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Frequently asked questions about college planning

How should I approach planning for my child’s college education?
When you’re trying to come up with a plan to finance a child’s college education, consider all your different sources of cash but also realize that the money you earmark for college means you may not have much money left over to save for your own retirement. Comprehensive college education planning should include a thorough understanding of all the family’s financial objectives and current and prospective financial positions. Grandparents who are able financially and interested emotionally in the education of your children should be included in the planning process. Retirement and estate planning perspectives should also be considered before entering into an educational funding program.

How much should I plan to save for my children’s education?
Tuition and fees have risen 94% since 1989, nearly triple the 32.5% increase in inflation. The sticker price -- tuition, fees, and room and board -- for a year of undergraduate education ranges from $33,000 at Ivy League schools to $10,500 at state universities. If college costs continue to increase at even twice today’s low rate of inflation, the cost of a four-year degree for a child born today would be $109,000 for a state university and $260,000 at an Ivy League school.

How important is it that I start saving for my child’s college education?
If you have kids or are planning to have them, the importance of starting to save for their college costs right now cannot be overstated. College costs have been rising about 6% to 8% annually for the past 20 years, more than twice the annual rate of inflation. In short, if you want your child to eventually go to college, you will be responsible for paying most or all of the costs. And because those costs are already skyrocketing, you need to start saving to meet them today.

Can I pay income to my children to help save for their educational expenses and also save on my taxes?
If you own your own business, a good way to start saving for your child’s college education is to put your son or daughter on your payroll. Doing so will reduce the taxable business profits you must report to the Internal Revenue Service, while the income your child collects will be taxed at the child’s lower individual tax rate. If you decide to hire your child, you will have to pay a fair-market rate for the work that is done. Keep careful records documenting that the child did the work for which he or she was paid because the IRS may ask to see them. Employing a child isn’t just a good way to start building a college nest egg. It can also help your son or daughter develop a sense of responsibility and skills they can use later in life.

Can I set up a mutual fund account to help my grandchildren start saving for college?
If you are a grandparent who’d like to help your grandkids start saving for college but don’t like the idea of setting up a trust, consider starting a mutual fund account for each of the children you want to help. You can establish a mutual fund account for each grandchild, using the grandchild’s Social Security number with a parent designated as guardian. The address of the grandparent can be listed on the account to facilitate ongoing deposits. It is important to make sure that tax information is forwarded to the parent each year.

Are custodial accounts a good strategy for saving for college?
Custodial accounts can be a useful strategy in planning for future educational expenses. Even with the "kiddie tax" for children under 14, there are still advantages. But be careful if making yourself the custodian, because if you die while the money is still in the custodial account, the value of the account will be included in your estate. You should also understand that generally the value of the account will belong to the child at the age of 18, regardless of college plans, and will definitely not be available for your retirement or other needs.

What’s wrong with saving money for college in the child’s name?
When financial experts say it’s a bad idea for parents to save for a child’s education in the child’s own name, they usually point to three issues. First, there’s little -- if any -- tax benefit in saving money in a child’s name. Children today can earn only a little money tax-free. As of 2008, the rules for children under 19 (or under 23 and a full-time student) limit tax-free investment income to $900. Income between $900 and $1,800 is taxed at 15%, and everything above that is taxed at the parent’s rate. After these specified maximum ages, your children pay taxes at their own rate, but there’s little time at that point for compounding to do its magic. Any tax benefits that you receive may easily be offset by the second reason most financial planners say you shouldn’t save in your child’s name. The child can take legal control of the money at age 18 if you choose to save under the Uniform Gift to Minors Act (UGMA), or age 21 if you use the Uniform Transfer to Minors Act (UTMA). If there’s $50,000 or $100,000 in the account, your son or daughter could use it to pay for college. Or buy a Porsche, tour Europe for a year or two, or split to Las Vegas. The money will be theirs, and you can’t tell them how to spend it. The third issue is with college financial aid. The people who decide whether your offspring qualifies for a loan or grant know that you have other expenses, so they generally don’t expect you to devote more than 6% of your own savings to fund college costs. But those same people figure teenagers don’t have as many expenses, so they expect about one-third of a kid’s assets to be used to meet those costs. As a result, the more money your child has saved up, the greater the chance that a request for financial aid will be rejected.