So you think it was tough saving for college before?
In today’s economy, saving for college is more challenging than ever. College costs continue to increase, but many who are saving for college have been affected by a decrease in the value of their portfolio. They may be out of work or their salary may have been frozen.
The financial impact is that it will be tougher than ever to save for college. So what are your alternatives?
The good news is that your child may now qualify for financial aid or for more aid than in the past. The bad news is that there will be more competition for that aid than ever before - and there may be less aid available.
In fact, colleges are now among the needy themselves. Because of a drop in the value of their endowments and other financial issues, some colleges are basing admissions in part on each applicant’s ability to pay, according to Fox College Funding, so your child may not be accepted if financial aid is needed.
Even star athletes who are expecting sports-related scholarships may be out of luck, as many schools are re-examining their sports programs to determine whether they should continue to be supported at a time when academic programs are being cut.
Conversely, some colleges are accepting more students than they have in the past. That may help if you’re seeking to be admitted this year, but it also means classes will be larger than ever and there will be less room for housing on campus.
Saving during a recession
As bad as the economy is today, keep in mind that the economy is resilient and your portfolio may fully recover and earn the money you need to pay for your children’s college education by the time they are ready to attend college.
The market has already made some recovery this year and, while past performance is no guarantee of future performance, when the economy improves the market may follow.
That may be of little consolation if you have a child currently attending college or beginning college in the next year or two. If your child is close to entering college and you have less money available than you anticipated you’ll need to re-examine your approach.
Start by looking at how much you have saved, how your investments are performing and how much you will need to pay for college. If there is a shortfall, there are several ways to cover it.
Reduce expectations.
Maybe the school your child had his or her heart set on isn’t worth the cost. Consider a state school, which may be half the cost of a private school. Granted that living away from home is an important part of the college experience, but you can also save a great deal of money by commuting.
Keep in mind that four years is a long time. Many children need a couple of years of college to determine their major course of study anyway. Even though your child may start at one school, he or she may be able to transfer to another school in the coming years. The transfer could be for academic purposes or the new school may be that preferred school that is now financially feasible.
Shop around.
While many people shop around for the best deals on everything from cars to insurance, few look for the best deals on college. Work with your children to research the schools that offer what they really want, then try to find comparable colleges.
Your child may make a decision based on the appeal of a campus, a major offered or the school’s reputation, but if there is a comparable alternative for less cost, then you may want to suggest they consider the alternative. If your child sticks with a more expensive choice, suggest that he or she pay the difference.
Today, with online applications being the norm, you can apply to more colleges than ever. Do so. Consider overall costs, and the availability of scholarships and financial aid when making your decision.
Apply for scholarships and grants.
It’s likely that one source of funding will not pay the entire cost of college, so keep your options open. Find out what scholarships and grants are available, then apply for them.
Borrow the funds.
There are two paths in this area. Parents can borrow money or the student can apply for a loan. If parents borrow, the first place to consider is the equity in your home.
A Home Equity Line of Credit (HELOC) is one method. The interest on these loans is tax deductible on borrowings up to $100,000 in most cases. The interest is variable and although currently the rate is low, it will increase in the future when rates go up. But you only pay interest on what you borrow and the HELOC allows you to borrow as needed.
Parents can also borrow money with organizations focused on education loans like Sallie Mae. If the loan is in the parent’s name, then monthly payments commence as borrowing occurs.
Your child can also apply for a student loan. While a loan would result in your child starting his or her working life being in debt, interest rates are low today, so it’s not a bad option if necessary. Payments are deferred until after graduation.
Review your investments
Regardless of whether you have a child ready to start college or your child is still in grade school, it may be a good time to review the performance of your investments and to consider changing them if they are underperforming.
A past column recommended considering a Section 529 plan or other tax-advantaged investment options. Section 529 plans have now been around for more than a decade, so they have a long enough track record to judge their performance.
Contributions to Section 529 plans are made with after-tax dollars, but beneficiaries never have to pay taxes on earnings from the plan, as long as plan funds are used for qualified expenses, which generally include tuition, room and board, and related expenses in an accredited college.
These are great tax advantages, but only if your 529 plan investments have earned money.
Of course, the greater the return on your investment and the longer your money stays in the plan, the greater the tax savings you’ll enjoy.
While 529 plans have been established in every state, keep in mind that you don’t have to invest in the plan for the state where you live. Unlike in many other states, Section 529 contributions are not deductible on state tax returns for Massachusetts residents, so there is no reason not to compare the Massachusetts plan with those offered by other states.
Ratings of 529 plans are available online at many different Web sites, including SavingForCollege.com, FinAid.com, 401kid.com, Morningstar, Kiplinger, The Wall Street Journal and USA Today. The ratings are typically based on factors such as fees charged, flexibility and investment options. It may take some digging to find a comparison of investment performance, but you can always check the annual reports of plans that interest you.
The Massachusetts 529 plan is the U.Fund, which is managed by Fidelity Investments. It is among 23 plans that charge a fee of less than 1 percent a year. Fidelity, which has managed the plan since its inception in 1999, had its contract renewed in July and announced that it would add some plan enhancements, including broader investment options and other changes.
If your current plan is meeting your needs, stay put. If its rating is not nearly as good as that of other plans, consider another plan.
There are no income restrictions for investing in a 529 plan and initially anyone can be a beneficiary. Once established you can change the beneficiary, for example to another child and even other relatives within certain limitations.
Other savings options to consider include Coverdell Education Savings Accounts (ESAs) and UGMA/UTMA accounts. Like Section 529 plans, Coverdell Education Savings Accounts (ESAs) provide tax-free distributions of earnings if funds are used to pay for qualified education expenses. The biggest drawback to ESAs is that no more than $2,000 can be added to the account each year. As such, you are unlikely to save enough in an ESA to pay for your child’s entire college education, but an ESA can provide an effective supplement to a 529 plan.
UGMA/UTMA accounts, which are created under the Uniform Gifts/Transfer to Minor’s Act, give parents an opportunity to gift funds to their children, but retain control on how such funds are invested and used. UGMA/UTMA accounts allow parents to gift up to $13,000 a year to each child without incurring gift taxes.
A disadvantage of UGMA and UTMA accounts is that gifts contributed to them are irrevocable. In addition, earnings on the accounts are taxable, mostly at the parent’s tax rate. Another disadvantage is the assets within this plan are given more weight than parent’s assets when looking at financial aid for a student.
Even with these savings options, you may fall short of your funding goals for your child’s education unless you invest regularly. The economy is struggling today, but hopefully it won’t be by the time your child graduates from college and is looking for a job. The most important principle is to follow a regular savings plan to assist in the funding.
Darrell J. Canby is president of Canby Financial Advisors LLC in Framingham. He can be reached at 508-598-1082 or dcanby@canbyfinancial.com.
