Strategies for Savings : Parents’ Proper Planning Can Make Kids’ College Funds Grow

Projections of what college will cost when your youngsters are ready to enroll can be terrifying, but parents needn’t fall into apoplexy. With proper planning, you can manage it. Here are some strategies that not only can help your kids, but can put you in a stronger economic position as well.

Strategy I: Speed Up the Mortgage

Gregg and Karen Ritchie of Malibu decided they would handle college expenses “on the house,” so to speak.

The Ritchies refinanced their 30-year mortgage into a 15-year loan when their children, Devon and Skyler, were toddlers. By the time the oldest is college age, they’ll no longer have house payments.

“When Skyler starts college, I’ll be done paying on the mortgage. I can either continue to make those payments to finance education costs out-of-pocket, or I can refinance and get cash that way,” Gregg Ritchie says.

Ritchie, a partner in the personal financial planning group at KPMG Peat Marwick, cites a key advantage: “It’s easier for me, from a discipline standpoint, to have that extra amount that I have to pay,” he says. “It locks you in.”

And it eliminates the risk that the kids will use the college money to finance a grand tour of Europe rather than their education.

How much extra would you need to kick in to pay off the mortgage by the time the kids reached college? The answer depends on the size of the mortgage, the interest rate and the age of your children. But an example may still help illustrate.

Consider a family that has a $100,000 30-year mortgage at 8% interest and a 5-year-old child. Their monthly mortgage payment now amounts to $734.

If they wanted to pay off the mortgage in 13 years to coincide with their child’s expected date of college enrollment, they would need to pay $1,033 a month--about $300 a month more than they’re currently paying.

Seem like a lot? Consider what they get in return. Not only are they free of mortgage payments 17 years sooner, they save a stunning $102,994 in interest expenses by paying early. Even though the effective after-tax savings is somewhat less than that for most people, the family is still going to be way ahead in the long run.

What if you just can’t afford such a big a payment? Pay what you can. It still builds equity, which boosts your borrowing power. And that borrowing power can be tapped when college bills arrive. Even small additional payments will save you a fortune in interest expenses.

Strategy II: Use the 401(k)

Possibly the smartest strategy of all may be to ignore the kids and just save vigorously for your own retirement--if you can save through a 401(k) plan at work, your employer matches a portion of your contributions and if you can borrow from the account.

A lot of assumptions? Perhaps. But, roughly 90% of the nation’s larger employers offer these plans; 84% match a portion of worker contributions, and 81% offer workers the ability to borrow from their accounts, according to a survey of 514 companies by Buck Consultants Inc. in 1994.

How does saving for retirement help? In some ways, it’s similar to paying off the mortgage. Consider Dave and Sherri Palermo, Lenexa, Kan.-based parents of four.

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When they were young, they saved like crazy for retirement, socking away the maximum amount allowable every year for more than a decade. Now that their oldest son is starting college, their retirement fund is so substantial that they feel comfortable putting contributions on hiatus while they get the kids through school. That allows them to use current income for college bills.

At the same time, such accounts grow fast due to the the tax benefit from 401(k) contributions, which are taken out of your income before taxes are deducted. Income earned on the account accumulates tax-free until it’s withdrawn at retirement.

Better yet, retirement plan contributions are not considered assets as far as federal financial aid calculations are concerned. That means your child also qualifies for comparatively more aid.

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Many of these plans allow you to borrow about half of the account value for major events, such as buying a house, dealing with a medical emergency or paying for college.

Let’s say, for example, that you contribute $9,000 annually to the account and your employer matches 25% of your contribution, pouring an additional $2,250 into your retirement savings each year. You earn 8% annually on the money. And you contribute faithfully for 15 years.

What’s your account worth? An astounding $324,410. Even if you can only borrow half of that, you’ve got better than $150,000 at your disposal.

What’s the catch? If you change jobs, you may lose your ability to borrow from the account. But by being so far ahead for retirement at that point, you are in a better position to slow your savings while the kids are in college.

Strategy III: Be aggressive as soon as they’re born.

Benjamin Kravetz is only 5 months old, but already he’s saving for college. When he was born, some of Benjamin’s relatives sent checks. But his newfound riches didn’t go to buy blocks, books or stuffed toys. Baby Benjamin bought stock in companies with good growth prospects so that someday he’ll be able to attend an Ivy League university without drowning in debt.

OK, so Benjamin’s parents--Jeffrey and Sandy Kravetz of Denville, N.J.-- actually did the investing. But, like many parents who start college saving early, they’re saving in Benjamin’s name to save on income taxes.

Benjamin is young, so his investment plan can be aggressive. As a result, the Kravetz family’s strategy boils down to starting small, starting early and investing solely in corporate stocks. For now, they are also using dividend-reinvestment programs to add stock over time.

Over short periods, stock prices are volatile, Jeffrey Kravetz acknowledges. But, since Benjamin is not going to need the money for another 17 years, he can afford to ride out these temporary swings. And, over the long haul, stocks have proven to perform better than nearly any other type of investment, raking in 10% average annual returns over the past 50 years.

In addition, Jeffrey Kravetz says he plans to start a regular investment program where he’ll add $50 a month to Benjamin’s account.

The Kravetz family chose to save in Bejamin’s name for a simple reason. Currently, the first $650 the child earns on his account is free of federal taxes. The next $650 is taxed at a 15% rate. If the money was invested in the parent’s account, the federal government would tax it at a 28% rate.

Since they’re starting so early, this strategy could save them a significant amount in income taxes over the course of several years. However, as Benjamin gets older and his account gets bigger, they may want to start shifting new investments--and, if possible, the existing account balance--back into the parent’s names.

Why? First, the tax benefits begin to evaporate as the account grows in size. Second, if Benjamin has too much money he’ll be expected to spend it all on college and won’t get as much financial aid. Finally, there’s the question of the Porsche.

What happens if Benjamin proves to be irresponsible with money--or simply uninterested in college? Mom and Dad are in a bind, because money given to a child belongs to the child. The child can use it for college. Or he can buy a Porsche. Parents who aren’t certain about just how responsible Junior might turn out to be may want to save in their own names--regardless of federal income taxes.

But, you may wonder, just how much will Benjamin have saved when he enrolls in college? Assuming he’s got just $200 now and everything goes as planned--his dad invests $50 a month and it earns an average of 10% annually on the investments--Benjamin’s college coffer will contain about $25,526 in 17 years.