Finding right strategy to pay your child's college bills

Question: I have established a successful practice, paid off my student loans, and am saving toward retirement. However, I have done nothing to plan for my children's college educations. What can I do now?

Answer: This is an important question atop many parents' minds. According to the College Board, a nonprofit membership organization, the current average cost (tuition, fees, books, room and board) for a four-year state school is $12,800 per year for an in-state resident, and $19,200 for an out-of-state resident. A four-year private school is estimated to cost $27,700 per year.

That means that a college education could cost over $100,000 in today's dollars. Once you factor in inflation, which according to the College Board has been 5% to 8% per year, the price tag could more than double by the time your child enters college.

With this in mind, planning on how to pay for your child's college education can be a daunting task. However, with careful planning it can be an achievable goal.

The strategy you should adopt is primarily dependent upon the age of your child.

If your child is older (fewer than three years away from starting college) you may wish to consider the following options: plan to pay expenses out of current income; shift income to the child through employment; and apply for financial aid and scholarships.

Now that your practice has been established, you should have more flexibility in terms of your monthly cash flow. If you're paying expenses out of current income, consider setting aside a certain dollar amount every month in anticipation of your child entering college. This way, you will get accustomed to not having the extra cash in your checking account.

Further, you will have at least some excess cash built up in case of unanticipated expenses during college, such as last-minute airplane flights home.

Another strategy is to shift income to your child. Before your child enters college, consider hiring your child to work after school or on the weekends at your medical practice to the extent practical. Also, your child could work even while in college during winter and summer breaks. This will be a deductible expense for your business and a strategy to shift income to a lower tax bracket.

Finally, even if you do not believe that you will qualify based upon your income or assets, apply for financial aid anyway. According to the College Board, there is approximately $90 billion available in financial aid. Also, some aid, such as scholarships and some loans, does not require you to demonstrate financial need.

If your child is still young (more than four or five years away from college), you luckily have more options available to you.

The passage of the Economic Growth & Tax Relief Reconciliation Act of 2001 made some college savings vehicles more attractive. Two savings plans in particular are the Coverdell Education Savings Accounts and the 529 College Savings Plans.

In the Coverdell Education Savings Accounts (formerly Education IRA), qualified distributions, including tuition, fees, books, supplies, equipment and certain room and board expenses are tax free. Check the Internal Revenue's Web site (link) for a complete list.

However, there are some drawbacks: the contributions are limited to $2,000 per year; your adjusted gross income must be less than $110,000 single ($220,000 joint) in order to take full advantage of the contribution limits; and the account is considered a student's asset, which negatively impacts financial aid eligibility.

Alternatively, the 529 College Savings Plan provides the same benefit of contributions growing tax free (assuming distributions are qualified) plus more.

There are no income limitations restricting who may contribute to the 529 plan, and high contribution limits apply. You may pay gift taxes on contributions of more than $11,000 per year, but you can donate up to $55,000 at one time and $110,000 if electing gift splitting with your spouse.

Further, the 529 account is considered an asset of the parent and therefore is less likely to negatively impact a child's financial aid than if it were considered the child's asset.

Some drawbacks, however, are that the tax-free status is threatened by the 2011 sunset provision, and expenses on these accounts tend to be higher.

For example, investing in the TIAA-CREF Missouri MOST plan, which is considered to be a low-cost plan, will cost 0.65% in annual expenses. However, if you can purchase the same mutual funds outright through TIAA-CREF, the annual expenses are 0.27% or lower.

There are many 529 College Savings Plans available. Check first with your own state's plan, as there may be state income tax benefits to participating in your resident state's plan.