Marcio Jose Sanchez  /  AP
Sending kids to college continues to cost more and grow more complex, but there are ways families can finance the costs of higher education.
By
msnbc.com contributor
updated 11/3/2005 9:26:30 AM ET 2005-11-03T14:26:30

This is the time when high-school seniors are putting their college applications in the mail, wondering if they’ll get into the school of their choice. It is also the same time when many of their parents are frantically worrying about how they are going to foot the bill.

Their worries are valid since college costs keep rising above the rate of inflation. According to a recent survey by the College Board, annual tuition and fees at public four-year universities rose 7 percent to an average of $5,500, while it increased by 6 percent at four-year private colleges to $21,235.

And figuring out how to pay has become more complicated for families as different types of financial aid programs, savings vehicles and tax incentives have sprung up in recent years.

"Planning how you pay for college has become extraordinarily complicated and increasingly important for people of all income levels," said Paula Hogan, a certified financial planner at Hogan Financial Management in Milwaukee. "If the family is eligible, they should try to maximize financial aid. If they’re not, they should concentrate on the most tax-efficient way to pay for college. Either way, the savings strategies vary greatly.”

Below are six ways families can finance the costs of higher education.

Apply for financial aid
Don’t despair if Junior gets into an Ivy League school and you don’t have the $40,000-plus for annual tuition. Truth is most students never end up having to pay sticker price for college. Instead, they pay what’s left after the college provides a package of federal, state and college-based aid. Because of financial aid, private schools can sometimes be as good or a better deal than an in-state public school.

“Many schools with higher tuition have to be competitive, so they’ll increase gift aid and scholarships, which decreases the actual net cost for students,” says John Heywood, a principal in charge of mutual fund company Vanguard's education markets group. “That may make the decision between Princeton and Rutgers next door easier based on what you will owe in loans.”  

The only way to know if you will qualify for aid is to complete the Free Application for Federal Student Aid form from the U.S. Department of Education. You’ll need to have a recent tax return and balance sheet handy when filling it out.

Hogan says families who qualify should maximize financial aid. “It’s not like past years when you were just missing out on an 8 percent loan. Now, since some of the most expensive elite schools are shifting from loans to grants, which a student doesn't have to repay, you could be missing out on several thousand dollars of free money.”

Colleges base your ability to pay this year's tuition on what you made last year. The “base income” year extends from Jan. 1 of the student's junior year in high school to Dec. 31 of the senior year. To lower your income level, Hogan suggests that parents defer income if they can (the self-employed and business owners are the best candidates), make major payments and refrain from cashing in assets for capital gains.

She also suggests qualifying families avoid custodial accounts in the children’s names, such as 529 plans, and not give appreciated assets to children, since financial-aid systems "tax" students’ assets at 35 percent, while parents’ assets are only taxed at 5.6 percent. Also maximize children’s use of subsidized Stafford loans, which have lower interest rates and do not accrue interest until after graduation.

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“An added benefit of that is students who make timely payments on their college loans go a long way toward establishing their own excellent credit record,” says Hogan.

Open special savings account for school bills
For families who won’t qualify for financial aid, savings accounts earmarked for education offer advantages.

Today, one of the most popular account types is the 529 plan, a state-sponsored savings plan allowing parents to prepay tuition at a qualified institution at today's rates or, more popularly, save money in a tax-deferred account to to pay for college at future tuition rates.

Heywood of Vanguard says the 529 plan is the best deal for most families. "If the money is used for qualified higher education costs, it comes out tax free. And it's good no matter how many years you have to save, even if a student is already in college. If they are in their first or second year, you can put the money into a 529 and use it for the fourth year of school.

“Another benefit is if you live in a state that offers a state-tax deduction on 529 plans (and half of them do), you can reduce your tax bill by up to a few thousand every year.”

Another option is the Coverdell Education Savings Account, or an Education IRA. Earnings grow tax-deferred and distributions are tax-free but the downside is you’re only allowed to save $2,000 per year. The longest-running education savings vehicles are the UGMA (Uniform Gifts to Minors) and UTMA (Uniform Transfers to Minor Act) custodial accounts, which parents set up for their children, but one disadvantage to them is that children have the legal right to the money when they turn 18.

"They can legally cash in that account and spend it as they wish," says Heywood.

Search for scholarships and grants
Millions of dollars in scholarship money goes unclaimed every year, sometimes with good reason — they may be too restrictive or too competitive, and colleges often deduct the money won from their financial aid packages. However, it does make sense to apply for them if you won’t qualify for financial aid, if your college offers loans instead of grants or if it doesn’t meet all your financial aid needs.

Scholarship searches can start online through Internet search engines like FastWeb or the College Board's Scholarship Search site. Both have extensive databases, but Mark Kantrowitz, founder of FinAid.org, a Web site for college financial-aid information, says smaller ones can often be found offline.

“Bulletin boards in your local library or outside the high-school guidance counselor’s office often list scholarships. The payouts may be low, but they often require less effort to apply for than larger, more competitive scholarships.”

Scholarships can also be found at local and national businesses, unions, places of worship, professional associations and service organizations such as the Elks, Kiwanis and the Rotary Club.

Stay away from scholarships that charge application fees, warns Kantrowitz. “Chances are, you’ll be taken in a scam.”

Two popular tax credits can help defray education expenses, and since they are credits instead of deductions, they take a bigger bite out of your tax bill.

The Hope Credit is specifically for those with kids in college. It applies for the first two years of college or vocational school and can be worth up to $1,500 per student, per year.

The Lifetime Learning Credit can be used for undergraduate, graduate and professional degree courses for anyone. If you meet IRS guidelines, you can count $10,000 of your Lifetime Learning education expenses and then claim up to 20 percent of those expenses to net a maximum $2,000 credit.

To qualify for either credit, you must pay post-secondary tuition and fees for yourself or your dependent, but you can only claim one credit per student each tax year. That means you can’t use the Hope credit to pay for your daughter's tuition charges and then claim the Lifetime Learning credit to write off $2,000 more in school costs. The credit may be claimed by the parent or the student, but not by both and if the student was claimed as a dependent, he or she cannot file for the credit.

You also can’t claim either credit for a student named as a dependent on your tax return if you already used the tuition-and-fees deduction for that same student. 

But you can now claim the credits even if you received a distribution from a Coverdell account or a 529 plan, says Kalman Chany, author of How to Pay for College Without Going Broke. “ Just make sure you don't use the distribution money to pay for the expenses you use to claim an education credit. Be specific about how the money was used — let the IRS know the distribution was used only for room and board, and the education credit was used strictly for tuition.”

Ask the grandparents to help out
Doting grandparents may want to help out with college expenses anyway. The best way for them to do so is by giving up to $11,000 per grandchild (married couples can give $22,000) each year, without incurring a gift tax.

529 plans, however, offer an accelerated gift option called “forward averaging” that allows a donor to give up to $55,000, or $110,000 for a married couple, per beneficiary in a single year, offering five years’ worth of gifts in one.

Grandparents can avoid the gift tax completely by paying tuition directly to the educational institution on behalf of their grandchild. But parents, especially those seeking financial aid, should make sure they know about payments beforehand, says Hogan. “Some colleges keep track of who is paying what part of a student’s tuition, and that can affect your child’s overall financial-aid package.”

'Negotiate' with your school
Aid award letters are not set in stone. But never use the word “negotiate” with a school if you want a bigger break on tuition, says Chany. “Instead, ‘request’ that the financial-aid office take a closer look at your financial situation.”

If you’ve had a change in circumstances or other issues not reflected on the aid request, such as a job loss or high medical expenses, bring it to the attention of an aid counselor. Make sure you have copies of relevant documents like the layoff notice or the hospital bill as proof.

Playing hard to get is another tactic for lowering tuition, but it works better if your child has desirable qualities that many colleges want. Some schools base their financial aid offers on whether they think a student has other options. If your child makes it clear that he or she is interested in just one or two schools, the college is likely to ''lowball'' the aid offer.

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