Proper savings now pays for tuition later

Your child or grandchild has entered high school and is just four years away from college. It’s time to get serious about figuring out how much it’s going to cost. Based upon recent data from the College Board, if he or she goes to a private four-year university, the cost for the four years will be about $160,000.
Which position would you rather be in – taking advantage of a “discount” of $18,000 off the sticker price or overpaying by $53,000? That, in a nutshell, is how to compare the difference between saving for college now and borrowing to pay for your child’s education later. These figures assume that the current cost of a four-year education at a private college is about $120,000; that inflation will increase costs by 5 percent a year; and that if you borrow, it will be for 10 years at an interest rate of 6 percent to pay those costs. Saving about $142,000 will cover the costs. By borrowing, you will pay $73,000 in interest, or about $213,000 total.

Solid savings opportunities
Even small savings can have a significant impact over time. Every dollar saved offsets a dollar that otherwise would have to be borrowed. More importantly, every dollar saved can earn additional income, which brings down the total cost.
Don’t look to your 401(k) plan or individual retirement account. These accounts are great ways to save for retirement, and they do permit penalty-free withdrawals to pay the costs of higher education. However, these are not good choices for building a college fund. There are potential tax and opportunity costs for tapping your retirement resources early.
There are, however, some ways to save that, thanks to the tax breaks offered by Uncle Sam, will permit you to help your college fund grow more quickly. For instance, you can open a Coverdell Education Savings Account, or as it was formerly known, an Education IRA, for each of your children and contribute up to $2,000 a year. The earnings in the account grow tax-free as long as withdrawals are used for qualified education expenses. Unfortunately, not everyone can fund a Coverdell account. An individual’s ability to contribute the full amount phases out between modified adjusted gross income of $95,000 and $110,000. For joint-filing couples the phase-out range is now double those amounts, $190,000 to $220,000.
No such limits apply to Section 529 college savings plans. A Section 529 plan is a state-sponsored savings account, available in all 50 states. The account is set up for the purpose of saving in order to pay for most higher education expenses at eligible institutions. No federal tax is paid on the income earned on amounts accumulated in a Section 529 plan. Even better, when withdrawals are made and used for qualified expenses, they won’t be taxed either. (This special treatment currently is set to expire after 2010 unless Congress decides to extend this tax break.) Often, there won’t be any tax consequences at the state level either.

How much do you need to save?
The table below illustrates how much you will need to save per month to meet the ever-escalating cost of a college education. The table assumes that your child begins college at age 17 and that inflation averages 5 percent a year. According to the College Board, since 1992, tuition and fees at both public and private four-year colleges and universities, after adjusting for inflation, have risen 38 percent. For the 2004–2005 academic year alone, tuition at public four-year schools increased by 10.5 percent and by 6 percent at private four-year schools. All rates of return in this table and article are for illustrative purposes only and do not reflect the return of any particular investment. Past performance is no guarantee of future results.
Your actual costs, of course, may be more or less, depending upon a variety of factors – for instance, whether the school is public or private, the year that your child starts college and the actual rate of inflation in the years to come. Still, these numbers will give you a good idea of just how important it is to develop a plan for saving and investing when your child is young.

Troy E. Kennedy is senior vice president and shareholder with Springfield Trust Co., a locally owned, independent trust company managing approximately $500 million in investments for families, businesses, charities and foundations.
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