Saving for College: Advice for Parents

Paying for a child's higher education is daunting, and the cost is only rising.

According to the College Board3, the average cost of tuition and fees at a private college was $22,218 for the 2006-2007 school year, up 5.9 percent from the year before. And 22 percent of students at private schools paid more than $30,000 a year in tuition and fees.

The average cost for tuition and fees at a four-year public college was $5,836, an increase of 6.3 percent. Room and board averaged $6,960 at public colleges and $8,149 at private ones, and those costs are rising annually at about a 5 percent clip.

The Wall Street Journal Online emailed Joseph Hurley, founder of Savingforcollege.com, a Web site that offers information about ways to save and pay for college.

Mr. Hurley, a CPA and the author of "The Best Way to Save for College -- A Complete Guide to 529 Plans," answered some of the questions parents face when thinking about college savings. Some questions and answers were edited.

WSJ.com: What are the most common mistakes people make when planning for a child's education?

Mr. Hurley: Neglecting to plan for college expenses while the child is young. College seems a long ways off for parents of a preschooler, but they should begin to plan and save for college as early as possible. Put college savings as an item on your personal budget from the start; later on you'll be glad you did.

Here's an example: To save enough today to fully pay for a four-year degree that costs $25,000 annually, and increases 6 percent a year, the parents of a 12-year-old would have to put away $1,140 a month, while the parents of a 2-year-old would need to save $645 a month. This assumes the monthly savings continue through the final year of college and that the investment grows at a 7 percent after-tax annual rate.

Another mistake is spending down assets to try and receive a lot more financial aid. Many parents don't realize the maximum "assessment" rate on their assets is only 5.64 percent, whereas the assessment rate on their income can be as high as 47 percent. [The "assessment" rate is the percentage of assets or income that parents would be expected to pay toward their child's education each year. The actual rate takes into account family size, parents' ages, income, assets and other factors.]

WSJ.com: Should savings be made in the child's name or the parents' names?

Mr. Hurley: I don't see anything wrong with keeping a modest amount of savings in your child's name. As long as the annual taxable earnings on interest stay below $850 (as adjusted for inflation) you won't have to file federal income tax returns for your child. And a small investment account can easily be liquidated and spent on behalf of your child if you decide those assets no longer belong in the child's name.

It's when parents or grandparents gift large amounts of money to the child that problems tend to occur, including the "kiddie tax," negative financial-aid consequences, and a parent's greatest fear: that the child finds out about the big pot of money waiting for him or her at age 18 or 21 and decides there will be better things than college to spend it on.

[The "kiddie tax" refers to IRS limitations on a child's ability to have unearned income taxed at the lower rate for children. "Negative financial-aid consequences" refers to the fact that children are expected to spend a greater percentage of savings on education costs than their parents.]

WSJ.com: In recent years, 529 plans -- state-operated investment plans that give a federal tax-free way to pay for college -- have become more popular. What should parents look for when deciding which 529 plan is right for them?

Mr. Hurley: You can find differences between any two 529 plans. My suggestion is to first investigate your own state's 529 plan for special benefits available that you lose with an out-of-state 529 plan.

For example, three states grant a state income tax deduction for contributions to any 529 plan, but 28 states restrict their deduction to in-state plan contributions. I encourage families to shop around and judge whether the investment managers, fee levels, or program features in an out-of-state plan are enough reason to forgo home-state benefits.

WSJ.com: What are the top tax breaks students and parents should be aware of? Is there any new information related to this year's taxes that is particularly important?

Mr. Hurley: There are so many tax breaks for higher education that it's difficult to select one. The lifetime learning credit of up to $2,000 can be particularly valuable for a moderate-income family with a hefty tuition bill. But it also competes against the Hope scholarship credit and the above-the-line tuition deduction, making the whole tax-planning process very confusing for many taxpayers.

Government studies have found that many families fail to take full advantage of the education tax breaks available to them. When planning for your taxes as your child gets closer to college age, be sure to consider the optimal liquidation strategy for your taxable portfolio of stocks and mutual funds. Gifting appreciated securities to your child prior to sale can sometimes make sense, if financial aid isn't significantly impacted.

WSJ.com: What should parents consider when balancing retirement savings and saving for college?

Mr. Hurley: First consider what you will need for a comfortable retirement and save in earnest toward that goal. Contribute fully to your IRA and be sure to take advantage of your employer's 401(K) match.

Saving for college comes second, though I believe that every parent can find a way to invest at least $25 a month into a college-savings account. Even if you can't save for the full cost, your monthly account statement will show progress towards that goal and will serve as a constant reminder of the college-funding challenge. Also, be sure you have adequate life and disability insurance.

WSJ.com: What kind of investments should parents seek when considering the age of their child?

Mr. Hurley: Most parents will seek to maximize their returns by investing primarily in equities when the child is young, and then switch to less volatile investments such as bonds, stable-value funds and money market funds as the child approaches college age. The "age-based" or "enrollment-based" investment options available in many 529 plans automatically adjust asset allocation as the beneficiary gets older.

The parents' other investments and their own risk tolerances should be considered as well. Some will decide to accept greater market risk and stay invested in equities until the college fund is totally spent, while others will look for high-yielding, low-risk options right from the start. We're now seeing some 529 plans offering bank CDs with competitive interest rates, and there are no taxes if withdrawals are used for college.

WSJ.com: What do you suggest for grandparents who want to help pay for educational expenses? Can grandparents' savings affect financial-aid awards?

Mr. Hurley: Grandparents should investigate 529 plans. If college intentions don't work out for the named beneficiary, the grandparent can change the beneficiary to another family member and, in a pinch, can even take the funds back (subject to income tax and 10 percent penalty on the account growth).

Wealthy grandparents can use 529 plans as a way to reduce their taxable estates without giving up control of the funds. Each grandparent has the option of giving $12,000 a year or a $60,000 lump-sum gift every five years without incurring a tax on the contributions. Grandparent-owned 529 accounts appear to have no impact on federal financial aid awards.

WSJ.com: How much responsibility do you think the child should be expected to take in financing higher education?

Mr. Hurley: That's a very personal decision that I think is significantly influenced by family precedent. If your own parents paid for 100 percent of your college expenses (as mine did) then I think you are much more likely to pay the college expenses of your child, assuming you have the means.

A poll on our Web site poses this question, and the majority of respondents seem to feel that the child should have a financial stake in his or her college education.

WSJ.com: What advice would you give parents who want to develop a savings plan but don't want to use a financial adviser?

Mr. Hurley: Keep it as simple as you can, spend sufficient time researching and understanding your options, and track your progress on an annual basis.

Some people are fully capable of doing it on their own, and the cost savings will add to their available college savings. Others simply don't have the time or financial savvy required to do a good job and the mistakes can be more costly than their savings in professional and brokerage fees.

If you decide to use a financial adviser, put the effort into finding an experienced and knowledgeable one who will place your interests first.