NEW YORK — None of the young Michigan couple's four children is older than 6, but the college their parents hope that they will attend someday already has collected their college tuition in full.
For the $30,000 the couple borrowed against the equity in their home, Hope College in Holland, Mich., guarantees four years of college for each of the toddlers--assuming that they can meet the admission requirements when they're old enough to enroll. Four years of college for four students at Hope already costs about $136,000.
Parents searching for affordable ways to finance their children's college education in an environment of soaring educational costs and dwindling tax benefits have been forced to become more creative. So they are borrowing against the equity in their homes, buying growth stocks, investing in savings bonds and zero-coupon municipal bonds and even--as the Hope College case illustrates--giving money to schools many years in advance in hopes of forestalling further tuition increases.
Although advisers say these options are the best still available to parents now that tax reform has undermined the usefulness of the most popular college-savings schemes, none is a panacea.
Investment advisers only recommend prepaid college tuition plans, for example, to the very conservative investor: Parents or grandparents who don't want to hassle with watching over their investment and who fear falling short of the actual schooling expenses if they don't take advantage of the prepaid tuition plans now. Both Duquesne University in Pittsburgh and Hope say their tuition futures participants overwhelmingly are grandparents and parents with newborns.
"We admit that it's a little bit of a gamble on both sides," said John Fedele, a spokesman for Duquesne, believed to offer the first tuition futures program in the country.
If tuition costs rise faster than the school predicts or if the college's investment of the prepayment falls short of expectations, the college suffers. And if the child fails to make the grade, selects another school or doesn't want to go to college at all, the parents may not get all of their money back and, at best, must forfeit the interest on their investment.
Amassing such a large up-front sum poses another problem for parents who choose this route, as does the uncertainty over whether the Internal Revenue Service will start taxing the income earned by the prepaid tuition contributions.
The state of Michigan, which is designing an umbrella tuition futures program under which parents could pay for four years of schooling at any Michigan college or university for as little as $4,000, has asked the IRS for a ruling on the taxation question and hopes to get a response soon. Also awaiting the outcome of the ruling are Indiana, Tennessee, Maine and Florida, all of which have plans on the drawing board, and Wyoming, the first state to offer a statewide prepaid tuition program.
Tax considerations have always been important for parents trying to salt away money to put their children through college. The less one has to fork over to the IRS, the more that goes toward the student's education and the faster compounded interest accumulates.
But with the advent of tax reform, financial advisers say parents are spending more time than ever before searching for tax-advantaged vehicles for college savings. That is because the investment earnings of children under age 14 now are taxed at the parents' rate instead of at the child's lower rate. Also, one of the most popular ways for parents with foresight to save for college many years in advance--the Clifford Trust--was undermined by tax reformers.
A Clifford Trust permitted parents to put income-producing assets into a trust fund for their children, pay little or no taxes on the income that accumulated because the tax was figured at the child's low tax rate, give the income to the children for college and take back the assets for themselves when the trust ended at least 10 years and a day later.
Parents can still set up such trusts. But these are no longer attractive as tax-advantaged vehicles for college savings because the income now is taxed at the parents' higher rate.
As a surrogate, financial advisers were steering parents toward growth stocks that pay no dividends because the increase in the stocks' value wasn't taxable until the shares were sold. Hence, parents could save money for college tax-free by keeping the stock at least until the child turned 14--at which point earnings on cashed-in stock are taxed at the child's rate.
But in the aftermath of the Oct. 19 stock market crash, some advisers are steering clear of stocks, favoring instead variable life insurance policies--which provide money for college tax-free as long as the policy is in force--tax-free municipal bonds or tax-deferred savings bonds for parents who have many years to save before their children head off to college.