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Saving for College? Section 529 Plans Can Help
Presented by Jane Taubner Barney, JD, CFP ®

Ah, the joys of parenthood! Nothing can quite compare. But what about the costs, especially when it comes to providing a college education? Saving enough to pay the tuition bills when they land on your doorstep may be one of your biggest financial challenges. According to the College Board, four years of tuition, room and board run about $90,000 for a private college and $34,000 for a public institution. Eighteen years from now, those figures are projected to rise to $235,000 and $100,000.

Don't panic. Now there is a way to channel a significant chunk of money into a child's college savings account, while receiving the benefit of professional investment management with the child's college dates in mind. And earnings and withdrawals will be tax-free as long as the money is used to pay qualified higher education expenses.

These are the main attractions of 529 college savings plans, which arrived on the scene in 1997. To date, families have invested more than $3 billion in such plans, currently available in 43 states—and many states offer more than one plan. The mechanics of 529 plans differ slightly from state to state, but in general here is how to get started on the road to college savings.

• Choose a plan . Begin with your own state's plan, if it has one, because you could qualify for a grant, scholarship, tax deduction for your contributions, or tax break on withdrawals. If your state plan does not offer enough benefits to make its plan an automatic choice, look around. Twenty-nine states allow nonresidents to open accounts. Search for a plan that offers solid investment choices and is managed by a nationally recognized investment company. Plans often will allow either investment in their portfolios or direct investment into the mutual funds they use in the portfolios. Costs are also a consideration. Most states charge an account fee, but expense ratios and other fees can add up. Be sure to ask about them.

• Open an account. There are no eligibility requirements. You can open an account for your child, your grandchild, or any child—regardless of family ties. Most plans allow contributions as low as $25 per month. Maximum contribution limits vary from state to state, ranging between $100,000 and $300,000. You may have more than one account in a child's name, but your total lifetime contributions to all of the accounts cannot exceed the state maximum.

• Select an investment option. Because the savings window for college is smaller than for retirement, most plans are built around age-based portfolios. They weight investments more aggressively for children in their early years and become more conservative as the college deadline approaches. Thanks to the new tax law, you can even roll over from one 529 plan to another if you have a change of heart about your investment choice. Rollovers are limited to one per year.

• Contribute regularly and encourage others to add to your child's savings. Grandparents, for example, can direct up to $55,000 in one lump sum ($110,000 for a couple) to any child's account without triggering a federal gift tax. A maximum contribution counts against an individual's $10,000 annual gift exclusion for five years, so another tax-free gift cannot be made to that child for six years.

What happens when the bill is due? When your child enters college, you may begin withdrawing money to pay for tuition at any accredited degree-granting school. Most states let you use these funds for room, board, books, and fees as well. But what if the child opts not to go to college? Or there is money left over after expenses are paid? You may name a new family member as beneficiary—another child of yours or a niece or nephew. Because the money is yours—not your child's—you are free to withdraw the balance and pay tax on the earnings at your marginal income tax rate, plus a 10 percent penalty.

But think twice before you give up the tax-free growth that you are entitled to as long as the money is invested. The tax savings and flexibility of 529 college savings plans are attractive, although the amount of tax savings can vary, depending on your tax and income bracket. And there is hope that clarifying rules accompanying the new tax law will eliminate any hurdle to financial aid eligibility which may exist because the account's gains are counted as income to the child when money is withdrawn.

Keep in mind that the recent enhancements to 529 plans are set to expire in 2011 unless Congress acts to make them permanent. If your children are under age 13, there is no guarantee that all withdrawals will be truly tax free; however, most financial experts believe that it will be difficult for Congress to back away from its commitment to help parents meet the rising cost of college.

To decide whether a 529 college savings plan is right for your family, as well as which plan offers you the best combination of features, talk to an investment professional. College savings plans are complex, so don't be shy about asking for a little help. After all, in this course the answers are available before you have to take the test.

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