MONEY TALKS - As a new parent myself, I recently experienced the euphoria of getting home from the hospital with my beautiful daughter. However, planner that I am, not far behind was the anxious feeling of, “how am I ever going to afford to send her to college?” I started to investigate what options were available by sifting through the maze of literature posted on the front of every business & finance magazine. I was familiar with 529 plans, but I didn’t know all the details and was concerned that it would limit my daughter’s college choices. As it turns out, I was half right. There are two different types of 529 plans with very different features from one another.
529 Plan - The IRS created the 529 plan, or “Qualified Tuition Program,” in 1996 to help taxpayers set aside money for a designated beneficiary to be used for college expenses. While this is more commonly used by parents and grandparents who want to contribute towards their child or grandchild’s education, there are no rules preventing an adult from setting up an account for themselves or anyone else for that matter. Specifically there are two different types of 529 plans, the Prepaid Tuition Plan and the College Savings Plan. Each state offers their own 529 plan, and you need not be a resident of a particular state to invest in that state’s plan. Although 34 states offer a deduction for 529 contributions, Massachusetts is not one of them, so I recommend shopping around for a state plan that best fits your family’s needs.
Prepaid Tuition Plan - The Prepaid Tuition Plan allows you to buy tuition certificates at today’s rates which can be applied towards tuition and fees at participating colleges in the future. The major benefit to choosing this option is it helps to fight against the rising cost of college tuition because you are essentially locking in a future tuition at today’s rates. For example, suppose public college tuition is $20,000 now and you contribute $5,000 to the plan. Since you prepaid 25% of the current year cost, if the tuition increased to $40,000, your certificate will be worth $10,000. One downside of tuition certificates is they only cover tuition and fees, they will not cover the cost of room and board, books, or supplies. Another downside is you are limited to the colleges and universities that participate in the plan. In the event your child decides not to attend one of the participating schools, you may withdraw your money at maturity; however, any earnings may be subject to taxation.
529 vs Prepaid Tuition - The more commonly used plan, known as the College Savings Plan, allows a participant to contribute after tax dollars. Any earnings are tax deferred and, if the money is used for qualified higher education expenses, withdrawals are federal income tax free. One advantage the College Savings Plan has over the Prepaid Tuition Plan is that qualified higher education expenses not only include tuition and fees, but also books along with room and board. Another advantage is you can use your account assets at virtually all accredited colleges and universities in the United States and eligible foreign institutions. If your child decides not to go to college, you can change the beneficiary on your account to an eligible family member or take out the money as a non-qualified withdrawal. However, if you do decide on the latter, keep in mind any earnings on non-qualified withdrawals are subject to federal income taxes at the recipient’s rate plus a 10% penalty.
The Right Plan - My wife and I ultimately decided to enroll in a 529 College Savings Plan because we liked the flexibility offered with the plan. The option of choosing an accredited college worldwide gave us great comfort that our daughter could attend virtually any college or university of her liking. Furthermore, the College Savings Plan we enrolled in had minimal initial funding requirements and flexible funding options such as automatic monthly withdrawals that made our contributions effortless. Choosing the right plan is up to you and your family, but before making such an important decision it is important to understand the facts. For more information visit www.savingforcollege.com or contact your local financial planner.