Saving for College

During a church lesson on self-reliance last week, the subject turned to saving for childrens’ education and college.  Someone mentioned that there are college savings plans and threw out the number 529.  I was curious because I had heard about Educational IRA’s, and had been thinking about opening a couple for the kids, but I hadn’t heard of “the 529.”

The 529 Saving Plan – Recently, I’ve been researching using the Fortune/CNN Money “Money 101″ site related to investing in bonds, and I skipped ahead to the college savings plans section to find out about this mysterious 529.

College Tuition Estimator – The site also referred me to http://www.savingforcollege.com which has a very simple calculator to determine what you’ll need to put away each month based on how much current tuition is and how much you think your college savings investment will grow.  I was astounded to see total college tuition estimates at over $100,000.  Crazy.  The calculator also lets you know how much you need to put away each month to cover the total tuition.

Giving or Earning? A Matter of Philosophy – It’s my personal philosophy that parents should not pay for children’s college.  Perhaps it’s because I worked my way through college.  Children will also learn money management skills if they save for their own college.  Who will appreciate their education more, the child that has it handed to them, or the one that has worked for it?  I’ll let you decide.

However, there is a good plan to help with your children’s college and help them feel the value of saving, money management, and their education.  Set up a plan where the child puts in a certain percentage from what they earn to be placed in their education fund, then match their contribution.  Now, you may want to contribute when your child is really young which is fine, but teach them about the fund and help understand as they grow older what it’s all about.

So What is a 529? - First of all, there are two types of a 529, we’ll talk about the Savings Plan (not the prepaid).  You access your plan through your state and there are state tax benefits for residents of the state.  Each state’s administration of the plan can be different, so the information and plans may vary from state to state.

The Gist From Wikipedia:

529 plans are named after section 529 of the Internal Revenue Code,[1] 26 U.S.C. § 529. While most plans allow investors from out of state, there can be significant state tax advantages and other benefits, such as matching grant and scholarship opportunities, protection from creditors, and exemption from state financial aid calculations for investors who invest in 529 plans in their state of residence.

Money from a 529 plan can be used for tuition, fees, books, supplies and equipment required for study at any accredited college, university or vocational school in the United States and at some foreign universities.

The money can also be used for room and board, as long as the fund beneficiary is at least a half-time student. Off-campus housing costs are covered up to the allowance for room and board that the college includes in its cost of attendance for federal financial-aid purposes.

529 plans are named after section 529 of the Internal Revenue Code, 26 U.S.C. § 529. While most plans allow investors from out of state, there can be significant state tax advantages and other benefits, such as matching grant and scholarship opportunities, protection from creditors, and exemption from state financial aid calculations for investors who invest in 529 plans in their state of residence….

The money can also be used for room and board, as long as the fund beneficiary is at least a half-time student. Off-campus housing costs are covered up to the allowance for room and board that the college includes in its cost of attendance for federal financial-aid purposes.

Money from a 529 plan can be used for tuition, fees, books, supplies and equipment required for study at any accredited college, university or vocational school in the United States and at some foreign universities.

Below is what we’ve learned from our state’s plan (again, check to see if your state is different or if the plan has changed):

• No minimum investment amount to get started
• Funds can be used at the institution of your choice (as long as it is accredited)
• There’s no yearly maximum contribution, however, if an annual contribution (per contributor) is larger than 13K, federal gift taxes may apply
• You can switch who the beneficiary is (if your eldest decides not to go to college for example or receives a full ride scholarship for all 4 years and room and board)
• Qualified withdrawals are not taxed.  So interest and earnings you gain from having your money invested is not taxed when withdrawn if the money is used for qualifiyin education expenses.
• You don’t have to report what you spend the money on to the fund.  However, you need to keep detailed records since this has to do with taxes, if you’re audited, the IRS may want to see your records.
• You can deduct your contributions from state taxes (deduction amount is 5% of the contribution up to a certain amount…not very much, but still)
• You can have multiple accounts per beneficiary (you would use this for investment strategies because you currently can select only one investment strategy at a time).
• You can change your investment strategy periodically
• The investments are based on Vanguard Index and Funds as well as FDIC insured Bank accounts, Bond Indexes, and/or State Investment funds
• You cannot contribute to the account once it has reached about $300,000 (check your state for the current limit); however, your investments can continue to grow past that point
• Withdrawals should be made in the same time period as the education expense
• You can choose to have the investment strategy change automatically from aggressive to conservative as the beneficiary ages.

Whats are the drawbacks of a 529? – Some of the drawbacks with the fund are that there are fees for managing (some of the fees are passed through from the underlying investments), and there are fees if you contribute as someone from out of state.  However, the fees are less than 1%/year, so compare that against a Coverdell account where you’ll pay a commission on the purchase and sale of your investments.

You can pull your money out at any time; however, you’ll face fees and taxes just as if you were to pull money out of your 401k early.  You’ll probably have to pay 10% federal tax fee and any other applicable state and federal taxes on the gains and/or return the amount deducted from state taxes.

Some states have brokerages manage their funds, this gives increased fees to the investor.  I was reading on CNN Money in a different article and saw that the author invested in our state’s fund because it’s not brokered by a traditional broker, the fees are low, and the investment options are better.

Earnings and Strategy for a 529 – You should be able to see from the 529 statements what the earnings are.  With the markets as they are right now, the returns look really bad if you’re making withdrawals right now and your money was invested in stock indexes, funds, or bonds.  This does mean however, it’s the perfect time to get started.  Buy low, sell high…you know.

One strategy is to go for stocks when the beneficiary is in elementary school, move to a mix of bonds when in junior high, and then move to an FDIC insured bank account when in high school.  The FDIC insured bank account is still within the plan’s management.

What other options are there for saving for college? – A Coverdell IRA is another option where you have full control over the investments, stocks, etc.  however, there is an annual $2,000 contribution limit per recipient.  Withdrawals can be made tax free, but contributions are not tax deductible.  Your brokerage will most likely have a minimum initial investment to open the account.

So, whether you choose a 529, a Coverdell, a Savings account, CD, mattress (not recommended), the important thing is to get started and teach the kids to be financially responsible.  Who knows, if they’re taught about correct money principles when they’re young, they will be a whole lot less likely to be in the mess many in America are facing right now.

DISCLAIMER: The information here is to get you thinking about saving for college, investments hold risk, etc., etc., etc., this information isn’t guaranteed to be accurate or complete. In other words, you’re responsible for your own financial decisions and shouldn’t rely on what is written here; don’t get mad or sue if things don’t go as you planned.

References:

529 plan. (2009, June 3). In  Wikipedia, The Free Encyclopedia. Retrieved 17:41, July 12, 2009, from  http://en.wikipedia.org/w/index.php?title=529_plan&oldid=294209892

Money101 Lesson 11: Saving for College.  In  CNNMoney.com. Retrieved 17:41, July 12, 2009, from  http://money.cnn.com/magazines/moneymag/money101/lesson11/