Saving For College

FIGURE 1: LIFETIME TOTAL INCOME. A college graduate can expect to earn more than $1 million more than a high school graduate in his or her lifetime.

It's getting harder and harder to find a decent paying job with just a high school degree. These days, a college education is virtually a must in order to get ahead. The 1999 US Census shows the average income for high school graduates is $23,410. For college graduates, the average income is more than double that amount at $51,251 (in 1998 dollars). Over the working lifetime of the two graduates, the college graduate will likely make more than $1 million more than the high school graduate (Figure 1). According to the College Board, a national, nonprofit association dedicated to preparing students for college, tuition and expenses for public and private colleges are increasing at a rate of about 5% a year -- and this from an already high price tag. The average total cost for a four-year public institution of higher learning in the US in 2000 was $9,000 per year, and $22,000 for a private institution. Over four years, the total pricetag for a college education exceeds $38,000 for the public school attendee and $94,000 for the private school student. And if you plan for your child to attend college about 15 years from now, the total cost is estimated to more than double (Figure 2). That's $80,000 for four years of public college and $197,000 for a private institution!

FIGURE 2: TUITION COSTS FOR PUBLIC AND PRIVATE INSTITUTIONS. Assuming that your child will graduate from high school in 15 years, at a 5% annual increase in tuition you can expect to pay $80,644 for four years at a public institution and $197,130 for four years at a private institution.

With escalating costs, how can you afford to send your child to college? Just like with any other financial plan, the earlier you start, the better off you are. You must develop a strategy that will help you meet the expenses necessary to help your child get a good, solid education.

Your options can be divided into two broad categories: a savings approach and an investment approach. With a savings approach, you will know exactly how much your initial investment should be in order to reach your goals. The savings approach may involve opening a special savings account, putting your money in certificates of deposit, or buying US Series EE savings bonds, which we will discuss later. You are guaranteed a certain level of interest on these savings products.

The investment approach is more speculative. While the possibilities for greater returns exist, the risk of losing some or all of your investment is much greater than in the savings approach. Investment approaches include everything from brokerage accounts to 529 plans and uniform gifts/transfers to minors accounts.

No single plan will work for every situation; you may need to use more than one method to meet your goals. Consider the following guidelines when choosing the plan that will have the greatest benefit for your family.

• Tax benefits. Are there any tax benefits for your options? If so, will you be able to take advantage of them?
• Ownership of account. This can affect taxes as well as decision-making issues. If the money were simply left in your child's name, there is always the possibility that he or she may not use it for college expenses.
• Financial aid implications. Some college savings plans will greatly affect your child's eligibility for financial aid.
• Accessibility to assets. Liquidity will increase in importance as the time remaining for your child to graduate from high school decreases.
• Time frame. The amount of time remaining before your child starts college can determine what type of investment vehicles you can use.

In this article, I will introduce you to the US Series EE savings bond, a choice that falls under the investment approach category. EE savings bonds are generally a good instrument to use for college savings because of their liquidity, tax advantages, low risk, and low costs.

US SERIES EE SAVINGS BOND

If "play it safe" is your motto, then a savings approach may be your best choice. Many of you are probably familiar with savings approaches like those available in banks. The low risk of the savings approach is alluring to many who want to play it safe.

With US Series EE savings bonds, you are not dealing with the banks, but directly with the US government. You can also purchase them online through the Bureau of the Public Debt. EE savings bonds are safe investments because they are backed by the full faith and credit of the US Treasury.

EE bonds are also relatively inexpensive; they are purchased at half their face value. For example, a bond with a face value of $50 will cost you $25. They are accrual securities, which means they accrue interest. This interest is credited on the first day of the month and compounded semiannually. If you don't want to hold your bonds till maturity, you have the opportunity to time your sales. Instead of selling on the last day of the month, you can wait an additional day to collect higher interest.

The current EE bonds are assured of reaching face value after 17 years. At the current interest rate of 5.54% as of November 2000, your investment can equal the face value of the bonds after 13 years, after which the bonds will continue to accrue periodic interest payments for 30 years from the date of purchase (Figure 3). You can see how the value of the bond is calculated in Figures 4 and 5. More information about US Series EE bonds can be found at www.savingsbonds.gov.

FIGURE 3: GROWTH POTENTIAL OF $10,000. $10,000 ($20,000 in face value) in US Series EE bonds at the current rate of 5.54% can grow to above $50,000 after 30 years.

In addition to being safe and guaranteeing investment growth, how do US EE savings bonds fare against our aforementioned guidelines?

• Tax benefits. Interest earnings on these bonds are exempt from state and local income taxes. You can defer the federal income tax until you redeem the bonds or until the bonds stop earning interest, whichever comes first, unless you meet the following criteria. Interest earned on US Series EE savings bonds issued after 1989 is excluded from your adjusted gross income (AGI) if the proceeds upon redemption do not exceed qualified higher education expenses paid by the taxpayer during the taxable year. The qualified higher-education expenses include tuition and fees but not room and board. This applies to the taxpayer and the taxpayer's spouse or dependent at certain educational institutions. This exclusion does not apply for taxpayers with modified AGI between $49,450 and $64,450 ($74,200 and $104,200 for joint returns). This interest exclusion is available only for those owners of US Series EE savings bonds who are at least 24 years old. You can't find such tax exclusions for simple bank savings accounts or certificates of deposit.
• Ownership of the account and decisions. Since you can take advantage of the tax exclusions by having your name on the EE bonds instead of your child's name, control over the assets will be in your hands. Face it: when an 18-year-old has to decide how to use a large sum of money, there are a lot of other tempting options besides college.
• Financial aid implications. If you don't have the time or means to save the necessary amount for your child's college expenses, you may need financial aid to help pay for college. As an owner of EE bonds, your eligibility to receive contributions will be lower in financial aid calculations. If the account is in your name, then 6% (35% if the account is in the child's name) will count toward your child's contribution in the financial aid calculations.
• Accessibility to assets. EE bond buyers must wait at least six months before redeeming their bonds.  Even then, there is a penalty equivalent to three months' worth of interest if the bonds are redeemed within five years of purchase. Beyond these limitations, the bonds can readily be redeemed for cash at local banks. This makes EE bonds very liquid instruments.
• Time frame. As always, the longer your time frame, the better off you are. Since EE bonds are safe investments, you can't expect high returns. In fact, their yields are lower than most other bonds, so you are better off waiting for a long period before redeeming them. See the potential growth of $10,000 in US Series EE savings bonds over 30 years in Figure 3.

One fact to consider before purchasing an EE bond is that there is a maximum amount you can purchase. This is set to $15,000 (equivalent to $30,000 face value of bonds) each year. Figure 4 indicates how making maximum contributions can help you reach your goals. If you can't make maximum contributions, you can opt to make smaller ones, but you will have to make them for a longer time. Figure 5 displays how making equivalent contributions can help you reach your goals. If you wish to make annual contributions, you will have to continue making them through the 13th year. So start planning early, especially if you plan to make small contributions.
 

US Series EE savings bonds are an inexpensive and safe way to obtain moderate returns with local, state, and even federal income tax benefits and can be part of a long-term strategy to help pay for your child's college education. However, keep in mind that these bonds have relatively low yields, and although the tax benefits seem attractive, you will have to pay taxes on the entire earned income at the time of redemption. EE bonds are a good alternative to consider when it comes to saving for college. The advantages are best exploited if you start early and redeem the bonds as late as you can. The sooner you start saving for your child's college education, the less you will have to worry about when the time comes to pay.