BANKING & FINANCE: Will you be able to afford to send your children to college?

Funding a program for a child’s education is harder than ever today, given the rising costs of education and the increasing dependency on student aid in the form of loans.

According to the College Board, college tuition and fees rose over 4 percent in 2000, and room and board expenses grew between 3 and 5 percent. For the 2000-2001 school year, the average cost for a student living on campus at a four-year private college exceeded $22,000. Many parents are wondering if they will be able to afford a college education 5, 10 or 18 years from now.

There are generally three ways to pay for college. You will probably use some combination of all these methods:

1. Out-of-pocket. You pay the tuition, room, board, books and other expenses from your current cash.

2. Student loans, scholarships and grants. College scholarships and grants are still available to some families, although the government has made eligibility based on financial need more restrictive. If your child is in good academic standing, private scholarships and grants may be within reach. When looking for any kind of aid, apply early and often. More often, parents and students are required to take out loans that can be a burden to pay back for many years after graduation.

3. Funding a program. Probably the best way to make sure you have a large sum when your child is ready for college is to contribute to a college investment program. You could invest a lump sum and/or contribute to your plan on a regular basis.

How to set up a program

First, estimate the amount of money you will need. Find the current cost of the type of school you want your child to attend (private or public, local or out-of-town) and use the education inflation factor for that school to gauge how much it will cost when your child reaches college age.

In selecting investment vehicles, keep the following in mind: the child’s age, tax considerations and your tolerance for investment risk. Generally, the younger the child, the more you should consider growth stocks. Over time they have outperformed bonds and cash-equivalent investments.

As the child gets closer to college age, you should shift assets into bonds, money market funds and other investments that offer greater safety and liquidity. Of course, if you stay up nights worrying about your money, stick to low-risk savings and investments from the start.

If you have begun to explore education funding programs, you have probably found that many traditional savings options have significant downsides.

For example, with a custodial account, you make an irrevocable gift to a child, which means you give up control of the money in the account. And although education-specific savings alternatives such as the Coverdell Education Savings Account (formerly known as the Education IRA) provide tax-free distributions for education expenses, parents with higher incomes may not be able to contribute. Even those who can contribute are limited to $500 annually ($2,000 annually after Dec. 31).

Today there’s another alternative when it comes to saving for college: Section 529 College Savings Plans. These programs, named after the Internal Revenue Code section that established them, let individuals contribute substantially more money toward higher education expenses while enjoying significant tax advantages.

Contributions to Section 529 College Savings Plans are often invested in a family of pre-selected portfolios, according to the age of the beneficiary or the number of years until enrollment in college. Some plans also provide other investment options, such as 100% equity portfolios or 100% fixed income portfolios. Once an investment option is chosen, it may not be changed at any time during the life of the account.

Assets in Section 529 grow free from federal income tax while in the account. Assuming there are earnings, this feature allows the account to grow faster than a comparable taxable account where earnings are taxed every year. Better yet, after Dec. 31, 2001, qualified withdrawals will be free from federal income taxes. Please note that the federal tax exemption is due to expire on Dec. 31, 2010, unless the law providing for the federal exemption is extended.

Many programs offer additional state tax benefits, so it’s important to examine the structure of your state’s plan. You should weigh any state tax benefits against the benefits, terms and conditions of plans offered by other states. Investment options, performance and other relevant factors should be considered when making a decision. You should also be aware that many states offer prepaid tuition plans, which are another type of 529 Plan.

If you are already saving within a custodial account, a Coverdell Education Savings Account or U.S. Savings Bonds, you may want to explore the tax consequences, if any, of transferring these investments to a Section 529 College Savings Plan.

Your professional financial advisor can provide more information to help you decide which education-funding strategy may be appropriate for your situation.

Don’t wait until your child receives a college acceptance to address the issue of how you will pay for this education. The sooner you begin to save, the more time your funds will have to grow and the easier it will be to achieve this major goal.

Keri Sabatini is a Financial Consultant with Salomon Smith Barney in Traverse City, specializing in education and retirement planning services, and professionally managed accounts; 932-7216 or keri.l.sabatini@rssmb.com. This information is for general informational purposes only. Salomon Smith Barney does not provide tax or legal advice. Please contact your tax and/or legal advisor for guidance as to how this information might apply to your personal circumstances. This material does not constitute an offer or solicitation with respect to any college savings plan or program.

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