Planning for college costs

Black Enterprise, April, 1997 by Terrence L. Johnson

If the retirement account earns 10% each year, you will accumulate roughly $310,000 in 15 years. "When your child is ready for school, you can borrow back $100,000. But begin taking some money out for college, like $20,000 a year, and pay it back over five years," Smith suggests. Your monthly payments would be about $424. "At that point, you could reduce the 401(k) payment if your funds are tight. This way, you're paying yourself back and not a bank."

However, 401(k) participants should remember that they may be charged a penalty for withdrawing money from the plan before retirement age. Some plans won't even allow early withdrawals. However, penalties will not be incurred if you take out a loan instead. Consult with your company's 401(k) administrator before making any decisions. Financial experts also note that as a last resort, you can borrow against your home equity. The interest on a home equity loan is tax-deductible up to $100,000.

PREPAID TUITION PLANS

They sound so good on paper that pre-paid tuition programs are already offered in 13 states, including Alabama, Ohio, Texas and Massachusetts. The lure is simple: under prepaid plans, you pay for future tuition at current prices. How do they work? The money you pay is used to purchase "units" which can later be redeemed for tuition costs. In Ohio, tuition units currently cost $42. One year's tuition at the average priced four-year state university will be covered by roughly 100 units; 400 units will cover four years. "Essentially, prepaid plans sell peace of mind," says Chany.

Barbara Jennings, executive director of the Ohio Tuition Trust, believes parents take on lower risk and shoulder a lower tax burden by using prepaid programs instead of investing in the stock market. For one, families don't have to pay state taxes on their investment, and federal taxes are deferred until your child enters college. Then, when your child enrolls, the IRS taxes the sum at a student tax rate of approximately 15%.

On closer examination, the drawbacks of prepaid programs may outweigh the strengths. For one, although some plans are portable, they are usually restricted to a particular school, and if your child does not attend that college, you are penalized with fees for withdrawing the money. Financial planners criticize prepaid programs, arguing that you could earn a higher return by investing elsewhere, even though you may pay more in taxes. And there may be greater concerns than these. There's no way to be certain of the future quality of education available at the school you choose for your child, and you can't guarantee that your child will want to attend and/or meet the academic requirements of that school.

If you feel a particular state's prepayment program goes too far in limiting your choices, the College Savings Bank in Princeton, New Jersey (800-888-2723) offers a national prepaid tuition plan for any school in the country.

In saving for college, what's crucial for parents to understand is that they must begin early, invest consistently and place the money in long-term investment programs. Good luck to your future scholar.