You probably already know that college is expensive—and it is getting more expensive all the time. The cost of four years at a top private school is nearly as much as the price of an average house.1 Unfortunately, there are no 30-year mortgages to finance the cost of your children’s education.

There is plenty you can do, however, to make sure that your children get the best possible education. Here are some guidelines, based on the age of your children.

For children under 14

1. Start putting money aside now! The earlier you start, the greater the potential for long-term growth.

2. Investigate Section 529 plans. These plans allow tax-free growth of your college savings and federal tax-free withdrawal of the proceeds for qualified educational expenses when your children enter college.2,3 Some states also allow tax deductions for a limited amount of contributions by in-state residents and tax-free qualified withdrawals.

3. In addition to Section 529 Plans, you can also put the maximum annual amount ($2000 per child) into a Coverdell Education Savings Account if your income meets eligibility requirements. Like 529 Plans, earnings may be distributed tax-free if used for educational expenses.3 In addition, Coverdell Accounts may be used for pre-college educational expenses, such as elementary or secondary educational costs.

4. Direct your investments in an age appropriate manner, whether you are investing in a 529 Plan, Coverdell Account, or other investment. You will need to determine an appropriate mix of assets in your college accounts based on your time horizon and risk tolerance. As a rule of thumb, the further your children are from college, the more aggressive your investments can be. Because stocks are subject to relatively wide price swings and lots of day-to-day volatility, it may be advisable to switch to less volatile investments, such as bonds, as your children get nearer to college age. Many 529 Plans offer a choice of investments, including funds that automatically change the asset mix as your child gets closer to college age. If you direct your investments, under federal law you are permitted to re-allocate Section 529 Plan investments once a year.

5. After other options have been exhausted, investigate variable annuities. Variable annuities offer tax-deferred growth potential and often have a wide range of investment options. Withdrawals are taxable, regardless of what they are used for and when they are taken. Withdrawals are also generally subject to a surrender charge in the contract’s early years. There is also a 10 percent penalty tax imposed on the taxable portion of withdrawals if taken before age 59 ½. Annuities have limitations and also contain an expense structure that may be higher than other college funding options.

For children nearing college age

1. Before investing in an account in the child’s name, you should be aware that colleges expect the student to contribute approximately 35 percent of his or her assets to pay for college costs, while the percentage expected of the parent is far lower (less than 5.5 percent). If you’ve put assets into an account in the child’s name, you may increase the amount that the college expects the child to pay and reduce your child’s chance of receiving financial aid. Section 529 accounts are not affected, because they are considered parental assets.

2. Investigate federal tax credits, including the Lifetime Learning Credit and the Hope Scholarship Credit. There are income limitations on these credits, so speak to a tax advisor to determine if you qualify.

3. Look into financial aid, even if your income seems too high. No matter what your income, do not assume your child is ineligible for financial aid. In addition to need-based aid, some colleges offer scholarships to outstanding students, regardless of need. In addition, there are private scholarships, sponsored by employers, clubs and religious groups. Most high school guidance counselors have access to databases that can give you a full listing. The financial aid office at the college may also put together a package based on the programs for which your children are eligible, including grants, loans and work/study programs.

4. Borrow as inexpensively as possible. There are numerous federal and state loan programs that charge below market rate interest to qualified college borrowers. Other lower-cost sources of loans for college expenses include home equity loans, loans against your 401(k) plan, and policy loans on cash value life insurance.

Paying for college is not easy, but planning is the key to making it happen. Taking the time to plan now is the first step toward making sure your children get the education they deserve.

1 A student entering Stanford University in 2003–2004 will pay $39,127 for tuition, room and board, according to 2004 data by the College Board (www.collegeboard.com). Even without taking account of rising costs over four years, the total bill would exceed $156,000. The median sales price of an existing house in the U.S. was $176,000, according to 2004 data published by the National Association of Realtors.
2 Under “sunset” provisions, current Section 529 tax rules are scheduled to expire on December 31, 2010, unless renewed by Congress. Before 2001, these plans generally provided tax deferral, not tax-free college savings.
3With both Section 529 Plans and Coverdell Education Savings Accounts, you can withdraw money for any reason, although you will pay taxes and may also be subject to a 10% federal tax penalty if withdrawals are made for non-educational reasons.