The Money Class Part 2

Set a seasonal clothing budget. Before you step inside the mall or sit down for some online clothes shopping, give your child a firm dollar amount they can spend. Then have them pull aside everything they want-or put it in the virtual shopping cart-and write down the cost of every item. If you're at the mall, ask the salesperson to put the clothing on a hold rack for a half hour and find a place to grab a drink or snack and talk through the list. Again, this is not a test. Help them decide what they need to let go of to come in at your predetermined budget. This is their first experience with living below your means, but within your needs. If they want more than they need, that's fine. They can either pay for it themselves or you can spell out extra ch.o.r.es and responsibilities they must complete to earn the extra money. If they spend less than the agreed-upon amount, deposit the money they didn't spend into their savings account as a reward.

MONEY LESSONS FOR TEENAGERS HEADING TO COLLEGE.

Between the ages of 16 and 18 is when you should start preparing your children for being out on their own. Your child's high school may not have a personal finance curriculum. That means you must step up and make sure your child has a solid grounding in basic money management before heading off to college. I cannot tell you how many young adults today leave college with thousands of dollars in credit card debt and a lousy credit score because no one ever took the time to teach them how to respect and handle money. To make sure your child emerges from college on solid financial footing requires teaching them what they need to know before they leave high school.

Put them on a monthly payment schedule. This is a natural progression from paying them every two weeks when they are a young teen. Set up a checking account at the bank and give your child a debit card. Every month deposit the money into that account. Do not sign up for an overdraft service tied to another bank account. The idea here is to give your child the opportunity to learn how to handle their money. If at the end of the month they have money left over, that's great. If they run out of money with a week to go, well, that's great too; it's an opportunity to learn money management.

Spell out your spending limits. Before each school year, sit down and agree on what expenses you will continue to cover. Be very specific. If they want to upgrade to a new smartphone or an unlimited data plan, they need to pay you for that cost. If they intend to borrow the car every weekend, discuss their responsibility for making sure they return it to you with the same amount of gas in the tank. If they want more clothes than you have budgeted for, they are going to have to come up with that money. Yes, now is the time to talk about getting a part-time job. Please do not tell me they are too busy with schoolwork or after-school programs. That's the att.i.tude that prevents a teenager from becoming financially responsible.

Give them access to your credit card. If your credit score is at least 700, add your teen to all your cards as an authorized user. Your child will begin to build his or her own credit report by piggybacking on your credit history. You need to add them to all your cards in order for this to work. You don't have to tell them you've done this. I'd recommend you give them a debit card (without overdraft protection) or a prepaid card first; let them get used to using it before you entrust them with a credit card that reports to FICO. (Debit cards and prepaid cards do not report to FICO.) When you feel they're ready, give them one of your cards. Have your child use that card at least once a month to make a purchase for the family. If you are out for a dinner, have them handle the bill; don't forget the need to teach proper tipping. The idea here is to familiarize them with how to handle credit cards. Then you are to review your bill with them each month. The most important lesson here is the information on the statement that shows the interest rate you would owe on any unpaid balance, and how long it would take you to pay off that balance if you made just the minimum payment. There is no better way to teach than to show. And the good news is that all monthly credit card statements now include all that important information. Use it as a teaching tool.

If your credit score is below 700 it does not make sense for your child to piggyback on your card. In that case, I recommend you cosign a secured credit card for your child. You will need to make a deposit to cover the card's charge limit-that's the secured part. I would keep the limit low, say $500 or less. Just make sure that the card you choose has the lowest possible fees and that it reports the card's payment history to at least one of the three main credit bureaus so your child starts to build a credit history.

Beginning in 2010, young adults under the age of 21 cannot be offered a credit card on their own unless they have the proven income to qualify for the card or if they have an adult cosign for the card. My recommendation is that you discuss with your child that you hope they will not try to get their own credit card until they have graduated from college. That's an important four years where you can still help them build a strong score and avoid costly mistakes. Give them a wider berth than in high school; decide what expenses you want them to put on the card while at school and set a monthly credit card limit. This isn't just about keeping them tethered while in college. The goal here is that at age 21 or 22 they already have four years or more of a solid credit history. And that will make their transition into the real world so much easier. If they emerge from college with a solid credit score, it is more likely they will be able to qualify for a credit card that doesn't charge outrageous fees, get their own cell phone plan-yes, it will be time to cut them off of your plan-rent an apartment, and set up their utility service without having to pay any up-front deposits. It can also mean they will qualify for a less expensive car loan and car insurance.

HOW TO HANDLE MONEY GIFTS AND SAVINGS.

Teaching your children the pleasure of saving is going to be one of your hardest tasks. If you force them to save they might grow to resent it. Rather than see the value of saving, they get stuck on how they can't spend the money that is supposedly theirs. It sends all the wrong messages. There are a few approaches to consider to try to ill.u.s.trate for them that, while it is indeed fun to spend money, there is satisfaction to be had, too, in putting money aside for later use: I would first encourage parents-and grandparents-to consider noncash financial gifts as a way to start this education process. I recently had a 13-year-old girl on my show who wanted to spend $8,000 she had received in cash gifts on a Rolex watch. Her family was aghast; they just a.s.sumed she would save that money for her future. You can't a.s.sume anything. And if you give cash with no strings attached, or you have not actively helped your child learn how to spend, and learn the value of saving, well, what do you expect?

I think money gifts such as U.S. savings bonds or a stock purchase of a company they are familiar with is a good way to introduce the concept of investing. At TreasuryDirect.gov you can learn all about Series EE savings bonds, which make a great gift for young children. For stock purchases, open up an account at a discount brokerage and purchase a few shares of stock; each month sit down and review the statement together. That's a great way to start an ongoing conversation about saving and investing.

That said, at the same time you must also help them learn how to handle money. By the time your child is 10 or so I want you to put your child in charge of how to handle any financial gifts. That's right, I said your child is in charge. As I will explain in a moment, you are going to give them a three-option framework to work from, but you must leave the choices to them. This is an opportunity for you to learn too: How good is your child at making the "right" money choices? You need to give them the room to make those choices, and then if you are not comfortable with how they are handling things, that's when your teaching begins. But first you must give them power over their money. I imagine that sounds very odd to you. But think about it. If you don't give them a true stake in the decisions, you likely won't get their full attention; they won't engage in this very important learning process.

THE THREE-OPTION APPROACH.

Sit down with your child and explain that the annual birthday and holiday money they receive is theirs to handle, but that they must tell you with each gift the how and why of what they choose to do with the money. You will frame this conversation by laying out three possible options: - They save it for a future goal.

- They spend it.

- They share some of it by making a charitable donation.

I would refrain from telling them what you think the proper split of the money should be for all three. And hey, if they look at you and say they want to use 100% to spend, well, Mom and Dad, welcome to your uncomfortable truth. You have some parenting to do on the importance of saving and giving. You really need to focus on what's going on here. As I noted earlier, kids don't simply do as you say, they often do as you do. If your child wants to only spend, I encourage you to consider whether your behavior has on some level "taught" them that this is acceptable. Children, of course, pick up many cues from outside the home-they're influenced by their friends, by what they see on television or online or in magazines-but what they experience at home is probably most influential of all. I am asking you to question whether your own spending habits and behaviors might be sending the wrong message. If you don't like what you see and hear as you start to have these conversations, it's time to recognize the signals you have put out for years that may have created this mindset in your child.

Ultimately I hope your child soon gets into a rhythm where she wants to use her money to save, spend, and donate. All these are important. I'd rather see a child spend some of their money than put 100% in savings or give it all away. The goal here is to teach your child how to handle money, and all three options have a place in our lives.

I want to make sure you really understand the importance of giving your child total control of a spending account: If you prevent your child from being able to use some of their money, to touch it-physically-and use it to buy things-yes, wants are okay!-they will just end up resenting the process and probably rebel when they get older by overspending. Help them learn how to spend responsibly-in moderation-today. That will serve them well as adults.

Some tips on each option: * Create an incentive to save Create an incentive to save. There is no question that the delayed gratification of saving for a future goal is hard enough on adults-just look at how many people are not saving enough for their retirement-but you should multiply that difficulty factor by 10 to capture the challenge it is for children. When you suggest to an 8-year-old that he should save money for when he is 18 or 22, you are asking him to set a goal that is longer than he has even been alive! That's not exactly an easy concept to grasp. I think you should encourage your child to set short-term goals. No longer than six months, at the start. That's how you keep your child engaged and enthused. That's how you convey the pleasure of savings.

Offering a matching contribution can help a child stay focused on a long-term goal. Just like with your 401(k), you might agree to chip in 25 cents or 50 cents for every dollar your child agrees to set aside in a savings account for a future goal you are all agreed on. And perhaps you offer an even higher match rate for money they set aside for charitable donations. That's a clear telegraphing of what you value most.

* Spending: Spending: Maybe your child will spend it carefully on treasured items. Maybe it will be thrown away on things that quickly lose their allure. You are not to judge, guide, or control. This is a learning process. We learn as much from our mistakes as our triumphs. Maybe your child will spend it carefully on treasured items. Maybe it will be thrown away on things that quickly lose their allure. You are not to judge, guide, or control. This is a learning process. We learn as much from our mistakes as our triumphs.

* Giving: Giving: Ideally your child is already familiar with the concept of giving; as I explained earlier, from a very young age I encourage you to have your child donate unused toys or outgrown clothes to your local charities; have the children be part of the actual transfer of goods. That tangible experience is how you start the conversation simply by doing. Once you introduce the concept of giving money to charities, help them understand their options. You can offer guidance, you can explain how they can help people close to home or on the other side of the world, but ultimately let your child decide. Ideally your child is already familiar with the concept of giving; as I explained earlier, from a very young age I encourage you to have your child donate unused toys or outgrown clothes to your local charities; have the children be part of the actual transfer of goods. That tangible experience is how you start the conversation simply by doing. Once you introduce the concept of giving money to charities, help them understand their options. You can offer guidance, you can explain how they can help people close to home or on the other side of the world, but ultimately let your child decide.

KEEP A MONEY JOURNAL.

I also encourage you to have your children keep a journal of how they choose to use their money. Every time they put money into a savings account, spend it, or donate it, I want them to record their thoughts and feelings in the moment. Be sure to sit down and review the journal after six months or a year. The journal is a written record of your child building a dream of her own. In it, she is beginning to explore and experience what it means to make a choice to consciously spend less than you have, to take pleasure in saving, as well as to enjoy spending.

When you are reviewing the journal you might also ask your child to reexamine her purchases. For example, if your daughter spent $35 on a video game eight months ago, ask her if she had it to do over again, would she rather have that video game or the $35 in cash. This conversation will lay some important groundwork for future conversations. In the coming months when your daughter is contemplating a purchase, you can ask her if she thinks this will be a purchase she will love or regret six months from now. Don't say it in a judgmental way. Your goal here is to simply guide your child through a thought process, not to impose opinions of your own.

LESSON 3. HOW TO CREATE A FINANCIALLY HONEST COLLEGE STRATEGY HOW TO CREATE A FINANCIALLY HONEST COLLEGE STRATEGY.

College can be one of the best investments you and your child will ever make. The lifetime earnings advantage for a college graduate is about $1 million compared to a high school grad. Moreover, our economy creates more opportunities for college graduates. In late 2010 the unemployment rate among people 25 years or older with a high school degree (and no bachelor's degree) was 10%. The unemployment rate among college graduates was 4.4%.

You will get no argument from me that college matters. But there is a very important truth I need each and every family to stand in: Cost matters. Putting your children through college was a cornerstone of the American Dream, particularly for immigrants and first-generation children. But the New American Dream cannot simply be, I want my children to graduate from college. It must be, I want my child to graduate from a college that is affordable for my child, and for me. The fact is, most families don't stop to think through the cost part. Oh sure, you know full well that it is a lot more expensive than you can afford to pay out of your savings. But that hasn't made you truly cost sensitive. You still tell your kids to set their sights on any school and you will figure out the money later. And then you end up making a mess of your other important dreams. You stop saving for retirement, or worse yet, you use money in your retirement accounts to pay the college bills. That is not standing in your truth. It is inc.u.mbent on you when your children are young to develop a strategy for how as a family you can send your children to college without compromising your other financial goals.

WHO SHOULD SAVE FOR COLLEGE?.

Before you start to save one penny for a child's future college costs, I insist that you have the following financial priorities taken care of: - You do not have credit card debt.

- You have an eight-month emergency savings fund.

- You have a term life insurance policy.

- You are saving for retirement; aiming to set aside 15% of your gross salary.

Until all of that is in place you are not to think about saving for college. Many of you have heard me say this repeatedly over the years: There is financial aid for college. There are loans for college. But there is no aid or loans to help you in retirement. There is no aid if you run into a rough patch and you do not have sufficient funds in an emergency savings account to navigate your way out of trouble.

Your first order of business is building a solid financial foundation for your family. Only when that is in place can you begin to save for college. And know full well that there is absolutely no shame if you are not able to save. As I explain later in this chapter, there are affordable ways for your child to obtain a quality education. Trust me on this one: What your kids really need from you is the peace of mind that you have your own retirement plan in place so they will not be asked to support you later on.

THE BEST WAY TO SAVE FOR COLLEGE: 529 PLANS.

If you have the ability to save for college, the best way to save is by setting aside money in a 529 college savings plan. The two big advantages of a 529 plan are a series of valuable tax breaks and the fact that just a small percentage of a.s.sets (less than 6%) inside your 529 account will be used by college financial aid offices when evaluating your family's request for financial aid.

529 Plan Basics A 529 plan allows anyone, regardless of their income, to contribute money into a special savings account that works much like an individual retirement account. There is no annual limit to what you can set aside; the lifetime savings limit is typically $300,000. You choose the investments for the account, and while the money is invested in the 529 plan there is no tax bill. Withdrawals from the plan that are used to pay for "qualified" school expenses will be tax-free. Depending on the state you live in and the specific plan you choose, you may also be able to claim some of your contribution as a deduction or credit on your state income tax return.

A 529 plan is, in my opinion, a better way to save for school than an UGMA/UTMA, a Coverdell Education Savings Account, or a Roth IRA.

UGMA/UTMA.

These are custodial accounts that adults set up for minor children, as permitted by the Uniform Gifts to Minors and the Uniform Transfers to Minors acts. The child is in fact the "owner" of the account. There are tax benefits to these accounts, but I do not like them for college savings for two important reasons: Once a minor child reaches the age of 1821 (depending on your state), he or she has complete control over the a.s.sets. If your child decides to take the money and head out for a global adventure, you have no legal right to stop her. The other problem is that UGMA and UTMA a.s.sets are treated differently than 529 a.s.sets when a.s.sessing your family's application for financial aid. Less than 6% of a.s.sets held in a 529 plan owned by a parent (for the benefit of a child) are used to compute a family's eligibility for aid. By comparison, 20% of a.s.sets owned by your child-such as an UGMA or UTMA-are factored into the calculation. In other words, money owned by a child will reduce your eligibility for financial aid, or the level of aid your family qualifies for.

COVERDELL EDUCATION SAVINGS ACCOUNT.

There is nothing inherently wrong with a Coverdell (previously known as an Education IRA) but they don't offer any major advantages over a 529. As with a 529, money you invest in a Coverdell grows tax-deferred and withdrawals will be tax-free if used for qualified education expenses. While there is no income test for making contributions to a 529 plan, married couples with income above $220,000 (or $110,000 for single tax filers) are ineligible to contribute to a Coverdell. Moreover, the current annual maximum contribution to a Coverdell-effective through 2012-is just $2,000.

ROTH IRA.

It is absolutely true that a Roth IRA can be an interesting way to pay for college costs. No matter your age, money you originally contribute to a Roth IRA can always be withdrawn without penalty or tax. And if you withdraw any of the money you have contributed before age 59 to pay for college costs, you will not owe the typical 10% early withdrawal penalty, though you will owe income tax on the earnings. (There are special rules for Roth conversion IRAs; see this page this page for details.) for details.) The problem with using a Roth IRA to pay for college costs is that it can compromise your retirement planning. A Roth IRA should not be asked to do double duty: It cannot be a college fund and and a retirement fund. If that's your strategy you and I both know what is going to happen: Because college costs occur before retirement it is likely you will sharply reduce, if not use up entirely, the money in the account, leaving you high and dry for retirement. You need to resolve not to allow your retirement to be derailed by a competing demand that chronologically happens to occur first; chronologically is not how I want you to prioritize. As I explain in the cla.s.s on retirement planning in your 20s and 30s, a Roth IRA is my favorite type of retirement account. I just want you to use it for retirement, first and foremost. Now, that said, if you have set up a Roth IRA with the explicit purpose of using it for college costs, that is a different matter. In that instance using your original contributions to the Roth to pay for school-they are not taxed nor do you owe any early withdrawal penalty-is a fine strategy. Just remember to leave the earnings in the account and use that for your retirement. If you were to make an early withdrawal of earnings from a Roth you might be hit with tax. a retirement fund. If that's your strategy you and I both know what is going to happen: Because college costs occur before retirement it is likely you will sharply reduce, if not use up entirely, the money in the account, leaving you high and dry for retirement. You need to resolve not to allow your retirement to be derailed by a competing demand that chronologically happens to occur first; chronologically is not how I want you to prioritize. As I explain in the cla.s.s on retirement planning in your 20s and 30s, a Roth IRA is my favorite type of retirement account. I just want you to use it for retirement, first and foremost. Now, that said, if you have set up a Roth IRA with the explicit purpose of using it for college costs, that is a different matter. In that instance using your original contributions to the Roth to pay for school-they are not taxed nor do you owe any early withdrawal penalty-is a fine strategy. Just remember to leave the earnings in the account and use that for your retirement. If you were to make an early withdrawal of earnings from a Roth you might be hit with tax.

But please stand in your truth. If you know deep down that the Roth IRA you have is needed first and foremost for your retirement, please do not use it for college.

WHAT IF YOUR CHILD DOESN'T NEED THE 529 MONEY?

There are some important rules you need to understand in the event your child chooses not to go to college or is awarded so much in grants and scholarships that you don't need all the money you have set aside in a 529 plan.

You can transfer the account to another beneficiary. Most 529 plans allow you to switch a beneficiary to another family member, including siblings (and step-siblings), nieces, nephews, first cousins, and in-laws. You could also name yourself the beneficiary and use the money to go back to school.

You can withdraw the money for noneducational purposes. There is no penalty or tax on money you contributed to the account, but if you withdraw earnings from the account and that money is not used for education purposes, it will be subject to income tax as well as a 10% penalty.

HOW TO CHOOSE THE BEST 529 PLAN FOR YOUR FAMILY.

There are two flavors of 529 plans: direct sold and advisor sold. I only want you to consider direct-sold plans. The fees for advisor-sold 529 plans are too high, and often the advisor-sold lineup of investment choices does not include low-cost index funds. If you want the advice of a trusted financial advisor on how to handle your college savings, pay the advisor a separate flat fee for his work rather than have him guide you into expensive advisor-sold 529 funds. If your advisor only uses advisor-sold 529 funds I recommend you find a new advisor who is not dependent on commissions. At NAPFA.org you can search for local advisors who work on an hourly or fee basis. you can search for local advisors who work on an hourly or fee basis.

TIP: I highly recommend every family spend some time at I highly recommend every family spend some time at Savingforcollege.com. It has wonderful articles and tools to help you make an educated decision about the best 529 plan for your family. Here are some important issues to consider: Compare your state plan to an out-of-state plan. Every state offers its own 529 savings plan. But please understand that you are not obligated or required to stick with a plan offered by your state. You can in fact invest in any plan from any state and use your money to attend any school in any state. The sole advantage of sticking with your state's plan is if it offers valuable tax breaks or other incentives to residents. For example, contributions you make to any 529 plan are not eligible for a federal tax deduction. But some states allow in-state residents to claim a state tax deduction or a credit on their contributions. That said, there is often a limit on the value of the tax break, and in some states there is an income cutoff to be eligible for the tax break.

At Savingforcollege.com you can find state-by-state information on the tax treatment for in-state residents. This is obviously an important consideration when choosing a 529 plan, but it should not be your only consideration. It makes absolutely no sense to sign up for an in-state plan that has high fees and expensive mutual funds. It can make more sense to pa.s.s up the tax breaks and choose a plan offered by another state that has lower fees and better investment choices. you can find state-by-state information on the tax treatment for in-state residents. This is obviously an important consideration when choosing a 529 plan, but it should not be your only consideration. It makes absolutely no sense to sign up for an in-state plan that has high fees and expensive mutual funds. It can make more sense to pa.s.s up the tax breaks and choose a plan offered by another state that has lower fees and better investment choices.

Focus on fees. Similar to how a 401(k) works, when you contribute to a 529 plan you will choose from a menu of investment options. Typically these are mutual funds. Every mutual fund has an embedded annual fee called the expense ratio. This can be as little as 0.20% or so, or it can be 1.5% or more. The more you pay in fees the less your money will go toward paying for college. Before you sign up for a 529 plan make sure it offers mutual funds with annual expense ratios below 1%, and the lower the better.

Check for conservative investment choices. As I explain below, by the time your child is a senior in high school you will want to have the bulk of your account in conservative investments; it is too risky to have your money invested in stocks when you know you will need that money in one to five years. Not all 529 plans offer a money market or certificate of deposit (CD) option. Please stick with a plan that gives you the option of pulling out of stocks as your child nears college age.

Understand beneficiary transfer rules. If you have more than one child and you antic.i.p.ate you may want to transfer the beneficiary from one child to another, make sure your plan allows this move.

HOW TO INVEST YOUR 529 PLAN.

Many parents with children in high school learned a very painful lesson during the 2008 financial crisis when their 529 accounts lost 30% or more because so much of their account was still invested in stocks. Given that they had just a year or two before they would need to start tapping their funds to pay the college bills, they should never have left so much in volatile stocks. And what was most alarming was that many of these parents had left it to the plan to make the decision about how much to have in stocks versus bonds and other conservative investments. A popular feature of many 529 plans is an age-based fund that leaves it to the plan sponsor to alter the mix of stocks and bonds based on the child's age. This works just like a target retirement fund; the idea is that as the child gets closer to college, the portfolio will become more conservative. In fact that's how many plans work, but not all. The bottom line is that you cannot blindly rely on anyone to make your investment choices for you. You are responsible for making sure your money is invested in a way that makes sense for you.

If you investigate an age-based fund within a 529 and are comfortable with how it ratchets down your stock allocation as your child progresses through high school, then that is fine. But please make an informed choice. You can always build your own portfolio by choosing from among the other investment choices offered within the 529 plan.

Here is my suggested allocation: - Under age 14: 80100% stock mutual funds 80100% stock mutual funds - Age 14: 75% stock funds 75% stock funds - Age 15: 50% stock funds 50% stock funds - Age 16: 25% stock funds 25% stock funds - Age 17: 0% stock funds 0% stock funds TIP: One absurd restriction imposed on 529 investors is that you are only allowed to change your a.s.set allocation once a year. Please be aware of this rule and make sure you complete all your rebalancing at one time. One absurd restriction imposed on 529 investors is that you are only allowed to change your a.s.set allocation once a year. Please be aware of this rule and make sure you complete all your rebalancing at one time.

If you do not choose the age-based all-in-one fund offered within the 529 (on this page this page I explain why I do not like these all-in-one funds), then the advice on investing your 529 echoes the advice in the retirement chapters: The bulk of your stock allocation-I recommend 85%-belongs in large U.S. blue-chip firms. If you see a fund with the words "S&P 500 index," that is a good choice. Or any fund that is described as investing mostly in "large cap" stocks. The remainder of your stock allocation can be invested in an international stock fund or ETFs. We live in a global economy; while your U.S. blue chips typically derive plenty of their business from foreign markets, it's also smart to have a small portion of your stock portfolio directly invested in an international fund. I explain why I do not like these all-in-one funds), then the advice on investing your 529 echoes the advice in the retirement chapters: The bulk of your stock allocation-I recommend 85%-belongs in large U.S. blue-chip firms. If you see a fund with the words "S&P 500 index," that is a good choice. Or any fund that is described as investing mostly in "large cap" stocks. The remainder of your stock allocation can be invested in an international stock fund or ETFs. We live in a global economy; while your U.S. blue chips typically derive plenty of their business from foreign markets, it's also smart to have a small portion of your stock portfolio directly invested in an international fund.

For the portion of your portfolio not invested in stock funds, I recommend you stick with the cash or CD option within your 529. As I explain in the Retirement Cla.s.ses, I have never liked bond funds. And with my expectation that in the coming years interest rates will rise from their current historic lows, bond funds will face especially rough headwinds.

THE COLLEGE TALK EVERY PARENT MUST HAVE WITH A HIGH SCHOOL FRESHMAN.

As a family you need to start talking about college finances no later than freshman year in high school and begin to map out a strategy that will make college affordable.

Explain what you expect to be able to contribute to annual costs. Your child deserves to understand exactly what, if anything, you will be able to contribute to his four years of college costs. Waiting until senior year to spring the news that you have little or nothing is unfair. By having the conversation earlier you give your child the opportunity to plan.

Put a financial safety school on your list. Guidance counselors are quick to talk about applying to at least one school your child will easily be accepted into. I would take this strategy one step further and make sure you have a financial safety school: Plan on applying to a public in-state school that you know will be affordable. A public four-year school can cost one-half to one-third what it costs to attend a private four-year college. If your child qualifies for a generous financial aid package at a private school, that's great. But the idea here is that in the event the aid package at an expensive school isn't generous enough, you will have an affordable option to fall back on.

Strive to make the most of high school. Once you explain your financial situation to a high school freshman or soph.o.m.ore you give them even more incentive to do well in school. Every A they receive now can help them qualify for financial aid. Advanced Placement cla.s.ses can also help all of you save on college costs: Many colleges will waive some basic required courses for students who score well on the AP test.

TIP: Mark Kantrowitz, the wizard behind Mark Kantrowitz, the wizard behind FinAid.org, also has the inside scoop on winning scholarships to offset tuition costs. If you have a child in high school, I would recommend you take a look at his new book, Secrets to Winning a Scholarship Secrets to Winning a Scholarship. The price is under $10 because Mark wants it to be available to everyone, including low-income families who could benefit the most. I approve!

Start the loan conversation. In the next lesson I will explain the best ways to borrow for college. One of the hardest steps in this process is for you and your child to limit what you borrow for school. Just because someone will loan you $40,000 a year-and yes, you can borrow that much or more-does not mean you should. As a family you must stand in the truth that the goal is for your child to emerge from college without anyone in the family being saddled with so much debt that they will not be able to reach their other financial dreams.

BORROWING RULES FOR COLLEGE LOANS.

As I stated at the beginning of this lesson, college is a smart investment. And I absolutely believe that college loans are "good debt." But too much of a good thing can become a bad thing. You and your children need to borrow wisely. One of the problems with the college loan system is that there are not any checks and balances to prevent you from borrowing more than you can afford. That just makes it all the more important for your entire family to stand in the truth-together-and create a borrowing plan that will allow both student and parent to easily handle the eventual payback of the loans. You need to understand that college debt, whether it is taken out by the student or the parent, is currently not eligible to be discharged in the event you file for bankruptcy. It literally stays with you forever. See what I mean: You need to really be careful in how you borrow for school, and how much you borrow.

Most families will qualify for some amount of need-based financial aid. You can get an estimate of what your family might qualify for here: http://bit.ly/a6VEJ. We all know that it is rare that your child will get a complete "free ride." So your family will need to cover the portion of the bill that exceeds your aid. You can of course use your current income, as well as tapping any college savings funds, such as a 529. But it is also likely you will need to take out loans as well.

This is how you are to approach the loan part of the college financing puzzle: - Student borrows first using a federal Stafford loan.

- Parent considers borrowing using a federal PLUS loan.

- Neither student nor parent uses a private loan Please follow this strategy closely. Federal loans are the only loans you should ever take out. They charge reasonable fixed interest rates, and borrowers have a few different repayment plans to choose from, including plans that will allow you to defer, delay, or reduce your payments if you lose your job or experience financial hardship.

The Risks of Private Loans for CollegePrivate loans offered through banks typically charge a variable interest rate. The starting rate is often higher than the fixed rate on federal loans. And listen to me here: General interest rates in the coming years are likely to move higher. When that happens, the interest rate charged on private student loans will also rise. That alone is enough reason to steer clear of private loans. But there's another reason why I want you to stay away: If you fall into financial trouble once you are in repayment, private lenders have no obligation to help you out with a different payment schedule. What is most galling is that in the event a private loan borrower dies, the debt may still be owed. With federal loans, the debt is forgiven in the event the borrower dies or becomes permanently disabled.My opinion is that private student loans should never be used. Period. If that means your child needs to consider a less expensive school, then that is the truth your family needs to stand in, united as one.Alert: What to Do If You Already Have a Private LoanIf you already have a private college loan or you have cosigned for someone who has taken one out, I insist that you take out a term life insurance policy that can cover 125% of the current loan amount. As I just mentioned, in the event someone with a private college loan dies, the loan may not die. It is up to the lender to decide if it will still demand repayment. By purchasing a term life insurance policy, your family-or your cosigners-could use the death benefit on the policy to repay the loan. This is an incredibly cheap way to protect your loved ones. The term policy should be for a minimum of 10 years after the student is scheduled to graduate. Given that many borrowers need even longer to repay their college loans, I would recommend you consider a 15-year or 20-year policy. I also recommend that the amount of your policy be 25% or more than what you currently expect the loan's expected total cost to be. Why? In order to provide some insulation from rising interest rates-remember the private loan is a variable rate-and the fees that the banking industry is expert at finding reasons to charge you. So for example, let's say you have private loans that you expect will end up costing you $50,000 to repay. I would consider a 20-year level term life insurance policy with a death benefit of $62,000 or so. For a 20-year-old male in good health that policy might cost $10 to $12 a month. That's it. Less than $150 a year to protect your loved ones from having to finish paying off your private student loan. And purchasing term life insurance is really simple. You can learn more at the websites of term insurance specialists SelectQuote.com and and AccuQuote.com.

HOW TO BORROW FOR SCHOOL.

When your child applies to college you should complete the Free Application for Federal Student Aid (FAFSA) form. Schools require the FAFSA form to determine your family's eligibility for financial aid. It is unlikely that grants and scholarschips will cover all your costs. If you can't make up the difference out of your current income or savings, your next move will be to take out loans. Families that meet a low-income test may be able to borrow up to $5,500 a year at a fixed interest rate of 5% through a federal Perkins loan; every school administers Perkins.

Student Borrows First: Stafford Loans Your child is to borrow for school before you take out a loan. The federal Stafford loan program is hands down the best college financing deal out there that is available to everyone, regardless of need.

There are in fact two types of Stafford loans: subsidized and unsubsidized.

A subsidized Stafford loan is based on financial need. For the school year that ends in July 2011 the fixed interest rate on a subsidized Stafford is 4.5%. For the 20112012 school year the fixed interest rate will be 3.4%. The interest rate for loans taken out in the 20122013 school year will be at a fixed interest rate of 6.8% and under current law will remain at that level in subsequent years. The government pays the interest on subsidized Stafford loans while the student is in school and during a six-month grace period after the student graduates (or leaves school). Once the student begins repayment he or she is responsible for the interest payments. is based on financial need. For the school year that ends in July 2011 the fixed interest rate on a subsidized Stafford is 4.5%. For the 20112012 school year the fixed interest rate will be 3.4%. The interest rate for loans taken out in the 20122013 school year will be at a fixed interest rate of 6.8% and under current law will remain at that level in subsequent years. The government pays the interest on subsidized Stafford loans while the student is in school and during a six-month grace period after the student graduates (or leaves school). Once the student begins repayment he or she is responsible for the interest payments.

An unsubsidized Stafford loan is available to all students regardless of financial need. The fixed interest rate is 6.8%, and the student is responsible for paying the interest while in school, or the interest can be added to the loan balance. My recommendation is to try to pay that interest while you are in school; a part-time job or maybe some help from mom, dad, or grandparents will help keep the loan balance lower so when repayment begins within six months of leaving school you will have a smaller balance to pay off. At is available to all students regardless of financial need. The fixed interest rate is 6.8%, and the student is responsible for paying the interest while in school, or the interest can be added to the loan balance. My recommendation is to try to pay that interest while you are in school; a part-time job or maybe some help from mom, dad, or grandparents will help keep the loan balance lower so when repayment begins within six months of leaving school you will have a smaller balance to pay off. At www.direct.ed.gov/student.html you can find more information about Stafford loans, including calculators to help you estimate what your payments may be based on a few different plan options. you can find more information about Stafford loans, including calculators to help you estimate what your payments may be based on a few different plan options.

STAFFORD LOAN LIMITS.

For the 20112012 year the student can borrow the following amounts based on their year of school:

MAXIMUM STAFFORD LOAN LIMIT MAXIMUM STAFFORD LOAN LIMIT.

Freshman $5,500 (no more than $3,500 may be subsidized) $5,500 (no more than $3,500 may be subsidized) Soph.o.m.ore $6,500 (no more than $4,500 may be subsidized) $6,500 (no more than $4,500 may be subsidized) Junior $7,500 (no more than $5,500 may be subsidized) $7,500 (no more than $5,500 may be subsidized) Senior $7,500 (no more than $5,500 may be subsidized) $7,500 (no more than $5,500 may be subsidized)

I am fine with every student borrowing these maximum amounts. Graduating with a total of $27,000 in debt is not an amount that will bury you. A good rule of thumb is to keep your borrowing below what you expect your annual starting salary may be at your first job. a.s.suming the student has picked a field that pays a starting salary of $30,000 or more, paying back the Staffords is realistic.

Go to The Cla.s.sroom at www.suzeorman.com:Find guidance on my website about what factors to consider when determining how much young adults can honestly afford to borrow for college.

Parents Borrow Next: PLUS Loans If the financial aid package and Stafford loans are not enough to cover the cost of school, your family's next step is to consider the federal loan program for parents of college students: the PLUS program.

I think the federal PLUS loan program is terrific. It charges a reasonable fixed interest rate of 7.9%. There is also a 4% fee on the initial amount of the loan. Like Staffords, the PLUS program offers a few different repayment schedules based on your financial needs. Most important, if the parent dies or is permanently disabled, the loan is forgiven.

That said, not every parent should take out PLUS loans to help pay for college. In my opinion, you should meet the following standards: - You pay off your credit card each month, in full.

- You have an eight-month emergency fund.

- You are on track with your retirement savings.

Please stand in the truth here: If you have not taken care of those financial priorities you are not in a position to borrow for a child's college costs. Your financial security is not yet firmly in place. Borrowing more at this juncture would just put you further away from reaching those more pressing financial goals.