Some College-Funding Methods

To many parents, saving for their children's' college education can seem so daunting that some just don't do it, banking on the wistful hope that something will present itself when the time arrives, just when it's needed. But college funding doesn't happen by magic, nor will it come without careful planning. It takes effort and commitment, put into effect as early as is prudently possible.

Apart from specific college-funding programs such as 529 plans and Coverdell Savings Accounts, there are a number of other ways to save for higher education expenses while at the same time staying ahead of inflation and rising tuition costs. Let's look at some of the most basic methods used to meet those needs.

Investing in stocks is an excellent way to accumulate a reserve; historically, stocks have averaged a 10 percent rate of return for the last one hundred years. However, you should only invest in stocks if your child is more than ten years away from college. The risk of losing on your investment will be reduced over the long period of time.

A diversified portfolio of mutual funds also offers good potential for growth. Again, the keyword is diversified; as with any investment, you don't want to be caught with just one fund that may turn out to go sour. Invest in as many as five different types of funds, such as a balanced fund, a municipal bond fund, and an international stock fund to control your risk.

The returns on U.S. savings bonds are generally not as great as they were ten years ago, but you do have the assurance of knowing that your money's safe. Additionally, if you redeem the bonds to cover college expenses and your family falls within prescribed income guidelines, the interest on the bonds is exempt from federal income taxes.

Zero-coupon Treasury bonds, also known as STRIPS, can be purchased at substantial discounts and, like all federal debt, are also considered to be very safe investments. The future value and maturity dates of these bonds are determined beforehand so that parents will know exactly how much money will have been accumulated for college. Income tax, however, must be paid on accrued interest every year even though that interest isn't received until the maturity date.

Although the rate of growth on cash value policies is somewhat anemic, life insurance nonetheless provides another alternative for college funding, especially if you have difficulty saving money through other means. You can borrow from most permanent life insurance policies or simply 'cash out' the policy when the money's needed for school.Many people borrow money through a home equity loan or line-of-credit to pay for college expenses. Because the loan is secured, the interest on home equities tends to be lower than on most other types of bank loans, and it's generally tax-deductible as well.

One final thought: if you're considering withdrawing money from your retirement accounts to pay for college, reconsider very carefully. If you take that course of action, you'll owe income taxes on the money that's withdrawn; you'll also have to pay a 10 percent penalty if you're under the age of 59½. Additionally, those funds will have to be declared on your child's financial aid form and could adversely affect his or her ability to qualify for a good financial assistance package. And think about this: every dollar that you remove is no longer working for you toward your retirement years, and it will be extremely difficult – if not impossible – to make up that loss.

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