Pros and cons of college savings plans
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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
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.
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
- 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
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
Longtime financial journalist Barbara
Mlotek Whelehan earned a certificate of specialization
in financial planning.
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