529 Savings Plans
Looking to build a war chest for the campaign against the
rising tide of education prices? Your state government may be
your best help with a tax shelter big enough to store the bulk of
your college fund.
How to get it
Along with the
529 Prepaid Tuition option, many states offer financial
assistance via the 529 Savings Plan. This type of investment
account grows tax-free (though the deposits into the plan aren't
deductible), provided that any withdrawals go towards college or
university expenses. Books, fees, housing and dining plans all
qualify as expenditures, not just tuition. If the donor makes a
withdrawal for anything other than education expenses, the funds
are subject to taxes and an additional 10% penalty.
The contribution cap for a 529 Savings Plan is substantial;
most carry a limit that reaches up to $265,000. This ceiling is
much higher than a Coverdell ESA's (formerly known as an
Education IRA). Plus, there are no tax bracket or age
restrictions for contributors, though a single contributor can
"only" donate up to $55,000 to the fund in a single year. Your
financial advisor should have more details on your state's
plan.
Unlike the Prepaid Tuition plans, 529 Savings distributions
are applicable towards both private schools and out-of-state
colleges. There's no "expiration date" for the funds to be used
by. In addition, the original donor always retains control of the
account and can change the beneficiary as often as she or he
likes (as long as the new recipient is a direct relative).
Flexing your money
The biggest drawback of the 529 Savings Plan is that it
doesn't provide much flexibility. The donor must assign the money
to a limited number of distribution options. From there, a money
manager handles the day-to-day investment decisions. Once the
donor decides how to allocate the money, the plan is fixed for 12
months—no further changes can be made in this period. Any
subsequent allocation change lasts another 12 months.
Some states are also beginning to charge exorbitant "handling"
fees that may make the final payoff less favorable than other
traditional market accounts. Again, terms vary from state to
state, so as always consult with your financial advisor before
subscribing to any plan.
529 versus the Coverdell
At first glance, a 529 plan is much more attractive than a
Coverdell ESA. 529s aren't shackled by the same tax bracket,
maximum donation and time limits. Cautious parents will like the
fact that they'll always retain authority over the funds. Also,
since the account isn't listed under the child's assets, it won't
count against them in the application for financial aid. However,
the ESA offers superior flexibility and management options.
Without the higher handling fees it could ultimately give you a
better rate of return than a 529.
