This is Part 2 of this 3 part series. In this installment we’ll discuss choosing your investments to meet your college funding goals.
(In Part 3 we’ll tell you how to reduce tuition costs and find help in paying for college.)
As with any investment, you should choose those that will provide you with a good return and that meet your level of risk tolerance. The ones you choose should depend on when you start your savings plan-the mix of investments if you start when your child is a toddler should be different from those used if you start when your child is age 12.
The following are often recommended as investments suitable for education funds:
Series EE Bonds are extremely safe investments. U.S. Government Bonds are also safe investments that offer a relatively higher return. If you use zero-coupon bonds for your child's education, you can time the receipt of the proceeds to fall in the year when you need the money. A drawback of such bonds is that a sale before their maturity date could result in a loss on the investment. Further, the accrued interest is taxable even though you don't receive it until maturity.
CDs are safe, but usually provide a lower return than the rate of inflation. The interest is taxable.
Municipal Bonds, if they are highly rated, can provide an acceptable return from the tax-free interest if you're in the higher income tax brackets. Zero-coupon municipals can be timed to fall due when you need the funds and are useful if you begin saving later in the child's life.
Tip: Be sure to convert the tax-free return quoted by sellers of such bonds into an equivalent taxable return. Otherwise, the quoted return may be misleading. The formula for converting tax-free returns into taxable returns is as follows:
Divide the tax-free return by 1.00 minus your top tax rate to determine the taxable return equivalent. For example, if the return on municipal bonds is 5 percent and you are in the 30 percent tax bracket, the equivalent taxable return is 7.1 percent (5 percent divided by 70 percent).
Stocks contained in an appropriate mutual fund or portfolio can provide you with a higher yield at an acceptable risk level. Stock mutual funds can provide superior returns over the long term. Income and balanced funds can meet the investment needs of those who begin saving when the child is older.
Deferred Annuities provide you with tax deferral, but the yield may not be acceptable because of the relatively high cost of these investments. Further, amounts withdrawn before you reach age 59-1/2 may be subject to a 10 percent premature withdrawal penalty.
If You're Caught Short
If you have insufficient savings for your child's education when he or she is close to entering college, there are ways to generate additional funds both now and when your child is about to enter school:
You can start saving as much as possible during the remaining years. However, unless your income level is high enough to support an extremely stringent savings plan, you will probably fall short of the amount you need.
You can take on a part-time job. However, this will raise your income for purposes of determining whether you are eligible for certain types of student aid. In addition, your child may be able to take on part-time or summer jobs.
You can tap your assets by taking out a home equity loan or a personal loan, selling assets or borrowing from a 401(k) plan. You (or your child) can apply for various types of student aid and education loans (discussed below and in Info Sources).
Tip: Sources of student aid and education loans should be exhausted before other types of loans are used, since the former make better sense financially. In some cases, however, a home equity loan can be advantageous because of the deductibility of interest.
Sources Of Financial Aid
(Here is a brief summary of the possible sources of financial aid. The types of aid and tax implications change frequently, so consult your financial advisor for specifics when you're approaching the time to seek financial aid.)
Grants, the best type of financial aid because they do not have to be paid back, are amounts awarded by governments, schools, and other organizations. Some grants are need-based and others are not.
Federal Pell Grant Program. Pell grants are need-based.
Tip: Don't assume that middle class families are ineligible for needs-based aid or loans. The assessment of whether a family qualifies as "in need" depends on the cost of the college and the size of the family.
State education departments may make grants available. Inquiries should be made of the state agency.
Employers may provide subsidies.
Private organizations may provide scholarships. Inquiries should be made at schools.
Most schools provide aid and scholarships, both needs-based and non-needs-based.
Military scholarships are available to those who enlist in the Reserves, National Guard, or Reserve Officers Training Corps. Inquiries should be made at the branch of service.
Tip: Try negotiating with your preferred college for additional financial aid, especially if it offers less than a comparable college.
In the third and final installment of this series, I will discuss strategies we’ve used in the past to help middle class families qualify for unexpected assistance not only from the government but also private institutions. We’ll even share some of our negotiation techniques so you don’t want to miss next week’s article!
Detailed guides outlining subject matters such as Life Events, Business Strategies, Investment Strategies, Tax Strategies and the answers to 500 every day financial questions can be found free at http://savemyretirement.com.
For the past 16 years Todd Hickman has co-hosted a weekly financial radio show on NewsTalk 560AM KLVI, airing each Sunday at 11AM. You can reach Todd during the week at 409-840-6900 or by visiting his company’s website at http://savemyretirement.com.