Hugh F. Doherty, DDS, CFP
All the horror stories you hear are true. And, yes, the bills are astronomical. But, there are ways to melt them down to a manageable size. How can you accumulate the cash you will need and tap into other sources of college money? Here is some help.
Start saving now. The sooner you begin putting money away, the lower the annual return you will need to reach your goal. But even if you start immediately, you will have to invest
shrewdly to beat college inflation, which has been averaging around 6 percent annually over the past four years, and taxes, which can shrink gains dramatically.
Investment strategies
If the kids are young, put all or most of the investments in stocks. It is the best way to net high returns. Starting early will give you time to recover from downturns. Mutual funds provide the simplest route to the market. To reduce costs, stick to no-loads.
Use dollar-cost averaging
This is a hassle-free way to invest. You contribute a certain amount each month. You can have it transferred from your checking or money-market account automatically - regardless of what is happening in the stock market or the economy. Let the investment grow over time. You will eliminate the uncertainty of trying to buy low and sell high. With 80 percent stocks and 20 percent bonds and money-market funds in your portfolio, you can produce average annual gains of about 8.5 percent. At that rate, if you invest $300 a month, you will accumulate about $110,000 after 15 years.
Years before you need the money
If you start with a stock-heavy portfolio, you should gradually shift into lower-risk investments as your kids approach college age. When they reach the last three years of high school, make the bulk of their college money safe and accessible by placing it in certificates of deposit, short-term bond funds or money markets. You do not want to take much market risk in those few years before college. Here is how a typical college fund portfolio might be allocated over the years:
A slightly more aggressive approach would be to have you put all their college savings into no-load growth mutual funds until the last three years before college.
Some fund recommendations for college investing include: Vanguard Index 500, T. Rowe Price Equity-Income and the Janus Fund.
Be wary of custodial accounts
Once you decide how to invest your kids` college money, there is another important question to consider. Should you invest in your child`s name or in yours? It depends. If you might qualify for need-based financial aid (some doctors do) or if you are reluctant to give control of the money to your child when he/she reaches majority, invest in your own name. However, if financial aid is not an issue, consider investing in your child`s name to lighten your tax burden.
Evaluate your family`s financial need
When colleges evaluate your family`s financial need, they will weigh your teenager`s assets more heavily than yours. For some doctors` families, the difference between getting financial aid and not getting it could depend on who owns the assets. Often, putting more than a couple of thousand dollars in a child`s name disqualifies him or her for need-based aid.
Drawbacks
Placing funds in your child`s name has three additional drawbacks:
1. You cannot take the money back.
2. The money cannot be spent on anything that does not directly benefit the child.
3. The child gains control of the money when he or she turns 18 or 21 (depending on state law). Maybe your son or daughter will use the money only for college, but there are no guarantees. When the children become of age, they can take the money and spend it anyway they want.
Tax considerations
Those worries addressed, some compelling tax advantages apply to putting money in your kid`s name. A child under age 14 may earn $650 per year on investments, tax-free. Another $650 is taxed at his or her low rate. Any investment earnings above $1,300 generally get taxed at the parents` rate. After age 14, all the money the child earns is taxed at his/her rate. These are nice breaks for heavily taxed doctors.
Gifting
What`s more, each parent may give each child up to $10,000 per year without owing a gift tax. You might limit gifts you make to young children, so that yearly investment income never exceeds $1,300; but, you and your spouse can give kids over 14 the full $20,000, knowing that all the income your gift earns will be taxed at their rate instead of yours.
Be money smart
If you trust your child and want the tax advantages, it is tempting to take the plunge. But consider limiting your contributions so your 18-year-old does not come into a small fortune. Once you put the money into a custodial account, there is no turning back. If you are not going to qualify for aid, you should think about putting at least some money into your child`s name.
Hugh F. Doherty, DDS, CFP, is a national lecturer, consultant to the health-care profession, workshop leader, author, management and financial adviser and Certified Financial Planner. For further information, contact Dr. Doherty at (908) 449-3225.
