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If you're good at planning ahead, you may have thought about it before your child was even born, perhaps while you were shopping for a bassinet and teddy bears. At any rate, you probably started thinking about it when your child was very young. After all, it's one of the major responsibilities you face as a parent: your child's college education.

Personal growth and expanded horizons are reason enough to send a child to college, but there are more practical considerations, too. College graduates have more jobs to choose from, and they generally make more money than people who have a high school education. That makes a college education very important for your child's future.

Start Early, Early, Early

As a parent with an eye to the future you should start early to save for your child's college education. College costs have risen consistently for the past 10 years, and there's little reason to think this trend will reverse itself. Most cost estimates predict annual increases of 5%. What's more, many people take more than four years to finish college and some go on to postgraduate studies, so you may need to save even more.

According to the College Board, in 2019-2020 the average yearly cost for tuition and fees ranges from $3,730 (public 2-year college) to $36,880 (private 4-year college).

If you have a specific school in mind, you may wish to contact the school - now and when the anticipated date draws closer - for information on tuition costs, how they have changed and the trend for future increases.

Clearly, it helps to begin saving early, preferably as soon as the child is born. The idea is to save or invest as much money as you can and pay taxes on as little as possible. It's like buying a house: the more you've saved ahead of time, the less you'll need to borrow. Set aside or invest as much as you can, even if it's just a small amount from every paycheck.

Increase your contributions to the fund as your salary increases. Add extra cash from raises or yearly bonuses, as well as some of the money your child receives as gifts. Money that comes unexpectedly and has not been budgeted will not be missed. Also, if your older child has a part-time job, encourage him or her to put some of those earnings aside for college.

Strategies for Funding College Tuition

Growth Stocks and Growth Mutual Funds

Good investments in the stock market have the potential to provide better returns than insured, fixed-rate investments (such as savings accounts and CDs/share certificates, which are generally federally insured) - if you have time to let the money ride the ups and downs of the market. This is a long-term approach to investing. And remember: What the stock market did in the past is no guarantee of how it will perform in the future.

The word to look for here is growth. When assessing the growth potential of a particular stock, consider looking for long-term appreciation rather than dividends. Growth stocks also allow you to postpone paying taxes on the capital appreciation realized until you withdraw funds.

Investing in just one or two stocks is always risky. If you'd like to participate in the growth potential of the stock market with less risk, consider a growth mutual fund. Money invested in such a fund is professionally managed and is usually diversified over many stocks which helps reduce risk. Also, you can start investing in mutual funds with a relatively small amount of money.

U.S. Savings Bonds (Series EE)

An EE Savings Bond is a U.S. Treasury security that earns interest for up to 30 years.

EE Bonds issued since May 2005 earn a fixed rate of interest. You know the interest the bond will earn when you buy it.

Series EE U.S. Government Savings Bonds can only be purchased online through TreasuryDirect.

The face values of these bonds range from $25 to $10,000.  You aren't required to pay federal income tax on the interest being earned by Series EE savings bonds until you turn them in, and interest earned is exempt from state and local taxes. 

The savings bond education tax exclusion permits qualified taxpayers to exclude from their gross income all or part of the interest paid upon the redemption of eligible Series EE Bonds issued after 1989, when the bond owner pays qualified higher education expenses at an eligible institution. Qualified higher educational expenses generally include tuition and fees and exclude room and board.

For 2019, this tax break begins to phase out at modified adjusted gross income (MAGI) of $81,000 for single filers or $121,600 for married joint filers.  The tax-free Savings Bond provision cannot be used for the same expenses that are used to claim other educational tax breaks such as the American Opportunity or Lifetime Learning credits.

Life Insurance

You shouldn't purchase life insurance unless you need protection. If you have a permanent life insurance policy paid with fixed annual premiums, you generally have the option of borrowing against its cash value. Of course, the amount of cash value available to borrow against varies, depending on the specific policy. The death benefit will be decreased by the amount of the outstanding loan. The interest rate charged on such loans is often reasonable, and in many cases you can pay back the loan on a flexible schedule. Talk to your insurance representative about the advantages of life insurance when planning your child's college education.

Prepaid Tuition Plans

Several states (and some higher education institutions) offer various types of prepaid tuition plans, generally for students attending state schools. They allow you to buy a contract or bonds at a fixed price, based on the rates of college tuition today. Payments can be made in lump sums or monthly installments. The state, in turn, invests the money to earn the difference between the amount you are paying and the projected cost of tuition at the time your child reaches college age. Those who sign up are fully protected, as the state assumes all the risk of the investments. Check with your state's commission on higher education to see if a prepaid tuition plan is available where you live.

Prepaid tuition plans are not for everyone. They mostly attract middle-income families who tend to be more conservative in their investments. Lower-income families using this option may jeopardize their chances for state aid and forfeit money needed for immediate essentials. If you're interested and a plan is offered in your state, you'll want to know if it covers only the cost of tuition, or room and board, too. Also, check to see if it applies to other than state schools. Finally, confirm that your original deposit will be returned if your child attends a private or out-of-state college, is not accepted at a state school or chooses not to attend college at all.

Savings Plan Trusts or 529 Plans

Certain states offer special college savings accounts known as savings plan trusts. These accounts allow the contributor to save as little or as much as they like on behalf of a designated beneficiary's qualified education expenses. Contributions may be as little as $25. These accounts may guarantee a minimum rate of return and generally provide favorable tax treatment. The account may be used at any qualified institution of higher learning within the United States. If you move to another state, the money in the trust goes with you.

Some savings plan trusts can be used for other family member's qualified education expenses. Check with your state's commission on higher education to see if a savings plan trust or 529 plan is available where you live.  

You can take tax-free distributions for qualified education expenses from your child's 529 College Savings Plan to pay qualified education expenses in the same year as the American Opportunity or Lifetime Learning credits, as long as you don't use them for the same expenses.

American Opportunity Tax Credit

The American Opportunity Tax Credit is a refundable tax credit for undergraduate college education expenses. This credit provides up to $2,500 per eligible student in tax credits on qualifying educational expenses. 

If the credit brings the amount of tax you owe to zero, you can have 40 percent of any remaining amount of the credit (up to $1,000) refunded to you. The credit is gradually reduced if your modified adjusted gross income (MAGI) is between $80,000 to $90,000 for single filers ($160,000 to $180,000 if you file a joint return).  You are not eligible if you are married, filing separately.  

The credit can be claimed for the first four years of post-secondary education. 

Lifetime Learning Credit (LLC)

You may be able to claim a Lifetime Learning Credit of up to 20% ($2,000) on the first $10,000 of college tuition and fees.  

You can claim the Lifetime Learning Credit on your tax return if you, your spouse, or your dependents are enrolled at an eligible educational institution and you were responsible for paying college expenses. 

Income restrictions apply.  You can claim a full LLC if you (the taxpayer) have modified adjusted gross income (MAGI) of $58,000 to $68,000 for individual filers, or $116,000 to $136,00 if filing a joint return.  You are not eligible if you are married, filing separately.  

Coverdell Education Savings Accounts

You can set up Coverdell Education Savings Accounts (ESAs) - previously called Education IRAs - for the purpose of paying for qualified education expenses for higher education, secondary or elementary schools. Contributions are allowed from the time the child is born until your child reaches 18.

The account allows up to $2,000 per year in after-tax contributions to be made in a child’s name. These contributions grow tax-deferred and may be withdrawn tax-free for qualified educational expenses.

The income limit for making a maximum contribution is $190,000 for joint filers, and contributions phase out at $220,000 in 2020.  For single filers, the contribution limit is $110,000.

If the money is not used by the time the child turns 30, it must be given to them or rolled over to a Coverdell ESA for another family member.

CDs/Share Certificates and Savings Accounts

Certificates of Deposit (CDs) or share certificates and savings accounts are two other places to put college savings. Although certificates and savings accounts are generally federally insured, they typically offer a lower return potential than other investment vehicles and are most appropriate for those with short-term goals.

Tax Considerations

Even if you invest wisely and defer the tax liability on savings for your child's college fund, you'll have to come up with the taxes when you liquidate those investments. Chances are you'll be faced with taxes at a time in the future when you are likely to be in a higher tax bracket and have other additional expenses. You'll need to be sure your investments earn enough to cover the anticipated taxes.

It's important to note, too, that tax laws are constantly changing. Consult your tax advisor before you begin investing, then check back regularly. If tax law changes negatively affect your college investments, you may want to move the money. How and when you move the funds also can affect taxes, so be sure to talk to your tax advisor first.

Here are just a few examples of tax considerations affecting college funds:

  • Loans. Generally, personal interest you pay, other than certain mortgage interest, is not deductible on your tax return. There is a special deduction allowed for paying interest on a student loan (also known as an education loan) used for higher education. This deduction can reduce the amount of your taxable income. The maximum annual amount of deductible interest is $2,500.  If you're single, you can deduct up to $2,500 of student loan interest. However, if you're married and file a joint return, you and your spouse can only deduct a total of $2,500, even if both of you have student loan debt.

    For 2019 and 2020 tax returns, phaseouts apply for taxpayers with modified adjusted gross income (MAGI) in excess of $70,000 ($140,000 for joint filers), and is completely phased out for taxpayers with MAGI greater than $85,000 ($170,000 for joint filers).  
  • UGMA accounts. You can put assets in a Uniform Gift to Minors Act (UGMA) custodial account for a child. However, if the child is under age 14, all income earned by these assets above a certain level (determined annually by the IRS) is taxed at the parents' income rate, whether or not the parent is the custodian. For children 14 years old and older, the income on assets in a UGMA account is generally taxed at the child's rate. You should keep in mind that putting assets in your child's name may reduce the amount of financial aid he or she is eligible to receive.

Other Avenues for Revenue

Even if you start early, it may be impossible to save enough for your child's college education. That doesn't mean, however, that college is out of the question. You have other cost-saving options available.

Student Strategies 
While they may not be options you should rely on, there are some strategies students can follow to help reduce their expenses prior to entering college and once they're in college. For example, many college students, particularly those who commute to a local school, are able to work part-time and in the summer to help subsidize their tuition or simply to earn spending money. Be aware, however, that money earned by the child prior to college may reduce his or her eligibility for financial aid. Some colleges offer cooperative education programs where students rotate study with periods of career-related work, allowing them to earn money and credits at the same time. However, it may take more than four years to complete a degree through a cooperative education program. Ask the college admissions office about the specifics of their program.

Depending on a child's scholastic ability, he or she may be able to earn college credits by taking college courses or advance placement exams while still in high school. First- and second-year college students can also take College Level Examination Program tests for course credit. These options can represent a significant savings over the cost of a full-semester course in the classroom. Check with your child's high school guidance counselor or with the college admissions office for eligibility requirements and program specifics.

Another cost-saving possibility is to attend a community college for the first year or two, then transfer to a four-year college to complete a degree. This can be a more affordable approach to receiving a degree from a prestigious institution that you may have been unable to afford for four years or which may have been more competitive to gain entrance in as a freshman.

Financial Aid
Think of this in broad terms. You needn't be the sole source of funding for your child's higher education. For example, when your child receives a gift of money, put it into a college fund. When grandparents ask what to give for birthdays, suggest college fund contributions.

And don't forget the traditional sources of financial aid: scholarships, grants, work-study programs and government loans. Your child's scholastic record, course of study, athletic ability and choice of college are just a few of the variables that may affect the availability of these options.

If your family meets certain financial criteria, the federal government has a program of low-interest loans with extended payment terms. Relying too heavily on loans, however, is costly and can burden graduates with large debts just when they are working to establish their financial independence. Also, you should be aware that government financial aid programs are subject to change.

Home Equity
If you bought your home when your child was small, you're likely to have built up a significant amount of equity by the time college is in the picture. You can tap that resource for your child's education with a home-equity line of credit. Interest payments may be tax-deductible.