Financing College Understanding College Costs What are you paying for when your child attends college? There are several components to college costs, but for simplicity we'll divide them into three categories: - Tuition. - Room and board. - Everything else. Tuition is an obvious expense at virtually all colleges and universities (with notable exceptions such as the military academies). Tuition costs vary widely. For the 1997-1998 academic year, some 73% of students paid tuition and fees of less than $8,000, according to The College Board. Official tuition and fees were $20,000 or more for only about 6% of students. The highest tuitions are charged by private four-year colleges and universities, which teach about one-quarter of the nation's 14 million students. Their average tuition of $13,700 for the 1997-1998 school year is more than four times the $3,100 average tuition charged by four-year public colleges and universities. The wide disparity between tuition levels arises because, unlike their public counterparts, private institutions can't rely on tax revenues for support. Many students may not be charged full tuition, especially the higher amounts listed by private schools, because colleges sometimes "discount" their published tuition as part of a financial aid offer. After tuition and fees, the next-highest costs are typically for room and board. As you would expect, these costs take up a greater portion of total college costs - about twice as much - for resident students than for commuters. The third broad cost component is everything else - books and supplies, transportation, laundry money, football tickets, pizza, activity fees, and so forth. When all the costs of attending college are added up one year of school in 1997 - 1998 might cost an average of anywhere from about $8,100 to more than $20,000. Private colleges are considerably more expensive than public schools, and resident students pay much more in room and board than commuters. Tack on substantially more if your child is an out-of-state resident at a public school. Trends in College Costs Unfortunately, college costs have been climbing steadily until recently, at an annual rate from 7% to 12%. The good news is that the annual rate of increase has slowed to about 5%. Nevertheless, college costs have been growing faster than both the typical family's income and the rate of inflation. If costs continue to grow at an annual rate of 5%, future college costs quickly assume startling proportions. Moreover, surveys indicate that most people are not saving enough for college and that they also tend to underestimate how much college will cost. One important question arises: Is the time, money, and effort of attending college worthwhile? Yes, when looked at strictly from an earnings point of view. United States Census Bureau data show that college graduates earn an average of 62% more than high school graduates, an income advantage that has increased significantly over the years. More years of school lead to higher incomes, according to U.S. Census Bureau data. The President's Council of Economic Advisers also offers a rough estimate of the worth of a college degree. The result: The return on an "investment" in a college education is between 11% and 13% a year for life. A Response From the Federal Government The affordability of college was high on the agenda during development of the Taxpayer Relief Act of 1997. In the following descriptions of the Act's educational provisions, note that eligibility may depend, for the vast majority of taxpayers, on adjusted gross income (AGI), which is calculated at the bottom of the front page of IRS Form 1040. Tax Credits Two types of tax credits are now available for education - the Hope Scholarship credit and the Lifetime Learning credit. The Hope Scholarship credit is available for each of the first two years of college. The student must attend school at least half time. If there is more than one student in a taxpayer's family, a credit can be claimed for each. The credit equals 100% of the first $1,000 and 50% of the next $1,000 of tuition and fees, for a maximum of $1,500 a year per student. The Lifetime Learning credit is available for up to 20% of qualified tuition and fees (to a maximum of $5,000). The maximum credit, therefore, is $1,000 per year per taxpayer. This credit applies only to expenses paid after June 30, 1998, through the year 2002. After that, the credit equals 20% of up to $10,000 in tuition and fees, for a maximum of $2,000 per taxpayer. The Lifetime Learning credit can be used for undergraduate or graduate courses, as well as courses at an eligible institution in which the student acquires or improves job skills. Note that the Lifetime Learning credit can be claimed only once on each tax return, no matter how many students are in a taxpayer's family, but it can be claimed for an unlimited number of years. Moreover, the minimum half-time requirement of the Hope Scholarship credit does not apply to the Lifetime Learning credit. For both types of credit, the full amount is available for single taxpayers with AGI of $40,000 or less ($80,000 for joint returns). After that, the credit gradually phases out until AGI reaches $50,000 ($100,000 for joint returns). The two credits cannot be taken at the same time for the same student, nor can they be taken in a year in which a distribution is received from an Education IRA. Deduction for Interest on Student Loans Beginning in 1998, deductions will be available for interest on student loans. The deduction is limited to $1,000 in 1998, but it grows to $1,500 in 1999, $2,000 in 2000, and $2,500 in 2001 and later years. The full deduction is available for taxpayers with AGI of $40,000 or less ($60,000 for joint returns) and phases out as AGI increases to $55,000 for individual taxpayers ($75,000 for joint returns). The deduction is available for interest paid in the first 60 months on any student loan. It may be taken even by taxpayers like many recent graduates who do not itemize. The New World of IRAs Other provisions of the Taxpayer Relief Act of 1997 extend the role of individual retirement accounts (IRAs) to encompass education. To encourage people to save, the government allows earnings in an IRA to grow untaxed until the funds are withdrawn. To discourage withdrawals for nonretirement purposes, a 10% penalty tax has been levied in the past (with a few exceptions) if funds were withdrawn before age 59-1/2. The Act changed many of the rules for traditional IRA contributions, which may be either deductible or nondeductible. As of 1998, withdrawals from traditional IRAs may be used without penalty for college expenses, though the withdrawals will still be taxed. The Act also created two new types of IRAs: the Roth IRA and the Education IRA. Withdrawals from a Roth IRA can be used for college expenses penalty-free, though the earnings portion will be taxed. The proceeds from a Roth IRA will be tax-free if the withdrawal occurs after age 59-1/2 and if the account has been opened for at least five years (as well as in certain other circumstances). By contrast, withdrawals from Education IRAs will be both tax-free at any time and penalty-free provided the proceeds are used for higher education.