Start Saving Now

Whether your child is a newborn or in high school, it is never too early or too late to begin your college planning program. The best way to ensure that you will be able to afford ever-increasing college tuition costs is to start a college savings program today.

In recent years, college tuition costs have risen twice as fast as the inflation rate, with no slow down in sight. Today, the average cost for four years at a private college is over $84,000, and a public university degree for out-of-state students costs over $40,000. In addition to this depressing news, traditional sources of education funding like scholarships, financial aid, and student loans have become more limited in recent years.

Once you have established how much and when the funds are needed, the next step is to decide how best to invest your money to meet your objectives. Certificates of deposits, US savings bonds and mutual funds have all been popular investments among parents planning for college. Factors in deciding which investment is right for you include the age of your child, the degree of investment risk you are willing to take, your time horizon, and the tax consequences of your investment

To help you compare the various alternatives, here is a brief description, along with the advantages and disadvantages, of the different investment vehicles available to use for a college savings program. Pay special attention to the new kid on the block called the 529 savings plan.

Custodial Accounts

These are accounts set up under the Uniform Gifts to Minors Act (UGMA/UTMA) and have been used by parents to gift money to their children for many years. $11,000 annually ($22,000 for married couples) can be given to each beneficiary without exceeding the annual gift tax exclusion.

Advantages

Wide range of securities are available to include in a custodial account.

Withdrawals are unrestricted and can be used for any purpose.

No dollar limit for account deposits.

Disadvantages

Account earnings over $1,400 are taxable at parent's tax rate for kids under 14.
Student is considered account owner for financial aid purposes.
Child has control of account at the legal age of maturity.
Beneficiary can not be changed.

Education IRA

A new type of IRA account that allows annual contributions of up to $500 per child. All earnings in the account grow tax free and assets can be withdrawn for qualified education expenses without taxes or penalty.

Advantages

All withdrawals are tax-free if used for qualified education expenses.
Wide range of securities are available for account.
Can change beneficiary of the account.

Disadvantages

Contribution limited to only $500 per year, per beneficiary.
Student is considered account owner for financial aid purposes.
Child has control of account when child reaches legal age.

Traditional IRA

This is the regular traditional IRA that allows annual contributions of up to $2,000 per taxpayer. Special rules allow unlimited withdrawals to pay for qualified education expenses without penalty, even if withdrawn prematurely before age 59 1/2.

Advantages

Account earnings grow tax deferred until withdrawn. - Early withdrawals of deductible contributions are not subject to the IRS 10% penalty if used for qualified education expenses.
Wide range of securities are available for account.

Disadvantages

Annual contribution limited to $2,000 per taxpayer. - Withdrawals are fully taxable at parent's tax rate if in parent's name.
If account is in child's name, child has control of account when legal age is reached.

529 Savings Plan

This new college savings plan is named after the Internal Revenue Code section that describes the plan. A 529 plan allows contributions of up to $11,000 per year ( $22,000 for married couples) and up to $50,000 ( $100,000 for married couples) in the first year of a five year period, without exceeding the annual federal gift tax exclusion, provided no other gifts are made to that student in the same five year period.

Advantages

Much higher annual contributions allowed - up to $50,000 ( $100,000 for married couples filing jointly) in first year.
Account earnings grow tax deferred and are taxed at student's tax rate when withdrawn and used for qualified education expenses.
Student does not have control of funds and is not considered account owner for financial aid purposes.
Ability to change beneficiary to other family members if student doesn't attend college or receives scholarship money.
Helps reduce possible estate taxes, by lowering the taxable estate subject to the federal estate tax, which starts at 37%.

Disadvantages

Once the account owner selects an investment option, it cannot be easily changed. Short of changing the beneficiary, only one rollover per year is possible if the account owner is unhappy with the investment results. Thus, a Section 529 Plan may not be the right vehicle for a donor who wants much more control over the investments.
There is no proven track record to determine the performance of a particular Section 529 Plan, particularly with Prepaid Tuition Plans where the state treasury office will be doing the investing.
Because the Section 529 statute and the Proposed Regulations are still new and untested, and seemingly subject to annual revision, the tax results with these plans are not yet entirely clear.

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