Taking the sting out of saving for college.

Birse Timmons Jr., 31, and his wife, Leslie, 28, began saving for their daughter Rachel's college education when she was barely a year old. Now, two years later, the Waterford, Conn., couple has stashed away $3,000 in savings bonds and another $500 in a savings account. Birse, a software engineer, also pays at least $25 a month to an investment club, the fruits of which are also earmarked for Rachel's education.

But like most young families, the Timmonses have plenty of other demands on their budget: They're shopping for a house and have tuition bills for Leslie, a dietitian's assistant studying to become a registered dietitian. With a household income of $75,000, the couple hopes that Rachel will be able to attend the college of her choice. Still, says Birse, "I worry whether I'll ever be able to save enough."

If their fears sound familiar, it's for good reason. Over the decade, the average annual tuition for a four-year private college has more than doubled and will reach an estimated $18,423 next year, according to the American Council on Education in Washington, D.C. Costs for public schools have soared as well--84% over the same period--spiking average tuition for a state college to $8,477. Long-term projections are even scarier. Assuming college tuition and fees grow 6% a year over the next 10 years, four years at a moderately priced private school, such as Atlanta's Spelman College, will cost about $100,000 in 2003. As for Yale? Be prepared for a tab nearly $200,000.

But experts say careful financial planning can take some of the sting out of rising college costs--particularly for people who start early. "Time is your best ally in any planning process," says Philip Johnson, a certified financial planner in Clifton Park, N.Y. "The important thing is to make a commitment and begin saving regularly for your kids' education."

Start Saving Now

"The most common mistake people make is waiting too long," says Gerald Krefetz, author of Paying for College: A Guide for Parents (The College Board, New York, $14). "You can't save for a kid's college education in the last two years of high school. You must start when the child is born."

Consider this: If you save just $21 a month from the time your child is born, you'd have about $10,000, assuming 8% interest, by the time he or she is ready for college. But if you put off saving until the child is 12, you'd have to save $109 a month to reach $10,000.

Of course, you'll need a lot more than $10,000. How much more? The answer varies dramatically, depending on what school your child will attend, how fast college costs continue to grow and whether your child is eligible for financial aid. Our accompanying chart shows how much parents should save for newborns through age 15 on a monthly basis.

The figures in the chart may seem high, but don't let them turn you off to saving altogether. "It's okay to save modestly at the beginning," says Johnson. Although many planners cite the 10% rule--putting away 10% of your gross income--Johnson encourages clients to save "an amount that won't cause you undue pain." As your financial position strengthens--with new jobs, promotions, etc.--plan to boost the sum you save.

Try to get other family members involved, too. Paying for college these days is often an extended family affair, notes Melody Kollath, a certified financial planner in Littleton, Colo. Encourage grandparents and other relatives to give savings bonds. Opening a separate account in the child's name gets them into the swing of saving, too, although most savings should be in the parents' name (more on this later). As an incentive, offer to match what they save from odd jobs or allowances.

Building A College Portfolio

Once you start saving, avoid the second most common mistake: putting your money in the wrong place. To keep up with rising costs, you'll need a diversified portfolio, with a sizable stake in stocks and/or mutual funds. "People tend not to take enough risk with their money," says Krefetz, noting that "a savings account or CD won't get them where they want to be."

That's why the Timmonses plan to roll Rachel's college savings account into a high-growth mutual fund as soon as the balance reaches $1,000. And Birse is hoping that the expertise he's gaining in his investment club will give him the confidence, and the funds, to allow him to invest more on his own. "It's early in the game, so we can afford to gamble a little," he says.

He's right. If your child is 10 or more years away from college, you can't afford not to shoulder a considerable amount of risk, warn the experts. Keep in mind, each year your money will need to grow an average of 7% or better just to keep up with inflation and rising tuition costs.

For the best chance at such gains, consider investing up to two-thirds of your savings in stock mutual funds. Why funds? Because they satisfy three key principles of investing for college: Funds allow investors to make regular, monthly, equal payments (known as dollar-cost averaging); provide the advantage of professional money management; and most importantly, they allow you to diversify cheaply (see "Picking the Top Performers," April 1993). Parents with $1,000 might want to start out with a single fund; those with more cash, say $5,000 to $10,000, should tap into at leat two or three different funds.

To minimize the tax bite, look for solid growth funds that emphasize capital appreciation over income. Within a 10-year investment horizon, "income is secondary," says financial planner Johnson. "You want a good strong growth vehicle that isn't going to throw off a lot of [taxable] dividends and capital gains." Three winning growth funds that he recommends: AIM Weingarten (800-347-1919); Calvert Ariel Appreciation (800-638-6731); and Fidelity Growth (800-544-8888). Each has returned at least in the double digits in the past three to five years.

Consider stashing the rest of your college portfolio in safer, fixed-income instruments, such as zero-coupon bonds or Series EE U.S. savings bonds.

Series EE savings bonds have long been a favorite college investing tool. And indeed, they have merits. Interest earned on bonds issued after Dec. 31, 1989, can be federally tax-free if the money is used to pay for college costs.

Still, financial planner Kollath advises limiting the savings bond portion of your portfolio to less than 25%, since interest rates--and hence bond yields--are expected to stay low. (Last February, the minimum interest rate on Series EE bonds dipped from 6% to 4%.) The other large caveat: When parents cash in these bonds, it adds to their adjusted gross income (AGI) at tax time. The bonds may end up being fully taxable, depending on the amount.

If you reach retirement age while your child is in college, consider stashing education savings in voluntary retirement plans, such as your 401(k)s, IRAs and tax-deferred annuities. Interest is tax-deferred, and you can withdraw the money without penalty as long as you're over 59 1/2. Younger parents may want to consider borrowing against retirement accounts.

A college blueprint, like any financial plan, must evolve over time. Parents may want to review their situation with a financial planner (see "How to Choose the Right Financial Planner for You," April 1993). As a general rule, parents should reduce their college portfolio's risk level two or three years before the child starts school.

How rapidly you do this depends on how much risk you feel comfortable with. Start putting any new savings into CDs or other conservative investments two or three years before your child starts college, Kollath suggests. The following year, if the market is up, begin cashing out of your mutual funds. If the market is down, leave your money in for another year.

Before you cash in any investments, discuss the pros and cons of transferring them to your child's name with a financial adviser. If the child is over 14, opening an account under the Uniform Gift to Minors Act (UGMA) may make good sense. All investment income in such an account, including interest and dividends, is taxed at the child's rate, which--unless the kid has his own television sitcom--will be at a lower rate than the parents'. However, once they transfer the funds, parents can't do a thing if their kid blows the money on a Porsche; kids gain control of the UGMA account at age 18 or 21, depending on the state.

Furthermore, savings in the child's name can reduce eligibility for financial aid. The federal formula for determining "financial need" weighs students' assets more heavily than their parents'. "If the family might get financial aid in the future, I strongly recommend saving in the parents' name," says Kollath.

Winning The Financial Aid Game

Even before your child's freshman year in high school, you should begin thinking about financial aid. This involves two things: 1) making sure your child has the strong grades and extracurricular activities that colleges and scholarship donors crave; and 2) researching the many forms of available financial aid.

Financial aid comes from a variety of sources, including the federal and state governments, colleges, and private groups and associations. Aid may be awarded in the form of grants, which you don't have to pay back, or loans, which students must repay over time, usually at favorable interest rates.

Most financial aid is based on need--but not all. Colleges, for example, may sweeten the financial aid package to attract a student with unusual talents or one from an underrepresented geographic area or ethnic group. Also, many private scholarships are awarded on the basis of academic merit. (See our tips on "How to Get Scholarship Aid.")

With the reauthorization of the Higher Education Act last year, all parents, regardless of income, can borrow what they need to make up the difference between savings, financial aid and actual tuition costs, thanks to the Parent Loan to Undergraduate Students (PLUS) program. This might sound attractive, especially since the adjustable rates (currently about 7%) are easy on the wallet. However, parents are responsible for the repayment of PLUS loans, as Johnson points out, and often must struggle to pay them off as they approach retirement.

Uncle Sam awards 75% of all student aid, more than $22 billion annually. The largest federal programs for undergraduates include:

* Pell Grants. Need-based grants of up to $2,300 per year.

* Stafford Loans. Need-based or non-need-based loans providing up to $23,000 over four years. Under the need-based program, the government pays interest while the student is in school. Under the non-need-based program, interest accrues while the student is in school. The current interest rate is 6.9%.

* Perkins Loans. Federal funds that are dispersed to schools, allotting funds to needy students. Perkins loans have an interest rate of 5%, with no interest accumulating while the student is in school. $3,000 per year is the maximum award.

* Supplemental Educational Opportunity Grants (SEOG). A campus-based program providing grants of up to $4,000 annually to students with the greatest need.

* Work-Study. A program, funded by a combination of school and federal dollars, that provides part-time jobs amounting to 12 to 15 hours a week. These jobs are usually on campus and pay minimum wage.

To qualify for federal aid, you must fill out a financial aid form (FAF), requesting information about family income, savings and assets, as well as the number of children presently in college. Most private scholarships require the same form. (For a copy, see your child's guidance counselor or call the Department of Education's toll-free financial aid hotline at 800-4FED-AID.)

The form is used to calculate your expected family contribution (EFC), which is the maximum amount the student and family are expected to pay toward the costs of attending college. On average, the child is expected to annually contribute 35% of his or her assets to pay for college, while parents are expected to contribute between 5% and 6% of their assets.

When applying for aid, remember these tips:

1. Apply Early. The financial aid process starts Jan. 2 for the following school year. You may file the forms right up until registration, but since colleges award monies on a first-come, first-served basis, you may be locked out of funds if you wait until the last minute.

2. Know where your money is. Keep in mind that the distribution and amount of your assets can affect your child's eligibility for aid. For instance, 1993 is the first year that home equity will not be factored in as part of the federal financial aid equation. In addition, money in qualified retirement accounts such as 401(k)s is not counted among assets. Similarly, the cash value of whole life and variable life insurance policies is not included on federal financial aid forms. The interest earned on these policies generally is tax-free or tax-deferred (unless you cash in, or surrender, the policy). Policyholders can borrow against the cash value of the policy, while still retaining insurance coverage.

The College Savings Catch-22

Lorenzo Ball Sr., a 47-year-old sales rep for a liquor distributor, and his wife Betty, 46, began saving for their son Lorenzo Jr.'s education when he was an infant. By the time he was ready for college, the Teaneck, N.J., couple had accumulated more than $15,000. Lorenzo Jr. won a handful of small community scholarships that cut $3,200 from Morehouse's $12,410 first-year bill. But he didn't qualify for need-based aid, thanks to the family's savings, assets and near six-figure income. However, Betty hopes that Lorenzo Jr. will qualify next year now that the family has depleted its savings.

Jean C. Hundley-Jones, 37, and husband, William B. Jones III, 39, of Annapolis, Md., intend that their two sons, ages 2 and 10, attend private four-year college, projecting a cost of up to $48,000 a year. The Joneses, both physicians, have seen their incomes climb more than 50%, rising comfortably into the six figures over the last few years.

Yet even for such an affluent family, aiming for the lvies--and saving early--has its consequences. William Jones, who describes himself as financially conservative, says funding his 401(k) plan is taking a backseat to education savings, which currently eats up $1,200 per month. "The downside is that the same money would create a tremendous nest egg."

The Jones and Ball families illustrate the double whammy facing all parents with college-bound kids. Why save, if the savings will penalize your child in the financial aid process and/or jeopardize your own retirement?

While a savings nest egg will lower your financial aid eligibility, it should not be used as an excuse for not saving. For one thing, more and more federal aid is awarded in the form of loans, rather than outright grants. A healthy college savings fund can help your child graduate from college with little or no debt.

As for parents whose retirement competes with their kids' education? For many, "education planning is also a retirement planning issue," points out Johnson. You'll need a comprehensive financial plan that takes both major life expenses into account.

Don't be overwhelmed by the amount of money you think you need for your child's education. Financial planners, educators and parents all emphasize this: The important thing is to begin saving, no matter what level. "Even a little bit is better than nothing," says Birse Timmons. "It's not easy, but you have to bite the bullet and make a start."