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Hey, baby. How's your college fund?

By Peter Andrew

Hey, baby. How's your college fund?

You have a newborn baby! Congratulations. Welcome to years of sleep deprivation, decades of horrific expense and a lifetime of being petrified that something bad is going to happen to your impossibly precious offspring. Most parents envy their childless friends' clear, bag-free eyes, relative wealth and carefree existences. But almost none would swap places for the tiniest fraction of a millisecond.

Anyway, there you are, up to your ears in diapers and cooing relations, while the laundry piles up, the housework is forgotten and all you can think about is how much you need to sleep. What better time is there to ponder your baby's college fund?

Starting early pays

Unfortunately, there is no better time. A couple of years ago, The New York Times did some calculations and found that, assuming continuing inflation in college costs of just 4 percent a year, an institution that currently charges $60,000 a year could be charging more than double that by the time your baby gets to enroll. That's comes out at a cool half-million dollars for four years.

But let's assume you're happy with a less expensive college, one that currently charges $40,000 a year. We'll also assume the education inflation rate remains at 4 percent annually, and that your savings return 6 percent annually. If your aim is to have saved half of the cost of college by the time your child's 18 years, you'd need to save $444 a month -- if you start now. Wait until his or her fifth birthday to open an account, and you're going to have to find $731 a month to achieve the same objective, according to The Times. Wow! Bet that woke you up.

Spread the load

Of course, a lot of young parents don't have $444 a month to spare, partly because they, er, have a new baby. Don't panic. Anything you can save now is likely to make a big difference in 18 years' time, and, when the moment arrives, there should be plenty of other sources of funding available (scholarships, student loans, philanthropic trusts and so on).

And don't feel the need to carry the whole burden yourself. Family and friends are likely to want to shower your child with gifts, especially now, and throughout his or her childhood. Ask them to cut down on the cuddly toys and instead divert at least some of their generosity toward a college fund.

529 plans

You may have raised an eyebrow when you read that The Times was assuming your savings could return 6 percent annually. Even today's best savings account rates are way below that. But help is at hand, most notably -- though you have other options -- in the form of so-called 529 plans.

These are tax-efficient vehicles especially designed for college savings. While you cannot deduct the money you put into a 529 plan on your federal tax return, when the time comes to withdraw the contents of a 529 plan, there will be no federal capital-gains tax due, so long as the money's used to pay for higher education. Some states also offer tax deductions or credits for contributions to these accounts.

Some caveats

These 529 plans are administered by individual states, and the ones offered by yours may or may not suit you. The good news is you don't have to use them, and can instead opt for another state's. However, you need to be careful you don't lose tax breaks or other benefits from your home state if you do so.

You can find a range of plans, some of which offer high returns and high risk (mostly stock-based), while others promise low returns and low risk (mostly bond-based). Some suggest it's a good idea to start off high risk, and then shift to more conservative investments as the child gets older, and his or her need gets nearer.

BabyCenter reports that some high-risk 529 plans lost 40 percent of their value in the 2008 crash, which would have been a disaster for a student entering college that year. However, the market recovered, and now occasionally reaches all-time highs, meaning a kid who was 12 in 2008 would be doing very well from that same high-risk plan as he or she enrolls in 2014.

Get help or go it alone?

If all this risk assessment and tax planning is too much for you, you could ask a broker to give you advice and set up a plan. But the fees you pay for that service might wipe out much of the gain you make in the first year or even longer, and you need to make sure you fully understand those costs before you commit.

You might decide it's better to do the research yourself. After all, it's not like you've got much going on right now! Come to think of it, just how busy are your baby's grandparents right now?

Peter Andrew has over 25 years of experience writing about marketing, advertising and management. He regularly covers consumer credit card topics for IndexCreditCards.com and other personal finance publications including Fox Business, TheStreet and MSN Money. He also writes frequently about mortgages and auto loans. Peter has spent extended periods living overseas, in the UK, France and Africa. He lives with his partner of 20+ years, and wastes too much of his time on cryptic crosswords.

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