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The first rule of saving for college is to save early and save often. Procrastination is the enemy, and so is inflation. According to the College Board, costs at four year, public colleges rose 5.9% in 2007 to $13,589 per year. What’s that going to cost you in 16 years? Are you sure you want to know? Okay, fine, it’s about $34,000. Multiply that by four and you’re looking at $136,000! Sounds terrible, right? Well it is. But if we start early, we can make this seemingly insurmountable expense a bit more manageable. In fact, if we assume a 7% rate of return over the 16 years, $400 a month should cover it. If you wait another five years to start your savings, plan on kicking in $680 a month. For those of you with older kids, it’s never too late. Start saving something, anything. Take advantage of compounding returns and whatever time you have left. Visit www.savingforcollege.com/college-savings-calculator/ for a good calculator to help you plan.
All the Cool Kids Are Doing It
Let’s turn our attention to where we’re going to put all of this dough. If you’re saving for college, a 529 Plan is an excellent choice. These accounts, named after the IRS code that makes them possible come in two flavors, a College Savings Plan and a Pre-Paid Tuition Plan. Pre-Paid Tuition Plans allow you to purchase tuition credits at today’s rates, and then use them in the future. As such, your maximum growth will equal the increase in tuition from when you buy the credits to when you use them. By contrast, College Savings Plans allow you to invest in a variety of mutual funds, and your performance will depend on the performance of the funds you’ve selected. While inside the College Savings Plan, your money will grow tax deferred and even better, can be withdrawn tax free if used for qualified higher education expenses (QHEE). QHEE typically include: tuition, rooming, books and supplies. Pre-Paid Tuition plans usually cover tuition only, so you’ll still need to come out of pocket for the rest.
529 plans are state specific, and while you’re not required to use your state’s plan, there are tax incentives to do so. In DC, you can deduct up to $4,000 per account owner, per beneficiary from your DC taxes. Federal gifting rules limit contributions to $12,000 ($24,000 for couples filing jointly) per year, per beneficiary. Using your state’s savings plan does not limit your child to in-state schools. Funds can be used at any school eligible for federal funding, including some outside the US. Pre-paid tuition plans, on the other hand, may limit you to in-state schools. They have cancellation options, but they’re not very generous. The tax incentives don’t mean you should automatically use your state’s plan. You’ll want to explore other plans as there can be significant differences in fees, investment offerings and quality between states. I recommend doing some homework before committing your money. A great place to begin is www.Savingforcollege.com. You can find more information on the DC plan at www.DCCollegesavings.com.
What Do You Mean I’m Not the Most Popular?
While 529s are the most popular college savings vehicles, they’re certainly not your only choice. Custodial accounts, sometimes called UTMA or UGMA accounts are also popular. Basically these are accounts opened in your kid’s name on which you are the custodian. Once your child reaches 18 years of age, the account becomes theirs, until then you make all of the decisions. It is important to note that upon turning 18, your child legally can do with this money as they wish. If they decide to blow the whole wad on a Beemer, there’s not a lot you can do about it. Custodial accounts can be bank accounts, CDs or investment accounts. So you can pick the investment that best suits your objectives and time frame. Since these accounts are in the child’s name, taxes are calculated using their tax rates. Also, funds in these accounts can be used for pretty much anything, including private school.
Coverdell Education Savings Accounts (ESA) are also fairly popular. Contributions to any one beneficiary can’t exceed $2000 per year. There are no tax deductions for your contributions, but deposits grow tax deferred and can be withdrawn tax free if used for education expenses. These expenses can include elementary and secondary school as well as college.
Less popular but still options are US Savings Bonds and Roth IRAs. Interest on Savings Bonds can be tax free if used for QHEE, provided the bond was owned by the parent who purchased it when they were at least 24 years old. Income limitations apply, so be sure to check the rules. Since contributions to Roth IRAs can be withdrawn, tax free at any time, you could use them to pay for education expenses too. Just be sure not to exceed your contributions and tap your earnings. If you withdraw earnings, provided they’re for QHEE you won’t owe the 10% penalty tax, but you will owe income taxes.
In-State, Out-of-State, There’s No Difference
Let’s shift gears for a moment and talk about how great it is to live in the District. Sure our public school system leaves something to be desired and parking stinks, but guess what? DC residents pay in-state tuition at any public school in the US. That’s a nice deal, yeah? The program called DCTAG (Tuition Assistance Grant) covers the difference between in-state and out-of-state tuition, up to $10,000 at any public school in the country. You can learn more by visiting www.seo.dc.gov.
There’s a lot more to know about the different education savings vehicles. Hopefully I’ve given you enough to get started, but I encourage you to do a little homework on your own, or consult with a trusted advisor. Remember, the best advice is to save early and save often.
Disclosures: Investors should consider their investment objectives, risks, charges and expenses associated with municipal fund securities before investing. This information is found in the issuer’s official statement and should be read carefully before investing.
Before investing, the investor should consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 plan. |
