529 Plans

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529 Plans: The Best Way to Guarantee Your Child (or Grandchild’s) Financial Success

by Alexander Green, Chairman, Investment U; Investment Director, The Oxford Club
Monday, September 17, 2007: Issue # 711

Last week I mentioned that the average college-educated worker in the United States makes 70% more per year than the average high-school graduate.

Intellectual capital is at a premium. The job market is begging kids to stay in school.

Yet the cost of college is rising faster than inflation. According to the latest report from the College Board, students and their families can expect to pay up to $1,238 more than last year for this year’s tuition and fees.

With higher education costs projected to rise at 6% a year, four years of tuition, room and board at a public school will cost $125,000 by 2022; for a private college, you’ll need closer to $300,000.

Before you despair, remember the immortal words of Derek Bok, former president of Harvard. “If you think education is expensive, try ignorance.”

529 Plans: The Best Way to Pay For College

For years, many parents (and grandparents) considered a 529 plan, but ultimately decided against one due to expiring tax breaks, high fees and questionable financial aid treatment.

These are no longer potential problems:

1. Over the past year Congress has made tax-free withdrawals from these accounts permanent. (They had been slated to end in 2010.)

2. 529 providers have slashed expenses and increased the number and quality of their investments offerings.

And…

3. Clarification of financial aid rules has put to rest concerns that 529 plans can hurt eligibility for grants and low-cost loans. (They may actually help now.)

In short, if you are planning to invest for a child or grandchild’s education, you’d be downright foolish to use anything other than a 529 plan.

Five Reasons To Invest in a 529 Savings Plan

Investments in a 529 plan compound tax free. Your withdrawals, if used to pay higher education bills, will go untaxed as well. (However, you don’t get a tax deduction up front. 529 accounts are like Roth IRAs for college savers.)

However, 32 states and the District of Columbia DO allow you to write off you contributions for state income tax purposes. And three states – Pennsylvania, Kansas and Maine – even allow residents to deduct their contributions to out-of-state plans as well.

In the past, high management and administrative fees often cancelled out tax savings and dragged down returns. (Some broker-sold plans still do.) But Vanguard and Fidelity, to name just two no-load groups, now offer plans with annual costs as little as a half of one per cent.

There is now a smorgasbord of choices, too. You can invest in a variety of different stock and bond funds to achieve your objectives. The idea, of course, is to invest primarily for growth while the child is young and then gradually move into fixed-income funds just before matriculation. Many funds offer aged-based portfolios, which work much like target-date retirement funds in a 401(k). The manager will gradually make the portfolio more conservative as the student gets closer to his or her freshman year.

And unlike assets in a regular custodial account, a 529 in a student’s name is not currently counted in federal aid formulas.

Incidentally, making a withdrawal from a 529 is a snap, too. In fact, with a single form you can arrange for the money to be sent directly to your child’s college.

Best of all, anyone who wants to save for a child’s higher education (even uncles, aunts or friends of the family) qualifies to contribute. There are no income limits. Many plans have minimums of as little as $25 a month. (And the maximum is typically $250,000 per beneficiary.)

The only stipulation is that the money must be used for qualified undergraduate or graduate studies (including room and board) at an accredited, degree-granting institution.

(If the money is used for anything else, you will pay income tax on the investment earnings plus a 10% penalty.)

College-minded parents should jump at this opportunity. And perhaps some grandparents, too.

After all, the holidays are just around the corner. Helping secure a child’s college education will likely have a bigger impact than anything else under the tree.

Compare 529 plans in your state.

Good Investing,

Alex

Today’s Investment U Crib Sheet

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