Perhaps, one of the greatest gifts you could ever give your child or grandchild is opportunity to achieve a higher education. Ultimately, their destiny is determined by their ability to get good grades and the desire to continue their education, but knowing that there is a college nest egg available is good motivation. But college costs are not getting any cheaper; on average college tuition tends to increase about 8% per year. An 8% college inflation rate means that the cost of college doubles every nine years. For a baby born today, this means that college costs will be more than three times current rates when the child actually attends college.
What Can You Do?
Lucky for those who are college bound, there are many different choices available when considering how to pay for college. Some of these include prepaid college plans, education savings accounts, UTMA accounts, and 529 plans to name a few. Unfortunately, those who invest in a lousy plan probably would have been better off investing on their own in a taxable account. But by choosing the right plan, parents and students can come out ahead in the end.
For the remainder of the article, we're going to focus on the advantages and disadvantages of 529 College Savings Plans. Currently, 529 Plans are state run programs, and all 50 states now offer the plans. With more than 80 different 529 college savings plans to choose from, the task of picking the right one can seem overwhelming. So, let's take a look...
The Pros
Forced Savings/Established Plan- Setting up an automatic monthly contribution to a 529 plan is a painless way to save for college. Once a plan is opened, it offers a constant reminder to the parent/grandparent to fund the account.
Tax-Free Withdrawals- Distributions are generally tax-free to the extent of qualified expenses. If the earnings generated in the account are used for qualified educational expenses (such as tuition, books, room and board, supplies, etc...) the beneficiary is not required to include the earnings as taxable income.
Higher Contribution Limits- Contribution details and plan terms vary from plan to plan, but many 529 plans have high contributions limits such as $200,000 or greater.
Beneficiary Flexibility- If the current 529 Plan beneficiary (child or grandchild) decides not to go to college, the money is not lost. You can simply change the beneficiary to another member of your immediate family.
Tax-Free Gifts- For parents or grandparents looking to maximize their gift-tax exclusion, each individual is eligible to gift the annual gift tax exclusion of $12,000 (indexed for 2006) to each beneficiary of their choice. Special tax laws also allow you to contribute more in a single tax year then spread your annual exclusion over a five-year period.
State Tax Benefits- Some states allow contributions to the plan to receive a state tax deduction on their state tax filing. You should always check your individual state sponsored plan first to verify the tax advantages.
The Disadvantages
Higher Fees- Since there are multiple levels in a 529 plan (mutual funds, state sponsor, financial advisor, etc...), the plans tend to have higher fees than a typical taxable account investment.
Limited Investment Options- Most 529 plans are limited to a selection of 10 to 20 mutual funds or an age-based investment program. In a typical brokerage account, you'll have more flexibility in investment selection such as individual stocks or bonds.
Sales Loads- More than 80% of all 529 plans are established by financial professionals. If you're not dealing with a fee-only advisor, you may be paying a sales load of 5% or higher on each new contribution to the plan. Don't be afraid to ask before you invest.
Shady Selling Practices- Just like many new investments, investors can be exposed to shady selling practices. Before you invest, you may want to contact the State Administrator of the plan you are considering for questions or check out the plan on the web.
Educational Use Only- While funds can be withdrawn from the plan at anytime, if they are not used for qualified educational expenses, the investor may be subject to a tax penalty.
Get Started Now!
Choosing the right college savings plan is not an easy decision to make. Perhaps, one of the most attractive features of the 529 plan is the tax-free use of funds if the withdrawals are used for educational purposes. Starting to save while your children are young will also help reduce the financial burden of college costs rather than waiting until the teen years to start saving. For those of you that like to do your own research on 529 plans, there are some excellent websites on the subject such as www.savingforcollege.com. Then contact your financial advisor to get started today.
|
