The third biggest financial goal for a family is saving for a
college education. Buying a house and retirement are the first two
goals. With the cost of higher education on the rise, parents are
beginning to try and set aside money for education as soon as a child
is born. There are two popular federal and state sponsored plans that
make saving for college easy: the Coverdell and the 529 plan.
The Coverdell Education Savings Account
The
Coverdell is a federally sponsored plan that helps you to set aside
money for higher education expenses. These expenses include tuition,
fees, books and supplies, and even room and board.
The annual
contributions are not tax deductible, making the withdrawals tax-free
as long as they are used to pay for eligible education costs. There are
limits to the amount of annual contributions that can be made each year.
The
Coverdell is established as a custodial account, set up by the parent
or another adult to pay for the education expenses of a designated
beneficiary. The child must be under the age of 18 to establish an
account. All balances must be spent within 30 days of the child's 30th
birthday.
Any financial institution that handles IRAs can assist
you in setting up a Coverdell, including banks, investment companies
and brokerages. The Coverdell is like an IRA in that it is an account.
You can put your account funds into any investment you want - stocks,
bonds, mutual funds and certificates of deposit are just a few options.
You
can establish as many Coverdell accounts as you want to for a child.
For example, you could have one account at your local bank and one at a
brokerage. Some plans have many fees associated with them. Make sure
that the management fees for the multiple accounts don't cancel out
your overall return.
If
your child decides not to go to college, he or she will lose a great
deal of money. When he turns 30, he must withdraw the balance of the
account within 30 days. Any money withdrawn that isn't used for
educationally eligible expenses is taxed and charged a 10 % IRS penalty.
If
your child decides not to go to college, that doesn't mean that his or
her child won't. The child can roll the full balance into another
Coverdell plan for another family member, including siblings, nieces
and nephews and sons and daughters.
529 College Savings Plans
These
state sponsored 529 plans are named after the federal tax code section
that provides for their use. All 50 states and the District of Columbia
offer 529 plans. The contributions to the plan are not tax deductible,
but your withdrawals are tax-free when you use the money for a
qualified educational expense.
529 plans fall under two categories: prepaid tuition and savings/investment plans.
The
prepaid tuition plan allows you to purchase units of tuition for any
state college or university under today's price. You are buying a
semester of attendance for a child. What you buy today will be good for
any future date, no matter how tuition rates rise. With private and
out-of-state colleges, the child's prepaid tuition does not include the
rise in tuition costs. For example, if you buy two years of college
tuition for an out-of-state tuition, you may only receive a single
semester in ten years.
Either the beneficiary or the contributor must reside in the state that the 529 is formed in.
With
savings plans, an account is opened and investments are chosen within
the account. If you start the plan when a child is young, you can
choose some aggressive investments for long term growth. As the child
ages, you can move your investments into more conservative options.
The
withdrawals are tax-free if they are used to pay for college expenses.
These expenses can include tuition, books and room and board. An easy
way to think about a 529 savings plan is as a 401(k) dedicated to
educational expenses. As with a 401(k), there are many different
investment choices. Many states programs are open to nonresidents, so
look around for the best plans.
If your child decides not to go
to college you have three options. You can hang on to the savings plan
in case your child decides to attend college at a later date. The
account can be transferred to another family member for college
expenses. You could also cash out the account and just take the loss.
Most states will charge a penalty of 10% of the earnings for any
withdrawal not used for education. On top of this, a federal penalty of
10% will be charged also. There is no penalty for withdrawals due to
death or disabled status.
The tax-free advantages of a college
savings plan makes 529 plans beneficial, but they aren't right for
everyone. If you have a 529 prepaid tuition plan, applying for
financial aid is affected by reducing your financial aid on a dollar
per dollar basis. Low income families, who are often eligible for large
amounts of financial aid, are advised not to participate in 529 plans.
Coverdell
plans will also decrease the amount of financial aid available, but
only by about 5 to 6% of the account's value. College savings plans are
great for families that will not qualify for financial aid or only
qualify for loans. Many times a family doesn't have enough money to pay
for college, but has too much money to get help.
The tax-free status on 529 plans will end in 2010, but many advisors expect that Congress will extend it.
Martin Lukac (http://www.MartinLukac.com), represents http://www.RateEmpire.com and http://www.1AmericanFinancial.com,
a finance web-company specializing in real estate/mortgage market. We
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