Dear Dr. Don,
I would like to start a college fund for our 2-year-old grandchild. We were debating between a CD and a 529 plan. I have friends who have lost a lot of their grandchildren's funds with the 529s. We thought the CD would be a safer place to put our money. Do we put it in trust for her? What is your advice?
-- Sandi Savings
Watching the balance dwindle in a 529 college savings account is very frustrating. But in most cases, you can choose to invest conservatively in these accounts and realize tax benefits you can't obtain with a CD in a nontax-advantaged account. Alternately, you can choose to fund a Coverdell education savings account with a bank and buy CDs.
There's more than risk to principal at stake here. There's also purchasing-power risk. College cost inflation is likely to outstrip the returns you earn on that CD. Your investment is secure but losing value in the education expenses it can fund in the future.
Prepaid tuition plans offer an approach for your investment to keep pace with college cost inflation. But you don't know where your grandchild will eventually choose to attend college, and that decision has a big influence on the attractiveness of these plans.
The grandparents' FAQ page in College Savings 101 on Savingforcollege.com, a Bankrate company, will help you learn about these programs. Talking with the child's parents about college strategies can help, too.
Putting the money in a trust sounds secure, but you still have the decision as to how that money is invested. To my mind, the Uniform Gifts to Minors Act, or UGMA, and Uniform Transfers to Minors Act, or UTMA, accounts became less attractive with the change in the kiddie tax.
UGMA-UTMA Section 529 accounts are available, but the concern with these accounts is how they will be viewed in the financial aid process. The current approach is favorable to the student, but will it stay that way?
The Savingforcollege.com feature "Should you open an UGMA/UTMA 529?" provides a nice primer on these issues.
You can be as conservative as you'd like. Just remember there's a price to pay for that conservatism when it comes to actually funding college expenses 15 to 17 years from now.
Find a tax-advantaged account where you're comfortable with the investment choices and keep the parents in the loop on what you're planning to do. Talk to your tax professional and legal counsel if questions arise in setting up the account.
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