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

August 27, 1995|KATHY M. KRISTOF | TIMES STAFF WRITER

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.

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