Congratulations. After years of blood, sweat and occasional tears, your child has just entered a dream college -- or any college. Now comes the hard part: paying for it.
It's a good idea to map out how you will pay for various expenses -- for example, with cash, loans or 529 plans -- to maximize financial aid and tax benefits and make sure you have resources to cover four or more years.
The best route for any family will vary depending on income and other circumstances. Here are some things to consider:
-- Financial aid: If your family qualifies for need-based financial aid or comes close, spend assets in the student's name first. This includes trust funds and custodial accounts that name the child as owner and an adult as custodian.
The reason: When calculating how much a family can pay for college, financial aid formulas assess student assets at a much higher rate than parent assets. The sooner you spend down student assets, the greater the chance of getting aid in future years.
If your family will never qualify for need-based aid, it might be worth leaving money in the student's name. At least some of it will be taxed at the student's rate, which is almost certainly lower than the parents' rate.
However, full-time students who are younger than 24 are generally subject to the kiddie tax if their earned income (from a job or self-employment) does not exceed one half of their support. In this case, their unearned income (from investments) that exceeds $1,900 for the year is taxed at their parents' rate. Investment income below $1,900 is taxed at the student's rate. Earned income is always taxed at the student's rate.
-- 529 plans, Coverdell accounts: If a parent opens one of these college-savings accounts and names the child as beneficiary, it is counted as a parent asset in financial aid formulas.
Money in these accounts grows tax free and remains tax free when withdrawn if used to pay qualified school expenses for the beneficiary.
It's usually wise to spend this money before other parental assets. If it is not used for qualified expenses, the parent generally will owe income tax plus a 10 percent penalty on the earnings portion. However, if the beneficiary can't use the money for college, these accounts can be transferred to another family member to use for college.
The argument for spending it later: The longer money stays in the account, the longer earnings accumulate tax free. These accounts can also be used for graduate school, so if the student is likely to attend grad school, consider postponing withdrawals, says Deborah Fox, founder of Fox College Funding.
-- Student loans: Student debt has gotten a bad rap, but "if you need to borrow to get through school, borrow carefully and know that federal student and parent loans are the safest option," says Lauren Asher, president of the Institute for College Access and Success.
The best option, if it is offered, is a subsidized Stafford loan. Payments are not due until six months after the student leaves school and the federal government pays the interest while the student is in school. The rate on loans taken out this academic year is 3.4 percent.
Unsubsidized Stafford loans are next best. The student is responsible for interest from day one, but can defer paying it and add it to the loan balance while in school. Payments begin six months after the student leaves school. The rate is 6.8 percent fixed.
Perkins loans, at 5 percent fixed, are also a good choice, but only available to students with exceptional need.
Mark Kantrowitz, publisher of Finaid.org and Fastweb.com, usually recommends spending 529 assets before taking out unsubsidized Stafford loans. "That way you won't have as much interest being accrued while you are in school." But keep in mind that there are limits on how much you can take out in Stafford loans each year.
For dependent undergrads, the limits range from $5,500 freshman year (no more than $3,500 of which may be subsidized) to $7,500 (no more than $5,500 subsidized) in junior and senior year.
If by senior year you have depleted your 529 plan and have only loans available, $7,500 might not be enough to cover your costs. In that case, it would have been better to use a mix of savings and loans each year.
-- Parent loans: If student loans and savings are not sufficient, the next best option is a federal Plus loan, which are offered to parents and grad students. The rate is 7.9 percent fixed. If you qualify, you can borrow up to the school's cost of attendance, minus other aid received.
Parents can also take out private loans or co-sign one for their children. Most private loans are variable rate -- which heightens the risk. Some lenders offer fixed-rate loans. If your credit is very good, you may qualify for a fixed-rate private loan at less than 7.9 percent, but private loans do not provide the same government protections and repayment options available on Stafford loans, Asher says.
For more on federal loans, see tinyurl.com/cccd2jb.