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Pros and cons of college savings plans -- Page 2

Coverdell education savings accounts -- You can open an account at most banks, brokerages and mutual-fund firms. These are more flexible than 529 plans (described below) in some respects: They can be used to pay education expenses for private schools at the elementary and high school levels, and also can be tapped to pay for books, computers and school supplies.

  • Negative: Annual contribution amount is limited to $2,000 (an improvement over the previous $500 limit, but not a lot, nonetheless). Also, married couples making more than $220,000 and single parents making more than $110,000 cannot contribute to these vehicles.
  • Positive: The Department of Education recently ruled that Coverdell accounts are considered parental assets, a big plus for federal formula purposes. Also, you have a broader selection of investment options to choose from than with other plans.
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529 prepaid tuition plans -- These are the 1980s forerunners of the 529 savings plans. The tuition plans lock in tomorrow's tuition costs at today's prices. That's a meaningful benefit, considering that tuition costs have been escalating at more than twice the annual inflation rate in recent years. Most plans allow you to make a lump-sum or installment payments. Not all states offer them, and some have discontinued new enrollments. Most are state-specific and impose residency requirements. However, recently a consortium of 250 private colleges, including Princeton, Stanford and Vanderbilt universities, introduced the "Independent 529 plan" which enables you to buy tuition in advance at discounted rates.

  • Negative: If you purchased a particular state's prepaid tuition plan and your child wants to go to a private or out-of-state school, you can use the credits, but will have to pay any difference in tuition. Conversely, if your child isn't accepted into the state's public university system, you can transfer the funds to another family member or into a 529 savings plan, or in some cases use credits to pay tuition at a community college. Also, be aware that these plans pay for tuition, not room and board or other college fees. And, when redeemed, they reduce financial-aid eligibility dollar for dollar.
  • Positive: Since 2002, federal income taxes have been lifted on the difference between the initial investment amount and the value of the credits at redemption. State taxes may apply.

529 savings plans -- Since 529 plans were introduced in the mid-1990s, they have amassed more than $55 billion in assets. You can sock away big bucks in these plans -- as much as a quarter-million dollars -- making these the investment vehicles of choice, especially among the wealthy, since no income restrictions are imposed. You can also make larger-than-usual gifts in these accounts. For example, grandparents with estate-planning challenges can shed assets by gifting $55,000 to each grandchild's 529 plan, taking advantage of five years' worth of annual gift exclusions all at one time (though they can't make any more gifts to the same children for five years).

  • Negative: 529 plans have been plagued with problems, most notably inconsistent fee disclosure. The state plans are voluntarily beefing up their fee-disclosure efforts this year, so transparency should improve before 2006. Go to Bankrate's 529 plan comparison page to check out plans with low expenses. Also, only cash contributions are allowed (you can't transfer stock into a 529 plan), and investment options are limited to the few funds available in a plan.
  • Positive: The funds in 529 plans grow tax-deferred, and are not taxed at the federal level when withdrawn for qualified education expenses. (State taxes may apply if you invest in an out-of-state 529 plan.) As long as parents own them, 529 plans are considered a parental asset for financial-aid purposes -- an advantage. Withdrawals are not considered income for either the parent or student, so they have no adverse effect on financial-aid eligibility calculations. You can transfer the plan to benefit a different family member if Junior decides he'd rather be a car mechanic.

Longtime financial journalist Barbara Mlotek Whelehan earned a certificate of specialization in financial planning.

If you have a comment or suggestion about this column, write to Boomer Bucks. If you have a particular financial problem that you would like addressed, please send your queries to Dr. Don, Tax Talk, the Real Estate Adviser or the Debt Adviser.

-- Updated: Oct. 20, 2006




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