College savings should begin with 529 plan
Dear Dr. Don,
What is the best college savings fund for my child?
— Cecilia Collegiate
I’d suggest a qualified tuition program that falls under the 529 plan banner for tax breaks when future distributions are used for certain education expenses.
The first thing to determine is whether your state offers an income tax break on contributions to the plan. Some states do this, but only for that state’s particular plan. Other states, such as Pennsylvania, provide a deduction regardless of which plan you choose.
If your state offers a prepaid tuition plan, take a look. Check whether your state guarantees the tuition benefit. There are different types of prepaid plans. Savingforcollege.com divides prepaid plans into three categories:
- Contract plans allow you to prepay tuition for a number of semesters or years at an in-state, public, four-year or two-year institution. This is similar to a future contract.
- Unit plans allow purchase of fractional units (typically 1 percent of one year’s tuition) redeemable in the future based on average tuition rates at a target group of schools. This is like a “tuition index” fund.
- Voucher plans help prepayment of a specified percentage of tuition at participating schools. This is more like a coupon providing a discount.
I like prepaid plans because of their protection against inflation of college costs. If choosing an investment account over a prepaid tuition plan, you’re betting the investment returns will be higher than college cost inflation. If not, then you have to make up the difference.
Knowing about the potential flexibility of the prepaid plan when you don’t yet know where your child will attend college is also important. Here’s an example of how one plan handles the issue. The Florida Prepaid College Board’s website says, “Prepaid plans are guaranteed to cover costs at specific Florida colleges and/or state universities, but the value of either a Florida 529 savings plan or a prepaid plan can be used at schools throughout the country.”
Also, after determining the tax impact of your contribution, look at the investment options, annual fees and expenses.
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