By Daniel Goodwin
College costs out pace core inflation by a long shot and if you have children or grandchildren the sooner you start a savings/investing plan the better. In fact, I think you should do it the year the child is born. You will get used to the cost coming out of your family budget and your account has a long time horizon. My wife’s dad started a college savings fund for our kids and added fifty dollars per month for 18 years. At graduation each child had a large head start with college costs. The accounts survived the tech bubble burst, the mortgage crisis and many other ups and downs the markets provided. Entering college each of my kids had close to $40K in the accounts. Our kids college is now being funded by savings accounts, kids working, scholarships and plain old bootstrapping…..paying as we go from cash flow. We have a daughter at Baylor and our son is at OSU. Our gift to them is a start in life without the burden and saddle of debt.
The most common college savings vehicle is the 529 plan, but it is not the only plan. Others invest in real estate earmarked for college and some use cash value life insurance among other funding choices. In this article we will limit the information to the 529 plan. Let me add here that I would never go straight into a 529 plan without discussing the pros and cons of all college funding options with a trusted advisor beforehand.
529 Plan Basics: A 529 plan is a tax-advantaged savings plan designed to encourage families to save for college. Earnings on 529 investments accumulate tax-free, and distributions are tax-exempt as long as they are applied toward eligible education expenses such as tuition and room and board. 529 plans are named for the section of the federal tax code that governs them. They are sponsored by individual states and managed by a mutual fund or other financial services company. The investments underlying a 529 plan typically consist of mutual funds.
Important points about 529 plans: Account owners maintain complete control of the account and there are no income limitations. Anyone who has reached the age of majority, as specified by their state of residence, may open an account and anyone may contribute to a beneficiary's account (grandparents, aunts, uncles, and friends.) Account maximums are typically high enough to cover qualified undergraduate, graduate and professional education expenses. Account owners may change a beneficiary to another eligible family member or to themselves if the beneficiary does not continue with higher education. Distributions must be used for qualified higher education expenses (tuition, fees, room, board, books, equipment and supplies) at any eligible educational institution nationwide including colleges, universities, graduate schools and trade schools. Earnings on distributions used for non-qualified expenses will incur taxes plus a 10% penalty and may also have state implications. No penalties are imposed for withdrawals in the amount of scholarships the beneficiary is granted. Account owners may make one investment strategy change per year.