529 college savings plan has multitude of benefits

PERSONAL FINANCE

March 18, 2001|By EILEEN AMBROSE

ACTUARY AND new dad Greg Poirier can do the math.

His daughter, Olivia, is about 3 months old, and college is likely to be a lot pricier when she'll be a student. The Ellicott City father is weighing his savings options and likes some of what he hears about state-sponsored 529 plans.

There are two kinds. One allows parents to pay tuition in advance, basically locking in future tuition based on today's prices. But far more popular - and the one that's captured Poirier's attention - is the college savings plan.

And with good reason. There's a lot to like.

Parents, or even grandparents, can put money into the plan, where it's invested for them. There's no guaranteed investment return, but the account grows tax-deferred until the money is withdrawn for college-related costs at any school. At that time, the earnings are taxed at the child's income tax rate, which likely will be lower.

Some states, too, allow residents to deduct plan contributions from tax returns and won't tax earnings at withdrawal.

And parents remain in control of the account. So, if Junior decides to bag college, parents can name another child or relative as the account's beneficiary. Or parents can withdraw the money for noncollege purposes, although they will owe taxes and a 10 percent penalty on the earnings.

"The 529 is protected from any spending urges that I or my wife may have," Poirier said.

Despite the benefits, college savings plans aren't for everyone, some financial experts say.

Parents in lower tax brackets may be better off saving for college outside the plan because it can adversely affect the student's ability to qualify for need-based financial aid, said K. C. Dempster, director of development for College Money, an education planning and consulting firm in Marlton, N.J.

Much of that aid today comes in the form of low-interest loans, which are still valuable resources for many families, she said.

College savings plans, too, may not be ideal for hands-on investors who don't like giving up control of how their money is invested, experts said.

"Some people who like to move their investments around a lot won't have the patience to put up with the investment restrictions in a 529 plan," said Joseph Hurley, chief executive officer of Savingforcollege.com LLC in Pittsford, N.Y.

Is a college savings plan for you?

Of course, a lot can change between now and when a child goes to college. Financial aid formulas may be readjusted. Congress is considering legislation to exempt earnings on college savings plans from federal taxes, making the plans even more attractive.

In the meantime, though, parents need to look at their finances, tax bracket and need-based aid prospects when weighing the advantages of a college savings plan or some other savings option, experts said.

And save they must, experts said. Most families are expected to contribute to their child's education, and the more money set aside now means less borrowing later.

You can get an estimate of your expected family contribution by filling out online worksheets at www.finaid.org or www.collegeboard.org, said Judy Miller, a financial planner with College Solutions in Alameda, Calif. Having more than one child in college at a time increases the chances of receiving aid.

"It's very likely the people who would qualify for financial aid when the children are younger also will qualify when they're older," Miller said. "College expenses are going up twice as fast as the cost of living."

College savings plans are best suited for parents in a higher tax bracket, because such people are less likely to qualify for aid and stand to gain the most from tax deferral, said Dempster, who has analyzed the plan's effect on aid and taxes.

Those in the 28 percent or lower tax bracket may be better off saving under their own names in a mutual fund that includes stocks, she said.

That is because of the way aid is determined. Parents are expected to contribute a much smaller percentage of their assets and income to college than their children are. Financial aid formulas consider assets in the plans as the parents' money.

But once withdrawals are made, the earnings are considered the child's income and can reduce financial aid the next year. "That's when the problem occurs," Dempster said.

Indeed, if parents are eligible for aid, but have salted away, say, a year's schooling in a college savings plan, they should postpone using the plan's funds until senior year to minimize the impact on aid earlier, Dempster added.

If you conclude that a college savings plan is best for you, shop around. Thirty-four states now offer the plan, and 27 of those open their plan to outside residents, Hurley said. Maryland, which offers a prepaid tuition plan, expects to launch a college savings plan in October.

Hurley's Web site, www.savingforcollege.com, provides details of state plans.

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