A 529 College Savings Plan is one that allows parents to put aside money for the future higher education expenses of their children. This plan is one of the best ways to save because, unlike most other savings plans, education-related withdrawals are free from federal income tax. Many states have chosen to adopt the same policy and also allow tax-free withdrawals for qualified expenses.

When we had our first son, it was a no brainer to open a 529 plan to save for his college.  We have followed suit opening a new plan with each child.  Well….almost.  Our now two month old doesn’t have one yet, but soon will.

Note:  Not sure how much to save?  If not, check out my post that addresses how much you should save for college.

Performance of 529 Plans

Earnings from 529 Savings Plans are based on the performance of its investments, usually mutual funds. These plans are only administered by states. An interesting fact about 529 Plans is that you can choose to invest in one from any state. And almost every state has one. State plans are often different from each other in one or more of the following ways:

• Structure of the plan
• Type of investments offered
• Benefits for out-of-state/in-state investing

Check Your State First

If you are interested in starting a 529 College Savings Plan, you should first look at the plan your state offers. Although most states allow non-residents to invest, there are usually advantages to investing in your own state’s plan including:

• State tax advantages and deductions – some states give tax-free status only to residents
• Matching grants
• Opportunities for scholarships
• State financial aid exemptions
• Creditor protection

Definitely go with your state if it gives deductions and/or credits on your tax return. This state tax break will most likely be a bigger asset than the possible lower fees from another state. The state of Illinois just increased the state tax rate from 3 to 5%, to give me even more incentive to use our state plan. New York, Minnesota, Missouri, and Michigan offer exceptional plans for their residents. Some states are so forward-thinking that they give their residents a state tax break no matter what state plan they invest in. Pennsylvania was the first state to do this.

If your state does not fall into this category and does not offer enough incentives to its residents, there are a number of states with a proven track record. Year after year, these states have had some of the best 529 College Savings Plans:

Some of Best College Savings Plans By State

• Alaska – T. Rower Price College Savings Plan
• Alaska – University of Alaska College Savings Plan
• Michigan – Michigan Education Savings Program
• New York – New York’s 529 College Savings Program (Direct Plan)
• Vermont – Vermont Higher Education Investment Plan
• Maryland – College Savings Plan of Maryland (College Investment Plan)

Some of these plans are direct sold, meaning you purchase the plan directly from the state. This is the way to go as broker-sold plans usually include sales charges, although they offer slightly more investment possibilities. Many of the best plans are managed by Tiaa-Cref, Fidelity, or Vanguard. In fact, those plans generally charge the lowest fees.

Other Factors to Consider

There are multiple factors that will affect return on your investment including:

• How much time do you have? Are you starting a plan when your child is an infant or a junior in high school?
• What sort of fees and other charges will you have to pay?
• What is the tax bracket of your family?
• How much money are you investing?
• Is there a possibility of state tax deductions?

It is amazing that you can choose to invest in a 529 College Savings Plan from almost any state in the country. With such selection, you are sure to find the perfect investment opportunity for you and your college-bound child.

photo credit: OldOnliner

If you’re like most Americans with school-age children or grandchildren, you may be wondering how you can ever save enough money to send them to college. Every year you hear that college costs are rising more than inflation and that, 18 years from now, it will cost a lot more to send your child to public or private school.  My son is almost two, and the cost of college is already on my brain.

Even if you can’t save a lot, you can still take advantage of a college savings plan. With this in mind, I thought it would be helpful to take a look at some popular ways to save for college. I condensed the information into 10 questions people frequently ask me about college savings.

1. How can I estimate future college costs?

The FinAid.org cost calculator can help you figure out how much a particular college will cost at the time your children or grandchildren will attend.  It’s a little more generic in nature, but it can give you a good sense of what the basic costs might be.   In working with clients,  I also have a software program that I use that has a list of most colleges throughout and you can get a real sense of what the estimated cost for an actual college might be.

2.  Why start a college savings plan early?

The longer you wait, the more money you’ll need to save to meet your goal. By the time today’s newborns are set to enroll in college, four years at a public university will cost more than $200,000. While getting an early start is key, it’s never too late to begin saving for the educational objectives of those you care about. Doing so can make a meaningful difference — by potentially reducing the amount you or the account beneficiary may need to borrow to pay for school.

3.  What are some tax-advantaged ways to save for college?

Section 529 savings plans and Coverdell Education Savings Accounts are the two most popular ways to save for college. Many investors also use custodial accounts such as those authorized under a state-sponsored Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA).  There are pros and cons to which would be best.  Most notably, is if the child does not go to school.  Typically, what I see is for parents that what to save some money for the child, but don’t want to force them to go to school, the the custodian account works best.  Reversing the situation, and you’ll see the other two being used, most commonly the 529 plan then Coverdell Education Savings Account.

4.  What is a 529 savings plan?

Named after Section 529 of the Internal Revenue Code, 529 college savings plans provide a tax-advantaged way to save for qualified higher education expenses. These plans are generally sponsored by individual states, while plan assets are professionally managed by independent investment firms or state government agencies. Anyone can open a 529 savings account regardless of income level and contribute up to $13,000 ($26,000 for married couples) a year without gift-tax consequences.

5.  What are some features of Coverdell Education Savings Accounts?

Coverdell Education Savings Accounts have been offering tax-free withdrawals for higher education since 1998.  Unlike 529 savings plans, withdrawals can be used for elementary and secondary education and even for academic tutoring and education-related computer expenses.

There are income restrictions though.  If your modified adjusted gross income (MAGI) is less than $110,000 ($220,000 if filing a joint return), you will be eligible to contribute to a Coverdell account.  Annual contributions are also limited to $2,000 a year.

6. Can I invest in both a 529 and Coverdell account?

Yes, investments in a 529 savings account will not affect your ability to invest in a Coverdell Education Savings Account for the same beneficiary.  Investing in both can be an especially good idea because the two complement one another.   It’s similar to having a retirement plan at work and then also having an IRA, as well.

7.  Are UGMA and UTMA accounts still good choices?

For many years, UGMAs/UTMAs were the only substantial education savings vehicles available, so many investors have built up sizable amounts in these accounts. UGMA/UTMA accounts do not have income or contribution limits. And, at least part of your earnings may be exempt from federal income tax. Some or all will be taxed at the child’s lower rate if the child is under age 18.

Contributions to UGMA/UTMA accounts are irrevocable, meaning that once the money or other property has been given, you cannot change your mind and withdraw the gift.

You can withdraw money anytime for the benefit of the child — not just for education. The child assumes control of the account upon reaching the age of majority (18 or 21 in most states).

8. Do gift-tax rules apply to college savings plans?

Contributions to 529 savings plans, Coverdell Education Savings Accounts and UGMA/UTMA accounts are subject to gift-tax rules. Under these rules, you can contribute up to $13,000 a year ($26,000 for married couples) without gift-tax consequences.

Under a special election, you can invest up to $65,000 ($130,000 for married couples) to a 529 account at one time by accelerating five years’ worth of investments with no federal gift-tax consequences. If you make this election, additional contributions or other gifts to the same individual over that five-year period will exceed the annual gift-tax exclusion.

9.  What if my child does not go to college?

With a 529 savings plan, you can leave the money in the account in case your child decides to attend college at a later time. Or you can select a new beneficiary, including yourself or anyone who is a member of the current beneficiary’s family. If you take the money out for anything other than education, you will pay ordinary federal income tax plus a 10% penalty on the earnings.  Keep in mind that the 10% penalty does not apply to scholarships.  This means that if your child were to receive a scholarship, you would be able to withdraw the scholarship amount of the account without getting penalized.

With a Coverdell account, the beneficiary must use the assets by the time he or she reaches age 30, or a new beneficiary must be named.

For UGMA/UTMA accounts, you will owe capital gains tax whenever shares, stocks or bonds are sold.

10. What do you use for your child?

Currently, we are using an out of state 529 plan because I felt it offered better investment options.   I will in the near future start an in-state plan as well, just as another level of diversification.   While helping our kids through college is on our minds, we do not expect to fund the full tuition.   If we have the money we will, but we also want our child to appreciate the gift of education.

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