College tuition adds up to 529

To parents trying to save, these tax-free plans have lots to recommend them

Your Money

August 22, 2004|By Andrew Leckey

It's back-to-school time, which translates into "have we got enough money" time for the nation's college students and their families.

One of the most powerful financial tools, the Section 529 College Savings Plan, has grown to $40 billion in assets.

Created in 1996 and named for a section of the tax code, it expanded in 2001 to permit tax-free distributions for education expenses. Almost every state and the District of Columbia offer 529 plans.

Yet there have been growing pains, most recently the market being unkind to investors with stock mutual funds in their portfolios. Mutual fund scandals haven't helped morale, either.

"I started investing two years ago in a 529 plan for my daughter Elizabeth, now 6 years old, with $100 debited from my bank account each month," said Cynthia Connell of Denver, mother of two youngsters. "The total amount is now the same as what I'd contributed, but at least it hasn't lost anything."

While Connell is smart to start saving early and will experience upward cycles, too, it's still disheartening. There's also confusion about these plans, and some charge more than others in fees.

"When you shop among 529 plans, it is obvious they are all different, with different investments, rules, fees and expenses," said Joseph F. Hurley, founder and chief executive of Savingforcollege.com LLC in Pittsford, N.Y., and author of The Best Way to Save for College - A Complete Guide to 529 Plans (Bonacom Publications).

To simplify, those states offering 529 plans have promised they'll come up with a uniform approach to presenting investment results and costs by year-end.

Rep. Michael G. Oxley, the Ohio Republican who chairs the House Financial Services Committee, asked the Securities and Exchange Commission to require better fee information, at least one low-cost option and protection against penalties for investing in out-of-state plans.

Fraud became an issue recently when the director of Utah's 529 plan, with $715 million in assets and 45,000 accounts, was fired for transferring money from the plan's administrative funds into his personal accounts. The Utah 529 plan is one of the better plans because of its low fees and range of investment choices.

The SEC set up a task force to examine 529 concerns, while the National Association of Securities Dealers is investigating securities firms for possible misconduct in their sale.

Understand the 529 positives because it's still a good deal.

Investment minimums may be as low as $25. Money typically can be invested in a number of portfolios and used at any school for all qualified higher education expenses. There are no annual taxes on dividends.

While all gains and withdrawals are tax free, Congress must decide by 2010 whether it will continue that tax-free status. Participants can transfer assets from one state's plan to another, tax free, once every 12 months. If you invest in your own state's 529, there may be worthwhile state tax deductions on contributions or exemptions on withdrawals. Check out plan details.

Some of the most attractive 529 plans, according to Sav ingforcollege.com, are the University of Alaska College Savings Plan; the Colorado Scholar's Choice Savings Plan, and the West Virginia Smart 529 College Savings Option. Comparative ratings of all 529 plans for state residents and non-residents are online at www. savingforcollege.com/529'plans/5'cap'ratings/.

Despite these benefits, consider all options.

"For people sure they're not going to qualify for financial aid, putting some money into the Coverdell Education Savings Account may be better than putting everything into the 529," advised Kalman A. Chany, president of Campus Consultants in New York and author of Paying for College Without Going Broke (Random House/Princeton Review Publishing).

"The Coverdell is always going to be a tax-free withdrawal, no matter what Congress decides to do about the status of the 529 by 2010."

With the Coverdell, interest earned is tax free and withdrawals aren't taxed if you use the funds for qualified college expenses. Single individuals with incomes under $94,000 and married couples with income under $190,000 can contribute $2,000 annually for each child until the child reaches age 18. Contributions decrease at higher income levels.

Most experts agree on whose name should be on any college savings account.

"It's generally best to keep all college savings in the parents' names because that keeps it out of universities' financial aid calculations," said Mark Balasa, president of Balasa Dinverno & Foltz LLC in Chicago, noting that parents also lose control of money held in a child's name when the child reaches the age of majority.

Parents should put as much money as possible into their own 401(k) retirement account because that money needn't be reported on the federal government's financial aid application and most colleges don't consider it when awarding aid, Chany said.

With a traditional or Roth individual retirement account you can avoid the 10 percent additional tax on withdrawals before age 59 1/2 when you use it for qualified higher education expenses. You must still pay income tax on at least part of the amount withdrawn.

"As a grandfather who just opened three 529 plans for his three grandsons, I think they're a terrific vehicle," said James A. Belvin Jr., director of financial aid at Duke University in Durham, N.C. "But the key is to start early in all college saving because the value of compounded interest is huge."

Andrew Leckey is a Tribune Media Services columnist.

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