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My college-savings secrets

February 28, 2012

By Robert DiGiacomo | Money Rates Columnist

When Donna set up college savings accounts for her children more than two decades ago, she had one goal: to have her two kids graduate without having to borrow.

"My parents paid for my schooling -- it's always been my goal to get my kids out of school debt-free," she says.

Today, with her daughter holding a bachelor's degree in fine arts from a private university and her son completing his sophomore year at a state school, the New Jersey-based professional photographer has almost realized her dream.

Funding a child's college education can seem like a daunting task, and having more than one college-bound child can make it even more challenging. But these five tips can make funding your children's education a manageable goal:

1. Plan ahead

Like saving for retirement, the earlier you start planning for your child's college education, the better.

Donna and her husband, Bob, who works in the aerospace industry, set up a 529 College Savings Plan to fund college. Similar to a Roth IRA, a 529 allows participants to make after-tax contributions, which can be withdrawn tax-free to be put toward tuition, room and board, and other education-related expenses.

Donna and Bob, whose household income is about $150,000 a year, started contributing to their children's 529s shortly after their births, and also received $1,000 annual gifts for each child from her parents.

"The ideal is to start saving when your child is born, because your greatest asset is time," says Mark Kantrowitz, publisher of FinAid.org, a financial aid information site. "Even if you're starting very late in the game, it's still worth saving. It's cheaper to save than to borrow."

2. Insure an educated future

Another savings strategy is to take out a variable universal life insurance policy, according to Rich Arzaga, CFP, founder and CEO of Cornerstone Wealth Management.

Here's how such a policy works: For an investment of $5,000 a year in premiums for 17 years, assuming an interest rate of 8 percent, when your child is 18, you should be able to withdraw $40,000 a year for four years.

The policies offer tax-free withdrawals and another key advantage: "If you don't use the funds for college, you can use them for anything you want," Arzaga says.

3. Look to the FAFSA

No matter your savings, you and your child should fill out the Free Application for Federal Student Aid on Jan. 1 or soon thereafter during your child's senior year of high school and each subsequent year of college.

"It's the main entry point to getting money from federal and state government and almost all colleges," Kantrowitz says.

Donna and Bob turned in the FAFSA for their daughter's first year to no avail: As the owners of two properties, they didn't qualify for aid. For that reason, they didn't go to the time or trouble to resubmit the form for their daughter's remaining three years.

"If you own anything, you don't get any money -- we soon realized it was a waste of time," Donna says.

But for many students, the FAFSA will offer federal money to help augment savings, so there's no reason not to try it.

4. Examine scholarships

There's a universe of scholarship funds waiting to be tapped, from the well-known National Merit Scholarship to lesser known grants, like a $25,000 offering from Jif peanut butter. Kantrowitz's other site, FastWeb.com, offers a free scholarship matching service that lists thousands of possibilities.

"Most families wait until spring of senior year, but there are deadline dates distributed throughout the year," Kantrowitz says.

Donna's daughter was fortunate to receive a scholarship from her school worth about $12,000 a year that went a long way toward defraying her annual tuition of more than $30,000.

5. Borrow as needed

If you need to borrow to fund college, opt for loans backed by the federal government because they usually offer lower interest rates and better repayment terms. Private student loans may entice with a lower interest rate initially, but they're usually variable, so they will cost more in the long run, Kantrowitz says.

Donna, despite having sufficient funds in her son's 529, opted to pay two semesters worth of his $24,000 annual tuition with her home equity line of credit because the interest rate of 2.24 percent was so much lower than the 7 percent return from the 529.

Remember this rule of thumb when deciding how much a student should borrow: "Your total educational debt should be less than your expected annual salary in your first job," Kantrowitz says.

Taking on the task

While Donna and Bob had the resources and foresight to save for their children's entire educations, not everyone will prove capable of achieving this. But if you educate yourself on the best options to see your child through college, you may be surprised how much you can help -- even if you didn't start saving from your child's birth.

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