Paying for College: What's the Smartest Course?

Today, the total cost for one year at a four-year public university averages about $10,450 (tuition, room and board, books and other expenses). At a four-year private school, the tab averages about $22,500.* If costs rise 5% per year, parents of a newborn could be paying $25,700 to $55,320 yearly for their child's college degree. Given the expense, the smartest course is to use all the saving, financing and tax breaks available.

A College Fund

First, create a college fund and make regular contributions. The size of the contributions and the kinds of investments you select depend on your goals, risk tolerance and the age of your children.

- Children under 10: Consider a mix of 80% stocks and mutual funds and 20% in bond funds. Look into an education individual retirement account (IRA) or a traditional IRA, which can be tapped to pay college costs, penalty-free.

- Children 11 to 14: Your timeline is still long enough to continue investing somewhat aggressively. You may want to invest 70% in stock funds and 30% in bond funds. But diversify your holdings to reduce risk. Also, see if your preferred college has a prepaid tuition plan, which allows you to save for future college expenses at today's prices.

- Children 15 and older: Consider shifting some investments to less risky choices, such as certificates of deposit. Look for financial aid, too. In 1999, roughly $64 billion in financial aid was awarded to students.

Student Financial Aid

Though education costs are rising, the financing options available are numerous.

- Federal Stafford Loans go to students with demonstrated need. These low-interest rate loans are government-insured. With a subsidized Stafford loan, the government pays the interest while the student is in school, and students may defer payment until six months after graduation. An unsubsidized Stafford loan allows students to defer payments until after graduation, but interest begins to accrue immediately.

- Federal parent loans for undergraduate students (PLUS) help parents cover the difference between the total cost of education and any financial aid awarded by the school. The government considers credit history, not financial need, when awarding these loans. Repayment must begin within 60 days of disbursements.

- Private and insured loans can supplement federal loans and scholarships. They usually offer better rates or terms than other consumer loans and are distributed according to creditworthiness rather than need.

- Scholarships are gifts from organizations to students who demonstrate certain merits and/or financial need. Search local employers, civic and fraternal organizations, foundations and corporations for scholarship opportunities.

To apply for federal and many state aid programs, students must complete a Free Application for Federal Student Aid (FAFSA). You can submit a FAFSA using the Internet ( or a paper application (see your high school counselor).

Tax Breaks

Several tax breaks also lower the cost of higher education.

- Custodial account in your child's name. This is an account that a custodian (usually a parent) controls for a child. Earnings may be taxed at the child's lower rate, depending on the child's age and earnings. Once the child reaches legal age, funds in the account are his or hers to spend.

- Education IRA. Contributions of up to $500 a year may be made for children under age 18 into an education IRA. Earnings accumulate tax-free and are tax-free upon withdrawal as long as they are used for college tuition, fees, books and room and board. However, withdrawals from an education IRA are not tax free in any year in which you claim a Hope Scholarship Credit or a Lifetime Learning Credit.

- Traditional IRA. Withdrawals prior to age 59-1/2 for education are penalty-free, but taxable. Contributions are limited to $2,000 per year.

- Hope Scholarship tax credit. Parents of post-secondary education students, or the students themselves, may claim up to $1,500 per student per year for out-of-pocket tuition and fees for the first two years of college. The maximum credit allotment will be adjusted for inflation after 2001.

- Lifetime Learning tax credit. Taxpayers with undergraduate and graduate students may claim a tax credit of up to 20% of qualified, out-of-pocket college expenses annually. Until 2002, the tax credit will amount to 20% on the first $5,000 spent on tuition. After 2002, the credit is based on the first $10,000 spent on tuition and fees. (The Hope Scholarship Credit and Lifetime Learning Credit can not be taken on the same student in the same year).

- Student loan interest deduction. Borrowers may deduct interest paid on any college loan for the first 60 months of repayment. The maximum deduction is $2,000 for 2000 and increases to $2,500 thereafter.

Some states now sponsor qualified state tuition programs. Under these programs, taxpayers can make contributions on behalf of a designated beneficiary. The contributions grow tax-free and the beneficiary can withdraw the funds as needed for higher education expenses.

Eligibility for any of the education tax breaks depends on your income level. Consult a tax advisor for more information.

*Source: College Board Annual Survey of Colleges

Jim Larranaga is Executive Vice President of Priority Publications, a Minneapolis-based publisher of financial newsletters.

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