529 Education Savings Plans

529 Education Saving Plans & Other Ways to Save for College

Qualified Tuition Plans (529 or QTP College Savings Plans)

Qualified investment plans were first developed by some states to allow parents to lock in today’s tuition rates for future students at that state’s colleges. They are still offered, but can cause problems if the student decides to go elsewhere, especially to an out-of-state institution.

There are more restrictions than are on the 529 savings plan and the impact on the Expected Family Contribution (EFC) is greater than with a simple 529 savings plan.

529 savings savings plans can be set up by anyone to pay the qualified educational expenses of a student. There are no income limits and you can set up a plan for your or anyone else’s child.

These plans are meant to pay for tuition, books and room and board (for students who are more than half time). The maximum contribution to a 529 plan is $300,000 per student. This amount cannot be contributed in a lump sum. Several smaller contributions are necessary.

The money is invested with certain mutual fund and other financial institutions. It grows tax free.

According to the IRS, “contributions to a 529 plan on behalf of any student cannot be more than the amount necessary to provide for the qualified education expenses.” So while the return of capital is tax free, earnings in excess of qualified expenses will become taxable to the student.

You can contribute to both a 529 savings plan and a Coverdell Education Savings Account for the same student each year.

These plans are run by major mutual fund companies and other financial institutions. As with any other investment of this kind, you have to consider costs and return. Try to avoid any fees to set up and maintain the account and look for mutual funds with good long term track records and low expense ratios. Under 1.5% would be best. Fees and expenses can cut into investment returns much deeper than you might think.

529 savings plans are considered parental assets and have a minor effect on financial aid.

Finally some companies, such as Upromise, Babymint, and Sage Scholars offer parents rebates of 1-10% on purchases made with certain retailers. These rebates are designed to be invested in specific 529 plans.

Coverdell Education Savings Plans

Coverdell Education Savings plans are designed to pay a child’s primary school (K-12) expenses. Funds are to pay tuition, transportation, uniforms and books. Also the funds can be used for tutoring or a personal computer.

Like an IRA, the Coverdell account must be a specifically designated trust or custodial account set up in the US for the sole purpose of meeting qualified education expenses.

Contributions must be in cash and cannot exceed $2000 a year per beneficiary. The $2000 limit also applies to the beneficiary, so that Grand Dad and Uncle Jack can’t be making additional $2000 contributions.

Contributions cannot be made once the child turns 18 unless he has special needs and any excess must be distributed once the child reaches 30, except again if he has special needs, or dies.

Uniform Gift to Minors Act

Anyone can gift a child under the age of majority (18 in most states and 21 in the rest) up to $11,000 a year under their gift tax exclusion. This money is placed in a custodial account. The custodian, who may or may not be the person contributing the funds, assumes a fiduciary duty towards the funds, meaning he must manage them in a reasonable business-like manner.

Once the child reaches majority, he can take control of the funds and direct the custodian on how to invest them (or buy a new Corvette).

The first $750 in earnings each year is free from federal tax and the next $750 is taxed at the child’s rate. Any other earnings are taxed at normal rates.

This form of giving was once popular. It was a way for grandparents or other wealthy relatives to transfer wealth to their descendants with some tax advantages.

But as noted, there is nothing to stop the child from blowing the money once he reaches majority and there’s no way to ensure the money goes for education or any other specific purpose.

So this form of giving is falling out of favor. These accounts can be rolled over into 529 savings plans and probably should be if your concerned about the child’s education.

Besides the 529 also provides better tax advantages.

US Savings Bonds

The old US Saving Bond program still has a life left in it. Series I bonds are even indexed for inflation.

As far as educational funding is concerned, there is a full or partial exclusion on the taxation of the interest if the proceeds are used to pay tuition at an eligible institution of higher learning.

You can buy up to $15,000 of Series EE bonds and $30,000 of Series I bonds a year. If the proceeds are used for education, interest is entirely free of taxation if your income is below $81,000 if married and $54,000 if single. If you make more, the exclusion falls as your taxable income rises.

Like 529 plans, savings bonds are considered parental assets for financial aid purposes.

Other Tax Sheltered Plans

While 529 plans may be the most popular and most flexible way to save for college, there are other, non-traditional methods that make sense in certain cases.

Recent laws have made saving for college via Roth IRAs a lot more favorable than in the past. All three major retirement vehicles listed below have advantages over 529 plans and Coverdells in that none of these plans count as assets when calculating financial aid, thus generally increasing grants and overall aid.

Roth IRA’s

Roth IRA’s are available if your adjusted gross income is under $95,000 for singles and $150,000 for couples. By the time you reach $111,000 for singles and $160,000 for couples, you no longer qualify for them. This year the contribution limit is $4000 if you’re under 50, $4500 if above.

Roth IRA’s can be invested in just about anything and growth is tax free. If used for qualified educational purposes, funds can be withdrawn free of federal (and maybe even state) taxes and penalties. Like traditional IRA assets, Roth assets are not counted in determining financial aid eligibility.

Traditional IRA's

Like Roth IRAs, traditional IRAs have a $4,000 annual contribution limit and funds can be withdrawn early for educational expenses. While withdrawals are penalty free, they not tax-free, since contributions into traditional IRAs are tax deductible on both federal and state levels, if you met the rather low limits imposed by the IRS. These IRA’s are not included in financial aid calculations.

Borrowing from Your 401 K Plan

This is not the best thing to do. You really should not sacrifice your retirement for your children’s education. Your children can get financial aid for college. You can’t get financial aide for retirement.

If this is the only form of savings you have have you might want to consider a 401K loan, but I would not do so it it means either stopping or limiting your contributions while the loan is being repaid. This is especially important if your employer is making matching contributions.

Also be aware, if you lose your job, you have to repay the loan quickly or face severe tax penalties.

Stocks, Bonds & Mutual Funds

It is good to save and invest and saving and investing for your children’s education is certainly a worthwhile goal. There are no tax advantages here, just a straight fort effort to grow income.

If you can afford it, open a mutual fund account in your name (for financial aid purposes) the day you child is born and add $50 or $100 a month to it. Earmark this for educational purposes only.

If you have more children, try to do the same for each.

If you put in $50 a month for 18 years and get a 6% after tax return you would have $19,357 to go towards tuition. If you could afford $100, you would have almost $40,000 saved up. In either case, you would have no worries about tuition.

Of course it makes more sense to do this within the confines of a 529 savings plan, but there are no limits on contributions and no penalties on withdrawals this way. The only thing you need worry about is taxes. (If you invested the same $50 for 18 years in a 529 plan, getting a pre-tax growth rate of 8.3%, the equivalent of 6% after taxes, the money would grow to $24809.)

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