When the College Savings Plan Falls Short

Updated on July 10, 2007.

IN AN IDEAL WORLD, parents would start socking away money for their children's college educations even before they're toilet-trained. But with college costs soaring, even the early birds can fall woefully short when it comes time to write the checks.

Don't panic. Even if your child has already begun to apply to schools, there's still time to find the extra funds needed to pay the tab. But be warned: If you're one of those generous parents who insists on funding your kids' entire education, you might need to make a real sacrifice.

Here are some last-minute tips to help ease the pain.

Financial Aid
Not everyone is eligible for financial aid, but everyone should apply. The key, naturally, is to present your assets in the most advantageous manner. Schools expect parents to contribute up to 5.6% of their assets toward a child's tuition. So instead of leaving money in a savings or investment account, put that money to better use. Consider paying off all high-interest consumer debt, such as credit-card balances. And make sure to max out your 401(k) and IRA. As a general rule, financial-aid officers don't expect parents to cash out their retirement accounts to pay for their kid's education. For more on financial aid, read our story.

Borrowing
The quickest way to raise funds is to borrow. Just keep in mind that all loans aren't created equal. Some have higher interest rates; others have inflexible payment schedules. So make sure you find one that suits your needs.

Steven Kaye, a certified financial planner based in Watchung, N.J., recommends that financially strapped parents first consider using the equity in their homes. A home-equity loan or line of credit not only offers a low interest rate these days, but also a tax deduction for the interest payments on the first $100,000. (For more on home-equity products, read our story.)

As a second choice, Kaye recommends that parents borrow from the government-sponsored Plus Loan program. Under this program, parents can borrow up to the full amount of their child's tuition, at rates that are lower than traditional consumer loans. You might also be able to deduct a small portion (up to $2,500) of your interest payments, provided your income doesn't exceed the phase-out level of between $55,001 and $70,000 for single filers and $110,001 and $140,000 for married couples filing jointly. There's one drawback: You'll need to start making interest and principal payments right away on your loan. Our story explains just how Plus Loans work.

As a last resort, parents can dip into their retirement savings. Many companies allow employees to take out loans against their 401(k)s for education purposes. Under such programs, you generally have five years to repay the money, plus interest. (Many companies will limit your loan to 50% of the vested portion of the account.) If, however, you leave your job for any reason, you'll have 30 days to pay off the remaining balance of the loan or face paying income taxes and a 10% penalty on the entire amount borrowed.

Keep Working
Now, a bit about that sacrifice we mentioned earlier. If you borrow money to fund your child's college education, you'll obviously have to pay it back. Short of an inheritance, many people find the only solution is to keep working past age 65, says Stewart Welch, a certified financial planner and author of "The 10 Minute Guide to Personal Finance for Newlyweds." By remaining in the work force for, say, another five years, you'll not only earn money that can go toward that loan, but you'll also have fewer years of retirement to save for. (Talk about looking at the bright side.)

Downsize
Do you really need a big house now that the kids are off at school? One way to raise cash is to sell your home and downsize into a condo. Not only are capital gains on personal real estate tax free up to $500,000 for couples and $250,000 for singles (with certain restrictions), but your overall expenses are likely to shrink as you spend less on maintenance, insurance and utilities. "It can have a ripple effect," says Welch. Just make sure you buy a pull-out couch for when Junior comes home to visit.

Ask for a Handout
If you really can't afford to borrow the money, you might need to ask relatives for help. If you turn to your parents, think of it as an advanced inheritance. Provided that the check is made out directly to the school — and not put into, say, a 529 plan — that money isn't considered a taxable gift.

If you feel uncomfortable asking mom and dad, consider proposing a loan with a better interest rate than what they're getting on cash sitting in a money market or CD. "Older people are looking for ways to increase their returns but don't want to put their money in the stock market," says Robert Tull, a certified financial planner based in Chesapeake, Va.

Finally, make sure you don't borrow any money that's going to put your own retirement in jeopardy. In other words, don't let your short-term goal make you lose sight of your longer-term needs, says Kaye. And remember, it's OK to ask your child to pitch in and take out some loans of his own. By sharing the responsibility, there's a greater chance he'll spend more of his time hitting the books and less time at the fraternity kegger.