529 plans or Coverdell Education Savings Accounts.  
  • Fidelity 529 College Rewards MasterCard.  The Fidelity 529 College Rewards MasterCard allows you to earn up to 2% of your eligible purchases as a rebate into your Fidelity Section 529 College Savings Plan account.  A maximum of $1,500 may be earned per rolling twelve month period from the anniversary date of first card usuage.  The Fidelity Mastercard is issued by MBNA.  
  • FutureTrust.  FutureTrust Mastercard allows you to earn 1% of your purchases as a rebate into your section 529 college savings plan account.  Additional rebates of 1% to 30% can be earned from a network of more than 250 merchants on the FutureTrust web site.  
  • LittleGrad.  LittleGrad members receive rebates from participating companies ranging from 1% to 65%. Members' purchases are tracked at more than 1,300 affiliated online retailers and rebates are deposited into their section 529 college savings plan account.  This program eliminates the need to shop via the loyalty program's web site.   
  • MyKidsCollege.  MyKidsCollege members earn rebates by shopping online from participating retailers.  Rebates range from 1% to 25%. Rebates may be redeemed for cash or invested in a ShareBuilder Investment Account.  Although there is no fee for a MyKidsCollege account, ShareBuilder charges a transaction fee.  MyKidsCollege users are not required to invest the rebates in a ShareBuilder account.  
  • SAGE Tuition Rewards Program.  The SAGE Tuition Rewards Program combines the normal return on investment on a variety of investments with an additional 5% return.  The 5% bonus is provided in the form of reduced undergraduate tuition at participating schools, not cash.  The tuition rebates are limited to undergraduate education and only families with children from birth through grade 11 can enroll.  The tuition discounts are not taxable.  The maximum possible tuition reduction is $15,600 or one year's tuition, whichever is less.  The tuition reward is spread out over four years of undergraduate education, yielding a maximum reward of $3,900 per year.   
  • Upromise.  Upromise members receive rebates from participating companies ranging from 1/3% to 10%.  The rebates can be deposited directly into section 529 plans set up for the member's designated children.  Participating companies include more than 15,000 grocery and drug stores, 8,500 retail stores, 7,000 restaurants, 100 online stores, and 50,000 realtors.  Major companies participating in Upromise include AT&T, America Online, American AAdvantage, Avis, Borders Books & Music, CVS, Century 21, Circuit City, Citibank, Coca-Cola, Coldwell Banker, Exxon/Mobil, General Motors, Giant Eagle, McDonald's, Sharper Image, Staples, Starwood Hotels, and Toys R Us.  
• CollegeSureCD from College Savings Bank .  The CollegeSure CD is an FDIC-insured certificate of deposit that is indexed to college costs.  Is is offered by College Savings Bank.  The CollegeSure CD pays interest just like any other certificate of deposit, but is guaranteed to yield a fixed percentage of average college costs at maturity.  Once a CollegeSure CD has matured, the family can use the principal and accumulated interest at any school.  Students are not restricted in thier choice of school.  
• US Treasury Savings Bonds, including Series EE Savings Bonds, Series 1 Savings Bonds, Zero Coupon Bonds and Treasury STRIPS, and Treasury Inflation-Indexed Securities (TIPS).  US Savings Bonds offer a low-risk and modest return investment for saving your children's college education.  Series EE Savings Bonds and Series 1 Savings Bonds offer special tax benefits when used for qualifed education expenses. Other instruments discussed include Treasury Inflation-Indexed Securities (TIPS) and Zero Coupon Bonds including STRIPS.  Savings bonds are very safe investments, since they are backed by the full faith and credit of the US government.  Principal and earned interest are safe and cannot be lost due to market changes, because Savings Bonds are not marketable securities.  Savings bonds are registered with the US Treasury Department, and can be replace at no cost if lost, stolen, or destroyed.  
• Coverdell Education Savings Accounts.  Coverdell Education Savings Accounts were previously know as Education IRAs.  They were originally established by the Taxpayer Relief Act of 1997, and then subsequently expanded by the Economic and Tax Relief Reconciliation Act of 2001 (EGTRRA).  Coverdell accounts are trusts created exclusively for the purpose of paying the qualified education expenses of the designated beneficiary of the trust.  The maximum contribution amount is $2,000 per beneficiary from all sources per year.  Coverdell accounts may be owned by the student or the student's parents.  Contributions may be made until the beneficiary reaches age 18.   
• Money from your Retirement Plan, including penalty-free withdrawals from individual retirement plans (IRAs) and borrowing from your 401(k).  Retirement funds may help you pay for college expenses.  You can withdraw funds from your IRA without penalty to pay qualified higher education expenses.  You can also borrow from your 401(k).  
• UGMA/UTMA Custodial Accounts.  In most states, minors do not have the right to contract, and so cannot own stocks, bonds, mutual funds, annuities, and life insurance policies.  In particular, parents cannot simply transfer assets to their minor children, but instead must transfer the assets to a trust.  The most common trust for a minor is known as a custodial account (an UGMA or UTMA account).  The Uniform Gift to Minors (UGMA) established a simple way for a minor to own securities without the services of an attorney to prepare trust documents or the court appointment of a trustee.  The terms of this trust are established by a state statute instead of a trust document.  The Uniform Transfer to Minors Act (UTMA) is similar, but also allows minors to own other types of property, such as real estate, fine art, patents and royalties, and for the transfers to occur through inheritance.  UTMA is slightly more flexible than UGMA.  For financial aid purposes, custodial accounts are considered assets of the student.  This means there is a high impact on financial aid eligibility.  
• Saving in the parents' names.  Saving money in taxable accounts in the parents' names has several advantages and disadvantages.  If you decide to invest in the parents' names, you should consider taking steps to minimize your taxes, such as investing in mutual funds that are managed to minimize the tax bite, such as those offered by Vanguard.  You can also invest in individual stocks and offset capital gains with capital losses.  But if you invest in individual stocks, you should take steps to diversify your portfolio.  
  • The advantages are:
    • The parent maintains control over the asset.
    • The impact on financial aid eligibility is low, because the money is a parent asset.
    • You can use the money for another purpose if the child decides to not go to college.
    • You can take full advantage of the other education tax benefits, such as the HOPE Scholarship and Lifetime Learning tax credits.
    • There are no limits on the amount you can invest.
  • The disadvantages are:
    • Earnings are subject to income or capital gains taxes.  Your after-tax return on investment may be lower.
    • You may have less motivation to save because the money is not designated for a specific purpose
    • You may be tempted to use the funds for a different purpose.
• 2503(c) Minor's Trust.  A section 2503(c) Minor's Trust is a separate legal entity (a trust) established to hold gifts in trust for a child until the child reaches age 21.  
• Crummey Trust.  Crummey Trusts may be used for gifts to beneficiaries of any age.  .
• Variable Life Insurance Policies (using the cash value of your variable life insurance policy).  Variable life combines life insurance with a tax-deferred investment account, and provides tax-free access to the cash value of the policy.  Some insurance companies promote variable life insurance policies as a college savings tool because the value of the policy is sheltered from financial aid need analysis formulas.  
• Using your home equity.  Investing in your home is a possible alternative to other college savings tools.  When it comes time pay college bills, you can tap the equity in your home by getting a home equity line of credit.  

 Click here for more information about College Savings Plans.

For more information on education tax credits, consult the IRS publication "Tax Benefits for Education".