FABULESSLY FRUGAL FRIDAY: Saving for Your Children’s College Educations-Part I
*DISCLOSURE: Although I took a few grueling finance classes in college, that is not what I obtained my degree in. I am not an expert. Not even close. In fact, to even elude to the fact that I am a Finance Expert would make my husband giggle (except boys don’t giggle, so maybe something more manly like chuckle?). Basically what I’m saying is this entire article is solely my opinion. PLEASE check with someone smarter than me before making any major financial decisions.
Last Friday I asked for some input and promised a post on the best ways to save for your child’s college education. Because I found an enormous amount of info on the subject AND because I’m terribly long-winded, I’m going to break it into 2 parts. This week I’ll talk about the Pros and Cons of State-sponsored 529 Plans. Next week, I’ll touch on Coverdale Savings Accounts, Roth IRAs, UGMAs and a few other less popular options.
Before I discuss the pros and cons of individual plans, let’s talk about 529 Savings Plans in general (not to be confused with a 529 Prepaid Plan which we are not discussing today).
EASY TO OPEN AND MANAGE
There are no income or age restrictions so EVERYONE is eligible to open one. Many plans have initial contribution amounts of less than $100. You choose a state’s plan and select your investment option, and the state or a third party, such as an investment firm, manages your funds.
Unlike many custodial accounts, with a 529 plan, the beneficiary does not gain control of the money when s/he turns 18 (or 21 depending on what state you live in). The account owner gets to decide when distributions are made, and how the funds will be used.
FAVORABLE TAX TREATMENT
Earnings in a 529 plan grow tax free while in the plan. Distributions are tax free, as long as the proceeds are used for qualified higher-education expenses. Qualified expenses include tuition, fees, books, and eligible room and board costs at an eligible educational institution. While contributions to 529 plans are not federally tax deductible, some states allow a full or partial deduction for your contribution. The Pension Protection Act of 2006 has permanently extended Section 529 Plan provisions that were scheduled to expire at the end of 2010.
Anyone can open an account and the proceeds can go towards any accredited educational institution, whether it’s public, private, two-year or four-year. There are no income limitations and there is no requirement that you pick the state in which you reside, although there may be some advantages to doing so. Keep in mind, too, that the beneficiary does not need to attend a school in the state of the chosen plan.
HIGH CONTRIBUTION LIMITS
Each state determines its own lifetime contribution limit, but maximums are generous with some exceeding $300,000 per beneficiary.
LIMITED IMPACT ON FINANCIAL AID
Generally, money in the student’s name has a larger impact on financial aid than money in the parent’s name, since colleges expect students to contribute a larger portion of their assets to the tuition bill. Since assets in a 529 plan are considered the property of the person who opened the account, there is less of an impact on financial aid on the student.
If the beneficiary of a 529 plan decides not to attend college, the account proceeds can be transferred to another member in the beneficiary’s family.
FEES AND EXPENSES
Expect to pay an enrollment fee as well as an annual maintenance and/or fund expense fee. Research plans and choose one where the fees to not outweigh the benefit. In many cases, the annual or start-up fees diminish the benefits.
LIMITED INVESTMENT OPTIONS
There are limited mutual fund-type investments offered by most 529 plans, so you can’t pick individual stocks, bonds, or other investments. All 529 plans also require cash only contributions, which means you can’t contribute stocks, bonds or mutual funds without first liquidating them.
PENALTIES FOR NON-EDUCATION USES
If you pull money from a 529 plan to use on non-qualified college expenses, be prepared to pay income taxes on the withdrawal amount along with a 10 percent penalty on earnings.
LIMITED INVESTMENT AND PLAN SWITCHES
Under current laws, once you have chosen your 529 plan’s investments, you can’t make a change for 12 months. If you are not happy with the 529 plan itself, you can transfer to another state’s plan but only once a year.
Now let’s talk about the pros and cons of the two major ways to obtain a 529 Savings Plan:
Direct-sold 529 Plans (You buy the plan directly without involving a broker)
PROS: Lower fees. Broker-sold 529s have higher annual costs and may include sales charges anywhere from from 1 percent to over 5 percent of your contributions. Also, many of the direct-sold 529s are invested in index funds with low expense ratios, while most of the broker sold 529s are not.
Additionally, your state may offer incentives on a direct-sold 529 plan, such as state income-tax deductions, a matching contribution, a scholarship or other financial-aid boost (must be a resident of the state you are purchasing the fund from to receive these benefits).
CONS: You have to be the expert. There are so many tax laws and rules and so much information out there, that you have to invest many hours to educate yourself.
Adviser-sold 529 Plans (You buy the plan from a broker)
PROS: A broker will look at your overall savings goals and offer a comprehensive plan to reach them. They will coordinate your college planning with your other financial objectives. Plus, chances are they know so much more about the income tax and gift tax treatment of 529 plans that their knowledge alone might be worth paying a few more fees for.
CONS: See the pros from above.