How to make college affordable today

There's no question – a college education is costly. Rates today are more than twice what students paid 10 years ago.¹ Unfortunately, coping with these costs seems even more agonizing in today’s economic climate, leaving many to wonder how they can make a college education attainable for their children. What can you do?

First, get your financial foundation in place

Before you allocate any money toward your child's college education, make sure you've shored up enough cash reserves to get through any potential crisis, such as a job loss. These funds are key to your family's financial stability and should cover at least three to six months of living expenses, maybe more.

Also remember that you can borrow for an education but not for retirement, so don't sacrifice any retirement plan contributions to build an education fund. And especially don't miss out on any potential retirement plan matches from your employer.

Once you've addressed these important financial objectives, you can begin to focus on your child's education fund. Here’s how to begin.

Be prepared to make some sacrifices

You may need to reduce your spending to free up money to save. For example, cut down on eating out, drop cable for the summer months or switch to public transportation. All of your efforts to spend less will mean more money you can set aside for a much bigger-picture objective: An invaluable education for your child.

Be resourceful

Consider every possible option, including investments, loans, scholarships and even grandparents. And get your kids on board, too. For example, on birthdays, encourage family members to skip the iPods and Wii games and help your kids with college instead. Here are some additional options:

New options for 2009 and 2010

The $787 billion American Recovery and Reinvestment Act of 2009 offers a number of incentives to make college more affordable:

• Tax credit for college expenses
  The American Opportunity Tax Credit modifies the Hope Scholarship Credit for 2009 and 2010. If you qualify, you could receive a tax credit of up to $2,500 to offset the cost of tuition, certain fees and course materials related to the first four years of a post-secondary education. While books are qualified expenses under the new American Opportunity Tax Credit, they aren't covered by the Lifetime Learning Credit.
• Expanded qualifying expenses for 529 college saving plans
  In 2009 and 2010, computers, software and internet service qualify as higher education expenses and can be purchased using 529 funds (see "529 plans" below), regardless of whether they’re required for specific classes. Some restrictions apply.
• Additional Pell Grant dollars
  Undergraduate students who qualify for Pell Grants will see a $500 annual increase over the next two years.

Other tax credits and deductions

Numerous additional tax benefits are available for educational expenses, beyond the American Opportunity Tax Credit. These include the Lifetime Learning Tax Credit, the above-the-line deduction for tuition and fees (before 2010) and a deduction for student loan interest. Keep in mind that tax credits operate more like rebates than discounts – they're made available after you've paid tuition and cannot be directly applied to past tuition bills. For the most part, these tax incentives can only be used to offset your tax liability; however, the American Opportunity Tax Credit is partially refundable (may result in a tax refund if you have little or no income).

529 plans

529 plans are available as prepaid or savings plans, both through state and educational institutions. There are no restrictions based on your income, age or where you live. Earnings are free of federal tax as long as you use them for qualified educational expenses. And some states offer tax and other benefits associated with 529 plans. For financial aid purposes, 529 plans are considered assets of the parents.

Coverdell Education Savings Accounts (ESAs)

You can use a Coverdell ESA to pay for qualifying elementary and secondary school expenses as well as college costs. Income limitations apply. Contributions are made with after-tax dollars, but any growth in the account is tax free if used for qualified educational expenses. Education Savings Accounts are considered assets of the account owner.

Qualifying U.S. savings bonds

The interest you earn from EE and I savings bonds issued after 1989 is tax free, as long as you meet the requirements (e.g., owner must be at least 24 years old prior to issuance) and use it to pay for qualified educational expenses. Certain restrictions apply concerning who may purchase these bonds and who may benefit from their use to fund education expenses. The bond owner is considered the asset owner for financial aid purposes.

Traditional and Roth IRAs

When you make a withdrawal from an IRA and use the money to meet eligible educational expenses, the withdrawal is a penalty-free distribution. But you may owe income taxes on the taxable portions of the withdrawal. Plus, if you were planning to use your IRA for retirement expenses, pulling funds from the IRA could impact your long-term goals. So consider using other asset options first. Of course, check with your financial advisor and tax advisor before making any IRA withdrawals. IRA accounts are not counted as assets for financial aid purposes.

Custodial accounts (UGMA, UTMA)

You can use custodial accounts to finance an education; however, there may be drawbacks. Once you've transferred assets into a custodial account, they legally belong to the minor and you're not permitted to take them back. This could be a problem if the minor decides not to attend college.

You may also face a tax situation, the so-called "kiddie tax," where the interest on the account is taxed at your rate (if the child's unearned income exceeds certain limits) – not the rate of your minor, which is usually much lower. Also, a custodial account is considered an asset of the beneficiary for financial aid purposes, so if the account is of significant value, it may be difficult for the student to receive financial aid. Talk to your tax advisor before making a decision.

Student (and other) loans

Student loans in 2006-2007 constituted 40% of all undergraduate financial aid, according to the College Board. Federal, private and college-sponsored loans are available for students and parents. Under certain circumstances, the federal government will cancel all or part of an educational loan (known as loan forgiveness) while most have lengthy repayment periods.

Scholarships

According to scholarships.com, "many people are almost completely misinformed and stand a much better chance than they think of qualifying for dozens of scholarships."² In fact, even students with a grade-point average as low as 2.5 can qualify. Start by investigating what scholarships are available at local colleges. Then check opportunities through your workplace and community organizations. Scholarships are generally tax free. Following are a few of the options listed on scholarshiphelp.org:

• High school scholarships
  Begin by checking with your student’s high school, which may offer scholarships to graduating students. The high school guidance counselor can help.
• College scholarships
  Colleges often have scholarship money available for applicants who have been granted admission. These scholarships are available under a variety of terms that may include maintaining a certain GPA or pursuing a specific major. Contact the college for more information.
• Departmental awards
  Specific college departments may have scholarships available to attract or retain students in the department’s field of study. If your student knows what his or her major will be, contact the related department to inquire about scholarships.
• Athletic scholarships
  Athletic scholarships are highly competitive, but if this is a realistic option for your student, you may want to start by visiting the National Collegiate Athletic Association (NCAA) website (ncaa.org). About $1 billion in athletic scholarships are partially funded by the NCAA each year (note that the scholarships are paid through the college).
• Corporate scholarships
  Corporations offer scholarships to attract and retain employees, and to support the communities where their business is located. These scholarships often go un-awarded for lack of applicants. Check with your employer to see if a scholarship program exists at your workplace.
• Scholarships through religious organizations
  Religious organizations often award scholarships to help their members afford the cost of a higher education. If you are affiliated with a specific religious group, ask about the availability of scholarships.
• Chamber of Commerce awards
  Chambers often have scholarship programs and also can be a great source of information on which businesses in your community offer scholarships. Visit chamberofcommerce.com to find the contact information for the chamber of commerce serving your community.

For more information on scholarship opportunities, visit scholarships.com, collegescholarships.org and students.gov.

Your financial advisor can help

Finding a way to make college affordable today may require more resourcefulness and determination than ever, but your efforts will be rewarded in the end with an invaluable education for your child. To help you investigate your options, talk with your advisor. Together, you can identify the best way to make a college education affordable for your student.