Financial Planning for April 2000
The 529 College Savings Plan is Available to You
By the time your children were five years old you probably had been asked more than once if you have a plan in mind to pay for their college education. If you have several children, you have probably been awake at night wondering what you will do when you have all these children in college at the same time. It is hard enough to support your children, much less save for their college education. Rest easy or easier might be more appropriate, state after state is enacting legislation to help you. Children and higher education is one of the biggest financial adjustments you will make and the rising cost of college will most definitely affect when you get to retire.
The 529 Plan
Twenty-two states so far have produced variations of the 529, originally offered by New Hampshire in 1997. The 529 helps you save tax-deferred for your children's college expenses regardless of income level. It allows states to offer tax breaks and investment vehicles customized for saving for college. The offerings vary by state but all offer tax-sheltered funds to parents, grandparents or anyone else who might feel compelled to donate to your children's higher education. When the money is withdrawn, the gains only are taxed at the child's low rate. All amounts initially contributed may be withdrawn tax-free.
Differences by state
States offer added incentives such as a state-tax deduction on contributions to the plan or even a state-tax credit. Missouri for example, offers a $8000 deduction on contributions that can be taken annually. (Such a benefit would only be offered to a state resident.) Each state's plan has different investment options and each state offers its own array of incentives to try and keep residents' dollars at home. New York for example, lets their residents withdraw their money state-tax-free, not just tax-deferred. When "shopping states" we could say, you need to consider the impact of the states tax incentives and investment choices of other states. Once you choose a state, you cannot change and your money is in the hands of that state.
What the state does with your money
Congress mandated that the states create fixed, asset allocation portfolios within the savings program that would not limit the investment options. One state invests 88% of a newborn's investment account in equities and the rest in bonds and shifts that allocation to a more conservative portfolio as the child gets older. When that child enters college, only 20% of the account will be in equities and the rest is split between bond funds and money market accounts. New York for example, is even more conservative and invests only 75% of the infants' account in stocks. North Carolina invests 100% in bonds no matter how old the child is when the account is set up.
Downside of the 529 Plan
It is hard to say anything bad about the 529 plan since there are so many advantages but you need to know one or two things. You are losing control of your money. For some, this could be a good thing, but generally speaking you need to do your homework and make sure the program you select meets your investment needs. You will have to pay management fees for the 529 plan. These fees range from 60 basis points to 150. These fees could be changing as states try to make their program more attractive. Connecticut has recently decided to cut their management fees in half. Expect to see more changes that will only be in your favor.
Upside of the 529 plan
The biggest advantage to parents is that they are allowed to defer state and federal taxes. Some states allow $100,000 or more per child. Grandparents can join in and so can anyone else under special regulations. The only rule is that the money be spent on college expenses. If the child does not use all the money for college, you can roll the account to a different child. If you have no other children going on to college, you can withdraw the assets and you only pay taxes on the growth and income at your rate.
Who can participate?
You can and it does not matter what state you live in. You will still get the benefit of federal tax deferral and the low rate (your child's) when you withdraw the money at college time. You can use the money for more than just the tuition. You can fund books, room and board or anything directly related to college or graduate school.
The 529 plan is uniformly been accepted as the best ways to save for your children's college. Other plans used to save for college such as the Education IRA have such low contribution limits. The Uniform Gift to Minors Account has advantages but your child could run off with money rather than going to college. The 529 plan is sure to change the way millions save for college and this will no doubt impact how you spent your golden years.
Tip: Information about each state can be found at www.collegesavings.org
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