Paying for College Without Going Broke, 2017 Edition - Princeton Review, Kalman Chany (2016)

Part II. How to Take Control of the Process

Now that you know how the financial aid process works, it’s time to start figuring out how to take control of that process—and prevent the process from taking control of you.

If you have read Part One of this book, then you have already taken the first step toward this goal:

Understanding What’s Going On

If you don't have time for homework, you can always pay someone to do your homework

The college FAOs don’t really want you to understand all the intricacies of the financial aid process. If parents don’t know what’s going on, they can’t ask embarrassing questions, and they will accept whatever the FAOs tell them.

We know of one case in which a financial aid officer from a private college told a parent who had called asking for an increase in aid, that “our hands are tied. Federal regulations prevent us from giving you any more money.” The parent, not knowing any better, accepted this as the truth. In fact, it was a bald-faced lie. Almost all colleges (and this one was no exception) hand out their own grants, funded by private funds, which are not regulated by federal law at all.

Another thing parents are often too willing to accept at face value is the initial financial aid offer by the college. In a recent trend, many schools (particularly the most competitive) have begun to build some bargaining room into their initial offers. They expect you to ask for more. In many cases, accepting that first offer means taking a lower number than the FAO was willing to give. These are just two examples of the facts you will learn in the next few chapters—facts that will enable you to understand and begin to take control of the financial aid process.

Parents whose children are several years away from college will find the next chapter on long-term planning particularly useful. In it, we will show you how to begin building a fund for college that will take advantage of both tax law and financial aid law. Families who are getting ready to apply to college should skip long-term planning and go directly to Chapter Three on short-term strategies. There we will begin to show you how linking your income tax strategies and your financial aid strategies can save you big bucks. We will show you how the colleges assess your income, your expenses, your assets, your liabilities, and how to influence these assessments to your advantage.

A word of caution, before we begin.

Don’t Let the Terminology Intimidate You

In the course of counseling thousands of families, we’ve seen how confusing financial aid jargon can be to the nonprofessional. Just remember, the FAOs don’t mind if you are a little confused. In fact, they would prefer it. And since they have a large influence on the instructions that come with the aid forms you will have to fill out, it shouldn’t surprise you to learn that the instructions to the forms are confusing and full of unfamiliar terminology as well. The introduction to one particularly confusing financial aid form states that some questions are “self-explanatory, and therefore no instructions are given.”

Don’t worry. By the time you finish reading this book, the jargon will be second nature. At the back of this book is a comprehensive glossary; feel free to refer to it at any time.

To avoid confusion, we have taken care to use the same terminology used by the need analysis companies and the IRS. Even though it seems a little ridiculous to refer to certain deductions as “unreimbursed employee expenses,” we did so anyway, just so that you will know what the terms mean once you start completing the forms and negotiating with the FAOs.

Chapter 2. Long-Term Strategies for Paying for College

Congratulations! If you are reading this section you’ve had the foresight to begin planning early for the expense of paying for college. What do we mean by early? We will be presenting strategies for parents with children who are three years away, five years away, ten years away, and 15 years away from their first year of college.

The point of this chapter is not to make specific investment recommendations or tout individual stocks or investment instruments, but rather to show you the ways and means to begin a long-term college fund for your children. Our purpose is not to be your financial planner, for no financial planner could responsibly set up a 10-year plan without being around to administer it (and obviously, we can’t do that). Things change. Investment opportunities come up suddenly. Interest rates go up or they go down. Tax laws are amended; financial aid laws are revised. We are going to outline some general strategies, but we advise you to invest cautiously, perhaps with the aid of a financial planner whom you can consult day to day.

If your child is applying for college next month, we recommend that you skip this section. It will only depress you. Instead, skip to the next chapter (which begins on this page), where we begin talking about short-term strategies. We think you will be pleased.

How Much Should We Save Every Month?

Any realistic long-term plan is more of an educated guess than an exact prediction. There are so many unknown factors—how much will college cost in ten years? Or 15 years? What will the inflation rate average over the next decade? Will stocks continue to be the best long-term investment as they have for the past 40 years, or will some unforeseen trend make real estate or bonds a better investment?

Any financial planner who says you have to save exactly $937 per month to reach your goal is being unrealistic—in part because you don’t even know with certainty what that goal will be. We think the main thing such pronouncements do is scare parents into paralysis. “We don’t have that kind of money,” clients wail to us on the phone after they hear these figures. “What are we supposed to do?”

The Important Thing Is to Start

It is easy to get so paralyzed by the projection of the total cost of a four-year college education that you do nothing. The important thing is to begin saving something as early as possible as regularly as possible. It doesn’t matter if you can’t contribute large amounts. The earlier you start, the longer you give your investments to work for you.

If you have not saved the total cost of four years’ tuition at a private college (and very few parents ever have), all is not lost. That is why there is financial aid.

So Why Bother to Save at All? If We Don’t Have Any Money, We’ll Just Get More Financial Aid

This is partly true, but only partly. A poor family without the means to pay for college will find concerned FAOs ready to look in every corner of their coffers to come up with the aid necessary to send that family’s child to college. An affluent family that has lived beyond their means for years and is now looking for the college to support this lifestyle with financial aid will find the FAOs to be very unsympathetic and tightfisted.

An honest attempt to save money, and a willingness to make sacrifices can make a large impression on the FAOs. These men and women have broad powers to increase or decrease your family contribution; to allocate grants; to meet your family’s entire need—or just part of it.

Trust us, you will be much happier if you have saved for college. Who can say whether in five years there will be many colleges left that can afford to continue “need-blind” admissions policies? Perhaps by the year 2030 virtually no colleges will be able to meet a family’s full remaining need—meaning that if you are without resources, your child will simply not be able to attend college at all. If you still aren’t convinced, think about this: A significant proportion of financial aid packages comes in the form of loans. You have the choice of saving now and earning interest, or borrowing later and paying interest. Earning interest is more fun.

Finally, under the aid formulas, colleges will assess parents’ assets at a top rate of only 5.65%. In other words, if you have managed to build up a college fund of say, $40,000, as long as it is in the parents’ name, the colleges will assess up to approximately five and a half cents of each dollar of that fund each year. We’ll be discussing the pros and cons of putting money in your child’s name later. You can certainly spend more if you like, but it is important to understand that having money in the bank does not mean the colleges get to take it all.

Money in the Bank Gives You Options

A college fund, even a small one, gives you control over your own destiny. What if the college your child really wants to attend doesn’t fully meet your need? What if you lose your job just as the college years are approaching? By planning a little for the future now, you can ensure that you’ll have options when the college years are upon you.

How Much Will a College Education Cost in X Years?

Every year, the price of a college education goes up. In the past couple of years the rate of increase at private colleges has actually slowed, the result in part of market forces: Families have been turning to state schools in greater numbers, forcing the private colleges to cut their prices, or at least to slow the increase of their prices. Partly in response to increased demand and partly because state budgets have been slashed, the rate of tuition increase at state schools has risen dramatically—especially for out-of-state students who must pay extra. Will these trends continue? The best we can do is make broad predictions based on current trends. Let’s look at some numbers.

The Cost of a Private College

The average cost of a year’s tuition, room and board, and fees at a private college last year was $43,921 (according to the College Board). Many experts predict that the cost of private college will increase at a rate of about 3.0% per year. Here is a chart of what the average cost of a year of private college would be over the next 15 years, based on 3.0% yearly growth:

Average Annual Cost of a Private College in

Of course, if your child decides on one of the most prestigious private schools, the cost will be even more. This year, most of the top colleges have crossed the $62,500-a-year barrier. In five years, at 3.0% growth per year, that will be approximately $72,455.

The Cost of a Public University

The average cost of a year’s tuition, room and board, and fees at a public university last year was $19,548 (according to the College Board). Many experts predict that the cost of public university will also increase at a rate of about 3.5% per year over the next decade. Here is a chart of what the average cost of a year of public university could cost over the next 15 years, if the experts are right:

Average Annual Cost of a Public University in

Of course, if you are attending one of the “public Ivies” such as the University of Michigan as an out-of-state resident, the cost right now is already close to $56,275. In five years, at a 3.5% growth rate per year, that would be close to $66,837.

How Much Money Will You Need?

If your child is 15, 10, or even five years away from college, she has probably not even begun to think about what kind of school she would like to attend. Since you can’t ask your child, ask yourself: What kind of college could you picture your son or daughter attending?

If you have picked a private college of average cost, and your child is ten years away from college, look up the price on the first chart we gave you above. Rather than concentrating on the cost of freshman year, look at the cost of junior year, two years further on. Whatever this number is, multiply it by four. This is a rough approximation of an average college education at that time.

If you picked an average public university, and your child is five years away from college, look up the price on the second chart above. Count two years more and multiply that number by four. This is a rough approximation of a college education at an average public university at that time. Of course, if costs increase faster than the experts are projecting, the figure could be more.

If you wish to be even more precise, find a guide to colleges and look up the current price of a particular school you are interested in. Let’s choose Spelman College, an Historically Black College for women, which has a current price of about $38,751, and let’s say your daughter is going to be ready to go to college in five years. Multiply the current price by our assumed rate of increase:

$40,359 × 1.03 = $41,570

The new number is the price of that school next year. To find out the projected price of Spelman in five years, just repeat this operation four more times ($41,570 × 1.03 = $42,817; $42,817 × 1.03 = $44,101; etc.). For 10 years, repeat the operation nine more times.

Of course, these will only be rough estimates since no one has a crystal ball. If your daughter were to start Spelman five years from now, the first year would cost roughly $46,787. By the time she is a junior, the projected cost would be $49,636. To figure out the grand total, multiply the cost of junior year by four. This is a rough projection of the cost of a four-year education. At Spelman five years from now, a college education will cost about $198,550. At Stanford or Yale, the bill will most likely exceed $325,000.

Now don’t faint just yet. This is a great deal of money, but first of all, there’s a lot of financial aid out there—and the majority of this book will be devoted to showing you how to get that financial aid. Second of all, you still have time to plan, save, and invest—and because of the joys of compounding, your investments can grow much faster than you might believe possible. Third, your earning power will most likely increase over time.

In the rest of this chapter you will find investment strategies for saving money for college. Try not to obsess about the total projected cost. The important thing is to begin.

When Do You Begin Saving?

Right now. The more time you give your investments to multiply, the better. Even if you can manage only a small amount each month, you will be surprised at how much you have put away by the end of the year, and even more surprised at how quickly that money multiplies.

The Joys of Compound Interest

Let’s say that you had a pretty good year this year and were able to save $5,000. Sound like too much? Okay, let’s say $4,000. You invest this money in a high-yield mutual fund. Some of these funds have been averaging a return of over 8% a year, but let’s be more conservative and say you get a 7% rate of return, which you plow back into the fund. Don’t like mutual funds? That’s fine. If you are uncomfortable with this level of risk, we’ll be discussing other investment vehicles a little later. This is just an example to show you how investments grow.

The calculation is actually the same one we used to figure out what college would cost in the future. To find out how much $4,000 would earn in one year at 7%, multiply $4,000 times 1.07.

$4,000 × 1.07 = $4,280

To find the value of the investment over five years, repeat this calculation four more times ($4,280 × 1.07 = 4,580; $4,580 × 1.07 = $4,900; etc.) In five years, your original $4,000 will be worth $5,610. In 10 years, it will have grown to $7,869. Not bad, especially when you consider that this comes from only one year of saving.

Of course, this example is a little simplified. One or two of those years might be bad years and the fund might not pay 7%. Other years might be extremely good years and the yield could be much higher. There are tax implications to consider as well. However, $7,869 is a reasonable forecast of what one $4,000 investment could be worth in ten years.

And if you continued to invest another $4,000 each year for the next ten years, with the same rate of return—well, now we’re talking real money. At the end of ten years, you would have a college fund in excess of $59,134.

Too Much Risk?

Let’s say you are too uncomfortable with the risk of high-yield instruments. You decide to invest your $4,000 per year in safe, dependable government bonds (or in a fund that buys government bonds), and you get an average yield of 5%. If you reinvest the yield, in ten years you will have built a college fund of over $52,800.

A Young Couple Just Starting Out

Let’s take the fictional couple David and Carmen, who have a daughter who is now seven years old. David and Carmen are pretty young, and they can’t afford to save much, but they decide they can manage $1,000 a year. They invest the $1,000 in a mutual fund with an average return of 8%, which they reinvest in the fund. By the time their daughter is ready to go to college in ten years, that first $1,000 has become $2,159. Each year, they invest another $1,000. The money they invest the second year has only nine years to grow, but it is still worth $1,999 by the time their child is ready for college. The money they invest the third year has only eight years to grow, but is still worth $1,850.

If Carmen and David invest $1,000 a year in this manner for ten years, they will have built a college fund of $15,645. Of course this is not enough to pay the entire cost of college, but there are several factors we haven’t taken into account yet:

✵ No one is asking them to pay the entire amount. If David and Carmen aren’t earning big money by the time the college years arrive, they may qualify for significant amounts of financial aid.

✵ David and Carmen might begin earning more money over the next ten years. Promotions and/or raises could allow them to save more than $1,000 per year as time goes on.

✵ The couple may have been able to make other investments as well (such as buying a house), against which they can borrow when their daughter is in college.

✵ During the college years, David and Carmen may be able (in fact are expected) to pay some of the cost of college from their current income.

Timing

Because of the way compounding works it would be better, in theory, to make your largest contributions to a college investment fund in the early years when the investment has the most time to grow. Unfortunately the reality of the situation is that a couple just getting started often doesn’t have that kind of money.

If you get a windfall—an inheritance, a large bonus, a year with a lot of overtime—by all means put that money to work for you. However, for most parents, it will be a matter of finding the money to invest here and there.

Many financial advisors recommend an automatic deduction plan, in which a certain amount of money is automatically deducted from your paycheck or your bank account each month. Parents often find that if the money simply disappears before they have time to spend it, the process of saving is less painful.

Should Money Be Put in the Child’s Name?

One of the most important decisions you will have to make is whether to put the college fund in your own name or in your child’s name.

There are some tax advantages to putting the money in your child’s name, but there can also be some terrible financial aid disadvantages. Let’s look at the tax advantages first.

Each year a parent is allowed to make a gift of up to $14,000 per parent per child. Depending upon the state in which you live, funds in such “custodial accounts” will be governed by the Uniform Gift to Minors Act (UGMA) or the Uniform Transfer to Minors Act (UTMA). Thus if you live in a two-parent household, you can give up to $28,000 per year to your child, without gift-tax consequences. This is not a $28,000 tax deduction for you, but neither is it $28,000 in taxable income to the child. You have merely shifted money from you to your child. From now on, some of the interest that money earns will be taxed not at the parents’ rate, but at the child’s rate, which is almost always much lower.

The child is not allowed to have control over the account until the age of 21 (or 18 in some states). By the same token you are not allowed to take that money back either. The money can be spent only on behalf of the child. You could use the money to pay for an SAT prep course, or braces, say, but not on the rent or a vacation to Hawaii—even if you took the child along.

Of course, if this gift is being made as part of a fund for college, this should be no problem. You don’t plan to touch it until your son or daughter is ready to enroll anyway. You can shift the money between different investments, or even give it to a financial planner to invest.

Years ago, many parents and other relatives—especially those in the higher tax brackets—found it beneficial to shift their funds into a child’s name so that the unearned income (i.e. interest, dividends, and capital gains) would be taxed at the child’s presumably lower tax rate. To thwart this income-shifting strategy, Congress passed legislation which would tax some of this unearned income of younger children at a parent’s rate, once such unearned income in a given tax year passed a certain threshold amount (which is $2,100 for the 2016 tax year.) In the tax years 2006 and 2007, this tax on the unearned income of a minor child at the parent’s tax rate—often referred to as the “Kiddie Tax”—applied to children under the age of 18 at the end of the tax year. For a child 18 and older, none of the money in the custodial account was taxed at the parent’s rate. (Prior to 2006, age 14 was the magic number. But Congress tinkered with the rules to prevent more families from shifting unearned income into a lower tax bracket.) To avoid the kiddie tax rules, many parents invested custodial account money in growth stocks, which would presumably appreciate in value but pay small dividends. Then, after the child reached the age when the rules no longer applied, they would sell the stock and generate a capital gain which would then be taxed solely at the child’s rate. In years past, this was a very effective strategy especially since capital gains have been taxed recently at a lower rate than most other types of income. However when Congress realized that the tax rate on capital gains (and qualified dividends) would drop to zero in 2008 for those in the lowest tax bracket, they passed a new (and far more complicated) kiddie tax in May 2007 that became effective January 1, 2008 in order to close this loophole. Here are the latest rules:

For a child under the age of 18 at the end of the year: As long as the custodial account generates less than $1,050 per year in interest or dividend income and there is no other income, there will be no income tax due at all. As long as the custodial account generates less than $2,100 in income and there is no other income, the excess over $1,050 will be taxed at the child’s rate (0% to 10% federal depending on the type of unearned income). Once the child’s unearned taxable income exceeds the $2,100 cap, the excess will be taxed at the parents’ higher rate, which can go up as high as 39.6% federal. State and local taxes will push this even higher.

For a child who is age 18 at the end of the year: The same rules apply as with younger children, though it is possible to avoid the kiddie tax if the child has earned income (e.g. wages, salary, income from self-employment) that exceeds half of her support.

For a child who is age 19 to 23 at the end of the year: If the child is unable to meet the “more than half support” rule, the kiddie tax will still apply if the child is a full time student for at least five months during the year. (While there may still be some clarification before the end of the year about what constitutes a “month”, other provisions of the tax code related to months of attendance in school have viewed enrollment for even one day in a particular month to be considered the same as if the student is enrolled for the entire month.) Given this increased age limit, it is possible that some students—including younger graduate students—who escaped the kiddie tax for a few years due to their age may again be subject to it post-2007. And if the child has not yet reached age 24 by the end of the year, it makes no difference whether the child is claimed as a dependent or not on a parent’s tax return.

So if you wish to avoid the kiddie tax, you would want to have some investments generate a little less than $2,000 in income per year, and the remaining funds allocated to investment instruments that generated little or no income. For example: if your child’s college fund was paying 4% interest, the fund could contain $52,500, and the interest the money earned would still be taxed at the child’s rate. As the fund gets larger than $52,500, some of the interest would begin to be taxed at your rate. It is important to note that there are other rules that apply if the child has both earned and unearned income.

Even with these new more restrictive rules, it is still possible to achieve some tax savings from putting money in the child’s name. Unfortunately, because of the regulations under which financial aid is dispensed, putting any money in the kid’s name can be a very expensive mistake.

If You Have Any Hope of Financial Aid, Never Put Money in the Child’s Name

When you apply for financial aid, you will complete a need analysis form, which tells the colleges your current income, your child’s income, your assets, and your child’s assets. The colleges will assess these amounts to decide how much you can afford to pay for college. Under the federal formula, your income will be assessed up to 47%. Your assets will be assessed up to 5.65%.

However, your child’s income will be assessed at up to 50% and your child’s assets will be assessed at a whopping 20%. A college fund of $40,000 under your name would be assessed (as an asset) for up to $2,260 the first year of college. That is to say, the college would expect you to put as much as $2,260 of that money toward the first year of school.

The same fund under your child’s name would be assessed for $8,000.

That’s a big difference. You might say, “Well that money was supposed to be for college anyway,” and you would be right—but remember, the colleges aren’t just assessing that money. They will assess 20% of all of the child’s assets, up to 5.65% of the parents’ assets, up to 50% of the child’s income, and up to 47% of the parents’ income. By putting that money in the child’s name, you just gave them a lot more money than you had to.

We’ve already noted the similarities between a college financial aid office and the IRS. Both see it as their duty to use the rules to get as much money as possible from you. It is up to you to use those same rules to keep as much money as possible away from them. It is an adversarial relationship, but as long as both sides stick to the rules, a fair one.

If you are going to qualify for financial aid, you should never, ever put money in the child’s name. It is like throwing the money away. You’ve worked too hard to save that money to watch it get swallowed up in four giant gulps. By putting the money in the parents’ name, you keep control over it. If you choose to, you can use it all, or not use it all, on your timetable.

The College Board made a number of significant changes to the Institutional Methodology (IM) starting with the 2000-2001 academic year. The maximum assessment rates under the IM for the 2016-2017 award year are as follows: 25% of the child’s assets, up to 5% of the parents’ assets, up to 46% of the child’s income, and up to 46% of the parents’ income. When we went to press, the rates for 2017-2018 were not available.

What If You’re Pretty Sure You Won’t Qualify for Aid?

If you are certain you won’t qualify for aid, then you’re free to employ every tax-reducing strategy your accountant can devise, including putting assets in the kid’s name. But be very certain. People are often amazed at how much money you have to make in order NOT to qualify for aid.

In the introduction we told you about a family who received financial aid despite huge assets. Parents always want to know exactly what the cutoff is. Unfortunately, it is not as simple as that. Each family is a separate case. Don’t assume that just because your friend didn’t qualify for aid that you won’t either. There are so many variables it is impossible to say the cutoff is precisely X dollars. It just doesn’t work that way.

If you are close to the beginning of the college years and you want to figure out if you qualify for aid, read the rest of this book and then use the worksheets in the back to compute your Expected Family Contribution. There is really no shortcut. We have seen books that give you a simple chart on which you can look up your EFC. These charts are much too simplistic to be of any real use. We’ve also seen a number of websites with outdated formulas.

And as you’ll soon discover, there are strategies you can employ to increase your chances of receiving aid.

What If You Aren’t Sure Whether You’ll Qualify for Aid?

If your child is a number of years away from the freshman year of college, your dilemma is much more difficult. How can you predict how much you’ll have in five years or 15 years? For safety, it would be better to avoid putting large sums of money in the child’s name until you are sure you won’t be eligible for aid.

Once the money is put into the child’s name it is extremely difficult to put it back in the parents’ name. If you set up a custodial account sometime in the past and have come to regret it, consult a very good financial consultant or tax lawyer who is also knowledgeable about financial aid.

Now that you’ve decided whose name to put the money under, let’s talk about what kind of investments you can make.

What Types of Investments to Choose for a College Fund

The key to any investment portfolio is diversity. You will want to spread your assets among several different types of investments, with varying degrees of risk. When your child is young, you will probably want to keep a large percentage of your money in higher-risk investments in order to build the value of the portfolio. As you get closer to the college years, it is a good idea to shift gradually into less volatile and more liquid investments. By the time the first year of college arrives, you should have a high percentage of cash invested in short-term treasuries, CDs, or money market funds.

To stay ahead of inflation over the long term, there is no choice but to choose more aggressive investments. Despite the recent declines, most experts still agree that the stock market is your best bet for long-term high yields. However, as we saw in late 2008 and early 2009, there can be significant volitility with stock prices. Yet it is worth noting that over the past 40 years, in spite of various bear markets, recessions, crashes, and acts of God, stocks have on average outperformed every other type of investment.

Stock Mutual Funds

Rather than buying individual stocks, you can spread your risk by buying shares in a mutual fund that manages a portfolio of many different stocks. Most newspapers and financial magazines give periodic rundowns of the performance of different mutual funds. In general, we recommend no-load or low-load funds that charge a sales commission of 4.5% or less. The minimum investment in mutual funds varies widely, but often you can start with as little as $1,000. Many of the large mutual fund companies control a few different funds and allow you to switch from one type of fund to another or even to a regular money market fund without charge. In this way, you can move in and out of investments as events change, just by making a phone call.

You can spread your risk even further by purchasing stock mutual funds that specialize in several different areas. By putting some of your money into a blue-chip fund and some into whatever you think will soon be hot, you can hedge your bets.

It should be noted that over the past several years, individuals who never invested in the stock market before have been putting money into mutual funds in an effort to earn a higher return than the current rates offered on CDs and savings accounts. We would just like to add our cautionary voice to the chorus of experts who have been warning the public that investing in mutual funds is not the same thing as having money in the bank.

High-Yield Bonds

Another aggressive investment to consider is high-yield bonds. For high yield, read “junk.” Junk bonds, which pay a high rate of interest because they carry a high level of risk, helped to bring the boom-boom decade of the 1980s to its knees. However, if purchased with care, these bonds can get you a very high rate of return for moderate risk. The best way to participate in this market is to buy shares in a high-yield bond fund. The bonds are bought by professionals who presumably know what they are doing, and again, because the fund owns many different types of bonds, the risk is spread around.

Normal-Yield Bonds

If you want less risk, you might think about buying investment-grade bonds (rated at least AA) which can be bought so that they mature just as your child is ready to begin college. If you sell bonds before they mature, the price may vary quite a bit, but at maturity, bonds pay their full face value and provide the expected yield, thus guaranteeing you a fixed return. At present, the total annual return on this type of bond if interest is reinvested can top 4.0%.

One way of avoiding having to reinvest interest income is to buy zero-coupon bonds. You purchase a zero-coupon at far below its face value. On maturity, it pays you the full face value of the bond. You receive no interest income from the bond along the way; instead the interest you would have received is effectively reinvested at a guaranteed rate of return. You still have to pay tax every year on the “imputed interest,” but the rate of return on zero-coupons can be substantial.

EE Savings Bonds

If you don’t earn too much money, Series EE Savings Bonds offer an interesting option for college funds as well. The government a few years ago decided that if an individual over 24 years of age with low to moderate income purchases EE Savings Bonds after 1989 with the intention of using them to pay for college, the interest received at the time of redemption of the bonds will be tax-free. The interest earned is completely tax-free for a single parent with income up to $75,550 or a married couple filing jointly with income up to $116,300. Once you hit those income levels, the benefits are slowly phased out. A single parent with income above $92,550 or a married couple with income above $146,300 is not eligible for any tax break. All of these numbers are based on 2016 tax rates and are subject to an annual adjustment for inflation. EE Savings Bonds are issued by the federal government, and are as safe as any investment can be. They can also be purchased in small denominations without paying any sales commission.

However, EE Savings Bonds have several drawbacks. One is their low rate of return. You might do better with a taxable investment that pays a higher rate, even after taxes. It is also hard to predict in advance what your income level will be when you cash in the bonds. If your income has risen past the cutoff level for the tax break, your effective rate of return on the bonds just plunged into the low single digits. To make it worse, the IRS adds the interest from the bonds to your income before they determine whether you qualify for the tax break. Finally, whether the interest from these bonds is taxed or untaxed, it will still be considered income by the colleges and will be assessed just like your other income.

Tax-Free Municipal Bonds

Those families that are in the 25% income tax bracket (or higher) may be tempted to invest in tax-free municipal bonds. If you factor in the tax savings, the rate of return can approach 6%. As usual, you can reduce your risk by buying what is called a tax-free muni fund. These come in different varieties, with different degrees of risk.

One thing to be aware of is that while the IRS does not tax the income from these investments, the colleges effectively do. Colleges call tax-exempt interest income “untaxable income” and assess it just the way they assess taxable income. If you’re eligible for aid, the real effective yield of munis will be pushed down by these assessments.

Trusts

Establishing a trust for your child’s education is another way to shift assets and income to the child. Trusts have all the tax advantages of putting assets in the child’s name—and then some; they allow more aggressive investment than do custodial accounts; they also give you much more control over when and how your child gets the money.

The drawbacks of trusts are that they are initially expensive to set up, costly to maintain, and very difficult to change—more important, they also jeopardize your chances of qualifying for financial aid.

If you have no chance of receiving aid, a trust fund can be an excellent way to provide money for college. There are many different kinds of trusts, but all involve you (called the grantor) transferring assets to another party (called the trustee) to manage and invest on behalf of your child (called the beneficiary). Typically, the trustee is a bank, financial advisor, or a professional organization chosen by you. You can design the trust so that your child will receive the money in a lump sum just as she enters college, or so that it is paid out in installments during college, or so that the child receives only the interest income from the trust until she reaches an age selected by you. Trusts must be set up with care to envision all eventualities because once they are in place, they are almost impossible to change. When you create the trust, you essentially give up the right to control it.

The tax advantage of a trust over a simple custodial account is that the trust pays its own separate income tax, at its own tax bracket. Not the child’s bracket. Not yours. This is especially useful when the child is under the age of 24: A regular custodial account of any significant size would most likely be taxed at the parents’ higher rate due to the “kiddie tax”.

The investment advantage of a trust is that there is no limit on the type of investment instrument that may be used. Unlike custodial accounts, which are not allowed to invest in certain types of instruments, a trust can dabble in real estate, junk bonds, or any new-fangled scheme the investment bankers can invent.

Obviously, trusts must be set up with care, and you have to find a suitable trustee; someone you can, well, trust. Parents should never try to set up a trust on their own. If you are considering this strategy, consult a good tax attorney.

Financial Aid and Trusts

For various reasons, financial aid and trusts do not mix. It is partly the “rich kid” image that trust funds engender in the FAOs, and partly certain intricacies of the financial aid formulas, which we will describe in more detail in Chapter Three of this book. A trust of any size may very well nix any chance your family has of receiving aid.

Qualified State Tuition Programs (529 Plans)

Forty-nine states—all except Wyoming—and the District of Columbia now offer special programs that are designed to help families plan ahead for college costs. These Qualified State Tuition Programs, which are more commonly called Section 529 plans (after the relevant section of the Internal Revenue Code), come in two basic forms: tuition prepayment plans and tuition savings accounts. Most states offer one type or the other, but a number of states offer or will soon offer both. Some plans have residency requirements for the donor and/or beneficiary. Others (like California) will allow anyone to participate. While some states limit who can contribute funds to the plan (usually the parents and grandparents), other states have no such restrictions. And with some plans, it is possible for the contributor to name herself as the beneficiary as well.

With some states, the buildup in value is partially or entirely free of state income taxes (provided the beneficiary is a resident of that state.) Most plans allow you to make payments in a lump sum, or on an installment basis. In some states these payments can be automatically deducted from your bank account—or even your paycheck provided your employer agrees to participate. With some plans, contributions are partially tax-deductible for the donor as well. For example, New York gives its residents up to a $5,000 deduction (up to $10,000 for joint filers) on the state income tax return for amounts contributed during a particular tax year. Many states have added some unique features to their plans.

Years ago, the prepaid tuition plans used to be a rotten deal as the funds could only be used in-state and normally only for public colleges and universities. Otherwise, you got your money back with little or no interest. But now, many of these state-sponsored plans have become more flexible, letting you take money out-of-state or to a private university in your own state. A major benefit of these prepayment plans is the peace of mind that comes from knowing that no matter how much tuition inflation there is, you’ve already paid for a certain number of course credits at the time of purchase. This peace of mind was rather costly during the Wall Street boom when returns on stocks far exceeded the rate of tuition inflation. However, given the recent volatility in the stock market and the reduced rates of return on CDs and bonds, the prepaid plans have regained some of their luster. So while many investment advisors still tell families they are better off avoiding these prepaid plans and funding the college nest egg using other investment vehicles which are likely to earn a higher rate of return, the prepaid plans are something to consider if the student will start college in the next few years.

Under the old tax laws, you had to pay federal income taxes on the difference between the initial investment and the value of the course credits when they were re-deemed, but such investment income was taxed at the beneficiary’s presumably lower tax rate. Starting in 2002, there are no longer any federal income taxes involved pro-vided the funds are used to cover qualified higher education expenses (i.e. tuition, and fees as well as allowances for room and board) at a federally accredited school, which includes most U.S.-based four-year colleges and universities, many two-year programs and vocational schools, and even some foreign schools.

Note: Given the high rate of tuition inflation at public universities, some prepaid plans have temporarily stopped accepting contributions or have added a premium onto the current price for each credit purchased.

Unlike the prepaid plans, the state-sponsored tuition savings accounts do not guarantee to meet tuition inflation. A major benefit over traditional investment options is that earnings in these accounts grow tax-deferred from a federal standpoint. Just as with the prepaid plans, withdrawals from these accounts for qualified educational expenses are now also completely free of federal income taxes. (Under the old law, the pro-rated share of the withdrawal that represented investment income—and not the original investment—was subject to tax at the beneficiary’s rate.) The funds in these plans are invested by professional managers. But if you choose to put some or all of the funds into any equity-based investment option that is offered, you could lose part of your initial investment. Just as with the prepaid plans, a number of states do not consider part or all of the earnings as income on a resident beneficiary’s state tax return.

Most of these tuition savings plans offer the choice of an age-based asset allocation model to determine how your funds will be invested. This means that the younger the child, the greater the percentage of the principal is invested in equities. As the child grows older, the percentage of equities falls, and the percentage of assets in bonds, money markets, and other fixed-income investments increases. The allocation models can vary tremendously from plan to plan. Besides the age-based models, most plans have other investment options that vary in the degrees of risk.

Most prepaid plans and tuition savings accounts allow you to change bene-ficiaries—which just means you can switch money you might have earmarked for one child to another child—or even to another family member. You’ll need to read the fine print if you envision actually trying this, because there are tax consequences if the new beneficiary is of a different generation. With the savings plans, you’ll also want to find out whether or not the asset allocation model will change to reflect the age of the new beneficiary. For example, if your oldest child decides not to go to college and you decide to transfer the funds to her kid brother, you would want to be sure that the mix of investments will be changed to reflect the age of the younger beneficiary. Otherwise, your nest egg may be invested mostly in money market funds for a number of years.

Another benefit of these Section 529 plans, from an estate-planning standpoint, is that a person can contribute up to $70,000 in one lump sum to any one beneficiary’s plan, provided you do not make any further gifts to that person for the next five years (and provided the state’s plan permits contributions of this size). So, in effect, you are being allowed to use the $14,000 annual gift allowance for the next five years and accelerate it into one lump sum. This allows a contributor to remove up to five years’ worth of income and growth on the contributed funds from her estate. Of course, if the contributor dies before the five-year period has elapsed, there could be estate tax consequences.

Coverdell ESAs

These special educational savings accounts were originally called Education IRAs even though they were never really retirement accounts. While contributions to these accounts (currently up to $2,000 per year per child under age 18) are not tax deductible, any withdrawals used for post-secondary education will be totally tax-free. While there are income limits that affect your ability to contribute to such an account—for 2016, this benefit phases out between $190,000 and $220,000 for married couples filing jointly, and between $95,000 and $110,000 for others—the law does not specify that contributions must be made by the beneficiary’s parents. Other relatives or even friends who fall below the income cutoffs could presumably contribute. However for 2016, no child can receive more than $2,000 in deposits to a Coverdell ESA in a given tax year from all contributors combined. But before you rush to fund one of these accounts, you should realize that the U.S. Department of Education currently views such accounts to be the asset of the student if the student is the owner of the account and also an independent student. In most cases, the parent will be the owner as long as the beneficiary is a minor, so this will not be a big problem. However, the situation gets tricky once the student reaches majority. Unless an election was made to keep the parent as owner after that point, the fund would then become student-owned, and could be assessed at the 20% federal financial aid assessment rate if the student is independent. Under the institutional methodology, any Coverdell owned by the student is considered a student asset.

Note: The current tax law permits tax-free withdrawals to cover certain qualified expenses from kindergarten through the senior year of high school including private school tuition, certain computer equipment and software, as well as internet access. So if you are otherwise eligible for financial aid for college, you should consider withdrawing funds from Coverdells to cover these expenses as well as any qualified higher education expenses if a) the ownership will soon revert to the student and b) the student is either applying for financial aid at a school that requires completion of the CSS/PROFILE or is an independent student. (Check with the financial institution where you have the account if you are not sure who owns the account and when, if ever, the ownership changed or will change to the student in the future.). In this way, student assets in the aid formulas will be minimized.

Sunrise…But No Sunset

Coverdell ESAs and Section 529s are wonderful ways to save money for college, but for years there had been a couple of important question marks about these programs. This was because some key provisions of the federal tax law pertaining to these programs had been scheduled to expire—or “sunset” - on Dec. 31, 2012. The good news is that these uncertainties have gone away as the American Taxpayer Relief Act, which became law in January 2013, made permanent some of the enhancements to Coverdells that were made in 2001. So for the time being, these enhancements will continue to be available:

✵The annual contribution limits for Coverdells will continue to be $2000 per beneficiary per year.

✵Withdrawals from Coverdells for certain expenses other than college tuition and fees (i.e. elementary and secondary school tuition, certain computer-related expenses, internet access) will continue to be tax-free

✵In a given tax year, a child can continue to receive contributions to both a Coverdell and a 529 plan.

✵Any tax-free distribution from a child’s Coverdell will not automatically eliminate one’s ability to claim certain Federal educational tax credits (i.e. the American Opportunity Credit, the Hope Credit, or the Lifetime Learning Credit) for that child in the same tax year. However, in order to be able to claim the full credit and have all the distributions from a Coverdell and/or 529 plan be tax-free, any funds paid for that child’s tuition for purposes of claiming the credit cannot be coming from a Coverdell, a 529 plan, or other tax-advantaged funds used to pay for college. This is because federal tax law does not currently permit one to claim two or more educational tax benefits with the same funds used to pay for tuition. So to be able to claim the tax credit AND have the distributions from a Coverdell and/or a 529 plan be completely tax-free, some funds to pay for the student’s tuition will have to come from your cash and/or your checking, savings, and/or money market account(s) and/or be paid with the proceeds of a loan.

It’s anyone’s guess what will happen in the future—which makes decisions down the road difficult. For example, if you think the law will change, and you’re likely to qualify for the American Opportunity Credit (which allows you to reduce your taxes based on money you’ve spent on college tuition for your child), then it would not be a good idea to make any more contributions to a Coverdell. In addition, if you believe the laws will sunset and you want to plan ahead to reduce any existing funds in a Coverdell, you should then consider paying for other qualified educational expenses—such as private elementary or secondary school tuition, computer equipment, etc.—which are currently permitted.

Because of all the fine print in these plans, and the possibility that the tax law may change, we suggest you consult with a competent advisor before contributing any funds to these plans or making any withdrawals.

Look Before You Leap

Even though the tax law did NOT sunset, there are still a number of potential pitfalls that you should be aware of before you sign up for these plans—or have any well-intentioned relatives do the same. And unfortunately, while the brochures for these plans might make you think they are the best things to come along since white bread, the promotional materials are often light on specifics—especially the drawbacks.

✵ THE FINANCIAL AID IMPACT OF THESE PLANS

The Higher Education Reconciliation Act of 2005 (HERA) made a number of important changes to Federal student aid programs—including the way Coverdell Education Savings Accounts (ESAs) and Qualified State Tuition programs (prepaid and savings plans) will be treated in the federal aid formula. Previously, Coverdells and 529 savings accounts were considered to be the asset of the owner of the plan. This was not a big problem if the parents were the owners of the plan; however, if funds were moved from a custodial account into a 529 savings plan, those funds instead became a “custodial” 529 account, and were then still considered in the federal methodology to be an asset of the child. In addition, some Coverdell accounts were set up so that ownership would revert to the student upon reaching the age of majority. This created the odd situation where these accounts were considered a parental asset on one year’s version of the FAFSA, only to become a student asset on subsequent federal aid forms once the student became a legal adult.

Also, some years ago under the federal aid formula, funds in a state-sponsored prepaid tuition plan were not considered an asset that needed to be reported on the FAFSA. That’s because the dollar value of the tuition credits redeemed was considered a “resource” that reduced your aid eligibility dollar-for-dollar. So if you weren’t able to save enough to prepay your entire tuition, the prepaid credits you used each year would reduce your aid eligibility (except for the Pell Grant) by the dollar amount of the credits redeemed. However, under HERA, prepaid 529 plans will now be treated the same way as 529 savings plans and Coverdells.

Unfortunately, in Congress’s haste to enact this law, they created a terrible ambiguity: they specified that 529 plans and/or Coverdells owned by a dependent student would no longer need to be reported on the federal aid form as a student asset. Yet, they failed to define how these accounts would be assessed. Would they be parental assets, would they not be required to be reported at all—or would they be treated in some other way?

For the 2008-2009 FAFSA, the Department of Education took the position that any of these accounts owned by a student who was required to report parental information on the FAFSA would not be required to report the value of the student-owned account as an asset on the FAFSA. However, the College Cost Reduction and Access Act of 2007 resolved this ambiguity. As such for the 2009-2010 FAFSA and beyond, such student-owned 529 plans or Coverdell ESAs will be reported as part of the parental investments on the FAFSA. (However, if the student is not required to report parental information on the FAFSA, such student-owned funds will need to be reported as a student asset on the form.)

With this clarification, the federal and the institutional methodologies now differ in their treatment of student-owned 529 plans and Coverdells. For a number of years, the College Board had considered student-owned 529s and Coverdells to be the assets of the parent if parental information needed to be reported on the PROFILE. However, such student-owned 529s and Coverdells are now considered to be student assets in all cases. In terms of income, any qualified tax-free distributions from a 529 or Coverdell owned by the student or the student’s parent are not considered as untaxed income in both the IM and FM. Of course, the colleges themselves may decide to assess the value and/or the distributions of these plans differently than the Department of Education or the College Board when awarding their own funds.

Accounts owned by individuals other than the student or a parent who must report their information on the aid form - for example, a grandparent or an aunt - are a different story. On the FAFSA, the value of such accounts need not be reported as an asset. While these funds are not considered to be assets in the IM either, some colleges that require the PROFILE may choose to ask questions about these plans in the customized, institution-specific question section that can appear at the end of the form Even if you need not list their value there, you are not out of the woods yet with such plans. There is still the question of how distributions from these accounts owned by others will be treated. Since this issue has not yet been specifically addressed in the financial aid regulations, there are many in the financial aid community who consider the dollar value of such distributions to be considered untaxed income for the student due to wording on the FAFSA regarding “money received, or paid on your behalf…not reported elsewhere on this form” which appears in the student income section. It is also important to note that each year more and more schools are asking questions about the value of and/or distributions from 529s and Coverdells owned by other individuals.

Under the Institutional Methodology, the College Board currently considers prepaid plans or tuition savings accounts originally funded and owned by parents to be parental assets. Of course, the colleges themselves may decide to assess these plans differently than the Department of Education or the College Board when awarding their own funds.

The promotional literature for most of these state-sponsored plans glosses over or puts the best spin possible on the financial aid consequences of these investments. So you need to take everything they say about this with a bucket full of salt.

✵ TAX IMPLICATIONS

If the funds are not used for the child’s education or are withdrawn prematurely, the portion of the distribution that represents investment earnings will be taxed at the contributor’s (presumably higher) rate, plus a 10% penalty. So if junior decides not to go to school, you’d better hope you can find some other qualified family member who can use the funds for school and take the necessary steps to change the beneficiary on the account. Otherwise your Uncle Sam is going to get a nice windfall. (There are exceptions if the beneficiary dies or receives a scholarship for college.)

You should also realize that both types of 529 plans (as well as Coverdells) can impact your ability to take advantage of other higher education benefits (under both the old and new tax laws) which can sometimes be more advantageous to claim.

Even though Congress a number of years ago voted to permanently extend the ability to withdraw funds from 529s free of federal income taxes, there are still some thorny issues regarding state income taxes— especially if you invest in a 529 plan sponsored by a state other than the state in which you (or the student) live.

Note: A handful of states will now grant a state tax deduction for contributions made to out-of-state 529 plans. So if you’re choosing between an in-state and an out-of-state plan, you should see what benefits, if any, that you’re giving up by choosing an out-of-state program over your home state program.

✵ LIMITED CONTROL OVER THE FUNDS

As we have just mentioned, once you contribute funds to these state-sponsored plans there can be sizable penalties if the funds are withdrawn prematurely. With the state savings plan, after you make your initial contribution you can only move those funds to another state’s plan or change your investment allocation plan once every 12 months to avoid any penalties.

If the plan uses an age-based asset allocation model, you may also find your assets being automatically transferred to fixed-income investments just after a significant short-term market correction. Any sane money manager would postpone such a transfer for a few months—but with many of these plans, the manager may not have that option: the transfer is automatically triggered on a certain date.

And because you’re tying up your money for a number of years and giving up control, there are a number of questions you should be asking yourself before you contribute one penny to one of these plans.

1)Which type of plan are you investing in? Some states offer only the pre-paid option. Some offer only a tuition savings account. Others offer both.

2)Is the plan offered in your own state superior to plans available in other states? Many tuition savings plans will accept contributions from out-of-state residents and you may prefer another state’s asset-allocation model to the one in your home state.

3)If you invest in an out-of-state plan, what additional benefits are you giving up? Funds invested in your home state’s plan may not impact state-funded financial aid programs and the earnings may be free of state taxes. A state income tax deduction may be limited to contributions to your own state’s plan. So, if you invest out-of-state, you won’t necessarily get a state income tax deduction. The student may also owe some state income taxes to his home state when the funds are withdrawn. (He may even owe some state income taxes to the state whose program was used.) Funds invested in an out-of-state plan may also hurt your eligibility for state-based student aid.

4)If you invest in a plan sold to you by a financial advisor or offered by your employer, is it the best deal around? Your financial advisor may not even mention the benefits of your own state’s plan or other more attractive out-of-state plans simply because she doesn’t sell those plans. In addition, similar 529 plans sold by advisors may carry higher fees than if you contacted the plan administrators directly. A plan offered through your job may not be your home state’s plan so be sure to read the fine print.

5)If you decide to transfer the funds to another state’s plan, are there any penalties involved? While you may be fine from a federal tax standpoint, you should understand that many states have begun to implement their own penalties in response to the rather liberal federal transfer rules currently in effect. For example, New York residents who claimed a tax deduction on their state tax return by contributing to the New York Saves 529 plan will have to recapture (add back) the amount of that deduction to their state taxable income in the year they transfer those funds out of the Empire State.

6)Is the plan an approved Section 529 plan? Some states begin accepting contributions on newly announced plans before the IRS rules on the matter. You want to be sure that you qualify for the federal tax-deferred status before you lock up your funds.

7)What asset allocation model are you comfortable with? For example, in New Hampshire, the age-based plan calls for 95% in equities for a newborn, versus the New York State plan which permits you to allocate 50%, 75%, or even 100% in equities for a similarly aged child depending on your risk tolerance level. Some states, such as California, let you choose among a number of investment options, including a social choice equity option.

8)What fees are charged by the investment managers? While you won’t be sent a bill, such charges can significantly reduce the return on your investment. Although traditional mutual funds are required by law to disclose such charges, tuition savings plans are not—and often bury this information in a thick prospectus (which you may not even see unless you specifically ask for it). Fees can vary tremendously from state to state, and are often much higher than ordinary mutual funds.

9)What happens if you are on the installment plan and can no longer contribute? For example, if you lost your job and can’t keep up with the payments, some programs might automatically cancel the contract and/or impose other penalties as well.

10)What is the likelihood you will move out of the state before college begins? If you are in a state prepaid program and then move to another state, most programs will only provide for tuition credits at the resident rates. You’ll have to come up with the additional funds to cover the extra tuition charged to out-of-state students.

11)If you are investing in a prepaid plan, how will the state determine the amount of funds you’ll receive if the student attends a college out of state? Some plans will use the dollar value of the credits at the public university based on the tuition charges for each academic year. Others simply use the total dollar value of all the credits at the start of the first academic year and then allocate one quarter of the value for each of the four years. In the latter case, your funds for the sophomore, junior, and senior year will stop increasing in value once the student begins freshman year, no matter how much tuition inflation subsequently occurs.

Do You Have a Crystal Ball?

Unless you can predict the future, you should carefully think and rethink any decision that completely locks yourself and your loved ones into an investment that will mature so many years into the future. Obviously, these plans make sense for many people, especially since the new “kiddie tax” rules make custodial accounts less attractive. But because of all the fine print in each state’s plan, you should know exactly what you’re getting into and carefully review the prospectus to make sure it is right for you. Because of the various tax consequences involved, it would also be a good idea to discuss the plan with your accountant or financial planner before you make your first contribution as well.

The following is a listing of states that offer prepaid programs and/or tuition savings accounts along with telephone numbers. The type of program offered is indicated by a “P” for prepaid plans and an “S” for savings plans.

*Closed to new enrollment

A Supplementary Form of College Fund: Owning Your Own Home

If you can swing it, owning your own home is a top priority in any plan for paying for college. Equally important, building equity in your home provides you with collateral you can use to help pay for college.

In addition, owning your home provides you with an investment for your own future, which you should never lose sight of. When the kids rush off to embark on their own lives, clutching their diplomas, will there be something left for you? What good is a college education for the child if it puts the parents in the poorhouse?

The Home as a Credit Line?

No matter how well prepared, many families end up at some point having to borrow money to pay part of the family contribution. Unfortunately, the financial aid formula doesn’t recognize most types of debt; that is to say they do not subtract these liabilities from your assets before they decide how much in assets you have available to pay for college.

We will be explaining this in great detail in the chapters on financial aid strategies, but here’s a quick example. Suppose you had $25,000 in assets, but you also owed $6,000 on a consumer loan. If you asked any accountant in the world, she would say your total net assets were only $19,000; but as far as the colleges are concerned, you still have $25,000 available for them to assess. Many kinds of debt (such as consumer loans and outstanding credit card bills) don’t make sense during the college years.

However, the more selective colleges that elect to use the institutional methodology (which looks at home equity) rather than the federal methodology (which does not) do recognize one kind of debt—mortgages, first and second, on your home. This means that your home can be a particularly valuable kind of college fund. Generally, the more equity you have in your home, the more you can borrow against it. And the best part is that if your child attends a school that assesses home equity, and you borrow against your home, you reduce your total assets in the eyes of the FAOs, which can reduce how much you have to pay for college.

Remember to Invest in Other Things Besides Your Child’s College Education

Providing a college education for your child is probably not the only ambition you have in life. During the years you are saving for college you should not neglect your other goals, particularly in two important areas: owning your own home (which we have just spoken about) and planning for your retirement.

While the colleges assess your assets and income, they generally don’t assess retirement provisions such as Individual Retirement Accounts (IRAs), 401(k) plans, Keoghs, tax-deferred annuities, etc. Any money you have managed to contribute to a retirement provision will be off-limits to the FAOs at most schools.

Thus contributions to retirement plans will not only help provide for your future but also will shelter assets (and the income from those assets) from the FAOs. In addition, many employers will match contributions to 401(k) plans, in effect doubling your stake. And let’s not forget that, depending on your income level, part or all of these contributions may be tax-deferred.

Now that you have an overview of some long-term investment strategies, let’s talk about some specific plans for investing based on how many years away your child is from college.

If You Have 15 Years…

Because there is so much time, you can afford to choose aggressive investments of the types we’ve outlined above. We recommend that you invest about 75% of your fund in these higher-risk investments, and the remaining 25% in investments that lock in a reliable rate of return. There is little point in keeping this money in a bank account because the rate of return will probably not even keep up with inflation. However, as college years get closer, start transferring out of stock funds into something less subject to temporary setbacks.

If possible, try to invest large amounts in the early years to take advantage of compounding. When you get closer to the first year of college, take a hard look at your college fund. You may find that you have already accumulated enough money to pay for school, in which case you can start investing your money in other directions. On the other hand, you may find that you need to increase the amounts you are saving in order to get closer to your goal.

In spite of what you may have heard, as long as you qualify for financial aid it is better to have two kids in school at the same time. If you are planning on having another child, but were putting it off to avoid staggering college bills, reconsider. Whether you have only one child in college, or two or three children in college at the same time, the parents’ contribution (the amount colleges think you can afford to pay for college) stays almost the same. Having two kids in school at the same time is like a two-for-one sale.

With this much time to plan, you should consider long-term ways to increase your earning power. Perhaps you might go back to school to pick up an advanced degree. Perhaps if one parent is not working at present you could begin thinking about a long-term plan for setting up a career for that parent to increase your family’s earning power.

As you get closer to the college years, you will need to consider other points. In order not to repeat ourselves too much, we will cover these points below. Please keep on reading.

If You Have 10 Years…

With 10 years to go, you still have plenty of time to build a sizable college fund. To build your capital quickly, try to save as much as you can in the first several years when compounding will help you the most. Aggressive investments will also help to build your fund quickly. We recommend that with 10 years to go, you keep 70% of your money in aggressive investments of the type outlined above. The other 30% can be put into fixed-return investments with limited risk. As you get closer to the first year of college, you should gradually shift your fund into investments with more liquidity and no risk.

Because your child’s academic ability will have an important effect not only on which colleges he can apply to but also on what kind of aid package the college will offer you, it is vital that you find a good elementary school that challenges his abilities.

In spite of taxes, braces, and saving for college, do not neglect your own future. If you have not already bought a home, consider buying one (in a good school district) if at all possible. Contributions to retirement provisions should also be made regularly.

Now is also the first time you can realistically speculate about how much money you might be earning by the time your child is in college. If you believe you will be earning too much to qualify for aid, it becomes even more important to build your college fund. If you are not going to qualify for aid, you might want to put assets into the child’s name.

As you get closer to the college years, you will need to consider other points. In order not to repeat ourselves too much, we will cover these points below. Please keep on reading.

If You Have Five Years…

There is still plenty of time to build up a large college fund. Even if it entails a sacrifice, a large contribution in the first year will help build your investment faster through the miracle of compounding. In the first year or so, you can still afford to invest aggressively, although we recommend that you keep only about 50% of your money in aggressive investments, with 30% in limited-risk fixed rate of return financial instruments, and 20% in liquid accounts that are completely insured.

With about four years to go, reconsider whether you are going to qualify for financial aid. You may have received promotions, raises, inheritances, or made investments that take you out of range of financial aid. In this case, consider moving assets into the child’s name. On the other hand, you may discover that you are doing less well than you anticipated, in which case you will want to start thinking about the strategies that are outlined in the rest of this book.

Find a great high school for your child and try to encourage good study habits. Good grades will increase your child’s options tremendously. It’s probably too early to tell, but try to get a sense of what type of school your child will be applying to, and how much that school will cost.

As you get to the last three years before college, you will need to consider other points. In order not to repeat ourselves too much, we will cover these points below. Please keep on reading.

If You Have Three Years…

Parents find that with the specter of college tuition looming imminently, they are able to save substantial amounts in only two years. After all, many parents are at the height of their earning power at this time. However, because you will need the money relatively soon, it is probably better to stay away from high-risk investments that may suffer a temporary (or permanent) setback just as you need to write a check.

These next academic years are the most important for your child. Sit down with him and explain (in as unpressured and nonjudgmental a tone as you can manage) that because colleges give preferential packaging to good students, every tenth of a point he adds to his grade point average may save him thousands of dollars in loans he won’t have to pay back later.

If your child did not score well on the PSAT, consider finding a good test preparation course for the SAT. Several recent studies have shown that coaching can raise a student’s score by over 100 points. Again, every ten points your child raises her score may save your family thousands of dollars—and of course allow her to apply to more selective colleges. We, of course, are partial to The Princeton Review SAT course.

If you have any interest in running a business on the side, this may be the ideal moment to start setting it up. Most businesses show losses during their first few years of operation. What better time to have losses than during the tax years that affect your aid eligibility? There are also many tax benefits to this strategy, but the business cannot exist just on paper. For tax purposes it must be run with the intention of showing a profit in order not to run afoul of the “hobby loss” provisions of the tax code. If this seems like it might be for you, please read our financial aid strategies section, and the section on running your own business in the chapter “Special Topics.”

Maneuvering

The most important thing to realize is that at this point, you are one year away from the all-important base income year. Colleges now use the tax year two years before college begins (from January 1 of the student’s sophomore year of high school to December 31 of the student’s junior year in high school) as their basis for deciding what you can afford to pay during freshman year.

Thus you have one year to maneuver before the base income year begins. Read the financial aid strategies that we outline in the rest of this book extremely carefully. After you have read these chapters and consulted your accountant or financial aid consultant, you may want to move some assets around, take capital gains, take bonuses before the base income year begins, and so on. During the base income year itself, you may want to make some major expenditures, pay down your credit card balances, establish a line of credit on your home, and make the maximum contributions possible to retirement provisions.

Many times, parents come to consult us when their child is just about to fill out the need analysis forms in the senior year of high school. There is still a lot we can do to help them qualify for more aid, but we always feel bad for the family because if only they had come to us before the base income year started, there would have been so much more that we could have done.

You are in the fortunate position of having that extra year to maneuver. Read the rest of this book, and enjoy.