Saving for College

What It Means

Most financial planners advise parents to begin saving for their children’s college educations as soon as possible. Some parents begin saving for college before their children are born, but many parents cannot afford to allocate funds for college until later in their children’s lives. Whenever parents begin to save, adhering to a set of basic guidelines can maximize the funds students have for school and minimize the debt they incur while completing their studies.

First, the parents or guardians (and possibly the student as well) should review their present financial circumstances and create a sensible budget. Parents who are beginning to allocate funds when their children are very young can consult one of the many online college-cost calculators to determine how much a college education is projected to cost when their child is scheduled to attend. Such calculators project average fees for public, private, and Ivy League schools. They also estimate how much money parents should allocate per month based on how old their children are when they start the savings plan. For example, according to some 2007 estimates, parents of a newborn child who plan to send the child to a state college should invest $312 per month in order to be able to cover expenses fully by the time he or she starts school. Another projection calculated in 2007 was that parents who want to pay for an Ivy League school and begin their savings plan when their child is 8 will need to invest $1,385 a month.

After establishing a budget, the next step is to choose an investment plan that offers tax advantages and to contribute funds to the plan consistently. There are four major types of college-investment plans: 529 Plans (also known as Qualified Tuition Plans, or QTPs); Coverdell Education Savings Accounts (often called ESAs); and Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts, which allow donors to give assets such as stocks, bonds, and real estate to their children. Most people investing in one of these plans seek professional assistance to help them choose and manage the plan. The final step is to monitor the progress of the investment and to make changes to the investment strategy if necessary.

When Did It Begin

The UGMA is an act of federal legislation that took effect in 1956 with the approval of the New York Stock Exchange, the Association of Stock Exchange Firms, and the American Bar Association (an association of American lawyers). The act permits minors to receive gifts such as cash, stocks, bonds, and other securities that are managed by a custodian until the minor reaches the age of majority (18, 21, or 25, depending on the laws of the state in which the minor lives). Under the provisions of the law a parent may transfer as much as $11,000 per year ($22,000 per year for a couple) to a child’s UGMA account without the funds being subject to a gift tax. When the child comes of age he may use the funds as he wishes. No one, not even the former custodian of the account, can dictate how the funds are allocated. Adopted in 1986, the UTMA extends the UGMA to include other types of gifts, such as real estate and art.

QTPs, or 529 Plans, were created under the Small Business Job Protection Act of 1996. These investment plans allow more significant contributions than UGMA and UTMA accounts (a parent can make a lump-sum investment of as much as $60,000 at one time), but all funds in the account must be used to pay for a college education. Coverdell Education Savings Accounts were created by the Economic Growth and Tax Relief Reconciliation Act of 2001. Parents may contribute up to $2,000 annually to Coverdell ESAs.

More Detailed Information

The investment plan most widely used by people saving money for their children’s college education is the 529 Plan. The specific details of a 529 Plan are determined on a state-by-state basis. In general, there are two types of 529 Plans: prepaid plans and savings plans. As of 2007, all 50 states in the United States as well as the District of Columbia offered at least one of the two types of 529 Plans. According to a prepaid plan, a person pays current rates for tuition credits that will be used in the future by the student (referred to as the beneficiary). Thus, the initial investment in a prepaid 529 Plan increases at exactly the same rate as college tuition. Prepaid plans can be sponsored either by states or by individual institutions of higher education. For example, if someone purchases a prepaid plan under the auspices of New York State, the beneficiary of the plan will have tuition paid at a New York State school at some future date. If a person invests in a 529 Plan through a private institution, the beneficiary must attend that institution.

Savings-based 529 Plans are only sponsored by states. According to this type of plan, a person invests as much as he or she wishes (up to $60,000 in one lump sum) in mutual funds (a bundle of investments, including stocks, bonds, and other securities, that is managed by an investment company). The mutual funds available for 529 Plans are determined by the state sponsoring the plan. Whereas the investment in a prepaid plan is guaranteed to cover tuition at a later date, investments in savings-based 529 Plans are subject to market risk. These plans, however, typically pay greater returns (meaning the money invested grows more) and offer the beneficiary the option of using the returns for all fees associated with college, including room and board. Profits on a 529 Plan are not taxed over the life of the investment. Nor are they taxed when funds are withdrawn. If the beneficiary does not use the funds for education there is a significant financial penalty.

Investors in both types of accounts are allowed to change the beneficiary. They are also permitted to name themselves as the beneficiary of the account. Any beneficiary on a 529 must be related to the investor named on the account.

In addition to saving for college, it is crucial that students research and apply for some of the many scholarships that are available. Students interested in obtaining scholarships should begin their research by consulting with their guidance counselors to find out what scholarships are available within their local communities and at the universities the student would like to attend. Churches and chambers of commerce in many cities offer modest scholarships, as do community foundations, nonprofit organizations, and volunteer organizations. Labor unions (organizations of workers that are formed to protect workers’ rights) frequently offer scholarships for members and their children. Upon first glance, the funds available from these organizations may appear to be small relative to the charges for tuition and dormitory expenses, but scholarships can help with payments for textbooks and school supplies.

Aside from scholarships, all students requiring financial assistance should fill out the Free Application for Federal Student Aid (FAFSA) forms that are available in the guidance or administrative offices of their school or online at the FAFSA website. Students seeking federal aid are required to submit a new form prior to each year for which they are seeking financial assistance. Based on the information submitted on this form, the government issues a Student Aid Report (SAR), which contains several figures, including the Expected Family Contribution (EFC; the dollar amount the government determines that the family can contribute toward the child’s expenses for college that year) and the amount that the federal government will contribute to the student’s college education that semester.

Awards are granted in the form of Pell Grants, Federal and Supplemental Educational Opportunity Grants (FSEOGs), Academic Competitiveness Grants (ACGs), and Science and Mathematics Access to Retain Talent Grants (SMART Grants). Although these figures are subject to change, in 2007 the maximum FSEOG was $4,000 per year and the maximum Pell Grant was $4,310 per year. The maximum Pell Grant was scheduled to increase to $5,400 per year by 2012. ACGs offer a maximum of $750 and $1,300 for each of the first two years of study, respectively. Aimed at returning juniors and seniors, SMART Grants provide a maximum of $4,000 a year for the third and fourth years of study. All funds are awarded at the discretion of the university. In addition to these grants, students can also qualify for student loans and work-study (programs wherein students are paid to do a manageable job at the university, such as answering phones in one of the department offices or working in the athletic facility).

Recent Trends

According to reports from 2006, the average cost for private colleges and universities was more than $30,000 per year, while the average cost for public colleges and universities was under $6,000 for the 2006–07 academic year. This later figure includes two- and four-year state institutions. These costs do not include room and board, which cost an average of $6,900 for state schools and $8,150 for private schools. Thus, at that time, going to college and living on campus for four years cost somewhere between $50,000 and $160,000.

Since 1995 the average cost of college has risen at nearly twice the rate of inflation (the general rising of prices in the economy). From 2002 to 2006 the rate of tuition growth for private colleges was about 6 percent a year, but most financial advisers were telling their clients to expect tuition to rise at 7 percent a year. From the 2004–05 academic year to the 2005–06 academic year, tuition at state schools increased by an average of 7.1 percent. That figure dropped to 6.3 percent the following academic year. At these rates, tuition and fees for state and private schools would nearly double in 10 years.

Increases in student aid lag behind the tuition increases. For example, from the 2004–05 academic year to the 2005–06 academic year, student aid increased by just 3.7 percent. Furthermore, student-aid packages often consist of loans, which must be paid back with interest, rather than grants, which are awards and do not need to be repaid. According to some reports, 51 percent of the money given in financial-aid packages comes in the form of loans. Only 44 percent of student financial aid comes from grants.

Data indicates, however, that the steep costs of college are worth the expense. As of 2005, women between the ages of 25 and 54 who held bachelor’s degrees earned 70 percent more income than women who only held high school diplomas. For men in that age bracket the difference was 63 percent.