Course notes on paying for college

Concerned about the cost of a college education? Chances are you have plenty of company, considering that the average cost of a four-year tuition (including room and board) is now estimated at $108,000 for private colleges and $42,000 for state schools. And if current projections are correct, those figures will jump to $260,000 and $100,000 respectively by the time an infant born in 2002 is ready to enroll.

How to cope? Start planning -- and saving -- immediately, no matter how many children you have or how young they are. Here are some steps you might want to consider, perhaps with the assistance of a financial adviser:

Participate in a state plan

All states have the option of establishing prepaid tuition or college savings plans, popularly known as "529 plans." They receive favorable treatment from the IRS -- no federal tax on earnings until they're used to pay for school. Even then, the tax is levied at the student's rate, usually less than 15 percent.

Under the 2001 Tax Act, distributions for qualified higher education costs would not be taxed at all beginning in 2002. (The 2001 Tax Act changes will expire and amounts will again become taxable in 2011 unless Congress again acts to extend the provision.) Many plans also give state tax breaks to residents.

Several states have recently established IRA-like savings programs that are not pegged to future tuition costs. They may produce a better return than prepaid plans for the long-term investor, given that college costs have been rising at about 4 to 5 percent annually in recent years.

If you don't like how your state's college savings plan works or its investment philosophy, shop around. A number of states have no residency requirements for contributors or beneficiaries. A caveat: Know what penalties may apply if the money in the account is not used for qualified education costs or if it is transferred to another state plan.

Ready a Roth IRA

If your income level qualifies, you and your spouse can set aside up to $6,000 in 2003 in a Roth IRA and use it to fund college when needed. The contribution limits gradually increase until they reach $5,000 per person (total of $10,000 for you and your spouse) in 2008. The investment growth is tax-deferred. You can take your own contributions tax-free at any time, and use the earnings to pay for college without penalty if you pay taxes on the early withdrawal.

Position for financial aid

Know that most college financial aid formulas place more emphasis on income than assets. If you're planning to cash in a much-appreciated investment to help pay for an education, it might make sense to do it a couple of years before the first tuition payment is due, so your capital gain isn't counted as income by the formula.

Assets are weighted by who owns them; the formula expects 5.6 percent of parent's assets to be used for education, compared to 35 percent of the student's assets. Be wary, however, of how private colleges view the assets in a state tuition plan. Some states count them as income when received.

Look for loans

If you don't qualify for a low interest, need-based loan, you can apply for a PLUS loan or your child can apply for a Stafford loan. There may be some advantages to borrowing money through a home equity loan or from your 401(k) plan, but you should think hard about whether you want to put your house or retirement at risk for Junior's studies.

Consider relativity

Don't overlook the fact that anyone can set up a state college savings plan for your child. For example, if Grandpa is looking to reduce future estate tax liability consider this: By taking advantage of the current federal annual gift tax exclusion ($11,000 in 2003) Grandpa can contribute up to $55,000 in a lump sum to a college savings plan account and elect to treat the contribution as having been made over a five-year period as long he makes no further gifts to that account beneficiary for the next five years. This effectively removes the amount from Grandpa's estate in most cases, but still allows him to retain control to take back the money (possibly subject to a penalty) at a later date.

Take advantage of tax credits

The Taxpayer Relief Act of 1997 produced two new tax incentives for students attending college and universities. The Hope Scholarship Credit goes up to $1,500 a year (2003 amount; indexed for inflation) for the first two years of college, while a Lifetime Learning Credit of up to $1,000 a year can be applied to college expenses for any year, though it cannot be taken in the same year as the Hope Scholarship Credit.

The credits begin to phase out if your modified adjusted gross income is above $41,000 ($82,000 on a joint return) and are eliminated entirely at $51,000 ($102,000 jointly). (These phase-out amounts are effective for 2003, and are indexed for inflation.) The Lifetime Learning Credit increases to $2,000 in 2003. Beginning in 2002, these credits may be utilized for a tax year in which a Coverdell Education Savings Account distribution is used for qualified education expenses.

Sharon Stanley is a representative of The Prudential Insurance Co. of America in Cape Girardeau. (334-2603 )