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Financial Literacy - College funding
Joe Hurley
Our College Money Guru tells you everything you need to know about college savings plans.
Smart ways to pay for college

Interview: Joe Hurley

Is a 529 better than a Coverdell account? Why would someone choose a 529 instead?

Understanding 529 plans
529 plans vs. other ways
Choosing the right 529 plan
Avoiding mistakes with 529 plans
Upcoming rule changes

Well, Coverdell accounts currently can be used for Kindergarten through 12th-grade (K-12) expenses, in addition to college. However, that K-12 provision expires at the end of 2010, so unless Congress extends it, that goes away. A Coverdell account certainly can be used for college on an ongoing basis. The problem with a Coverdell is the contribution limits are so low you're barely keeping up with annual college costs increases, much less the current cost of college, with a $2,000 annual contribution limit per child.

Coverdells, just like IRAs, can be set up directly with mutual funds, or you can set those up with your broker or your bank. So there are more investments available in Coverdell accounts. But because they're not state sponsored, no matter what state you live in, you're not going to get a state income tax deduction for your contributions to a Coverdell Education Savings Account, or ESA. Depending on where you live, 529s offer that state-tax benefit that you don't get with a Coverdell account.

What are the pros and cons of 529 prepaid tuition plans vs. 529 savings plans?

Well, different families will be attracted to different types of 529 plans. The prepaid tuition plans are generally only available in a certain number of states and are restricted to state residents. They're designed to provide a hedge against increasing tuition at public universities and colleges in that state. So, they can be attractive to families that are intent on sending their children to the in-state school and are looking for protection against increasing tuition at state schools.

But they can also be used for private schools and out-of-state schools. You simply have to understand the conversion formula in the plan if your child goes to one of those types of institutions. Because they're not paying the tuition for you at a state school, they have to give you a chunk of money in order for you to pay the out-of-state school or the private school. What most do is figure out what the average tuition rate is at in-state schools and they'll give you an amount based upon that average cost.

The 529 savings plans are your more familiar investment-type plans, much like a Roth IRA. You're investing in the market, which means that your 529 savings plans may go up in value greater than college costs go up, or they may lose value if your investments don't do well. There's more upside, but there's also a downside.

Each 529 savings plan will offer a menu of investment options. Each plan is different in how many options it offers and exactly what those options are. Most plans do have what might be called an "age-based" option. It's very popular and is where your money is invested mostly in stocks when your child is young, and as your child gets closer to college age, it shifts automatically into more conservative investments, to protect the value from stock market drops. So, it's kind of an auto-pilot approach that changes your asset allocation over time.

-- Posted: Sept. 17, 2007
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