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The old college try

Personal Finance | Tuition prices keep soaring, but 529 plans can help parents saving for higher education

Issue: "Left behind," June 28, 2008

Besides retirement planning, few financial issues generate as much attention as saving for college. Parents today are often in a better financial position than their parents were a generation ago, and want to bless their children with as much assistance as possible. Additionally, college expenses have sky-rocketed, and many feel a tremendous burden related to its affordability. The dramatic inflation rate associated with college tuition (averaging between 7 percent and 10 percent annually) creates anxiety as to what the expense will be by the time their now young children are college age.

The first thing that has to be done is to determine your goal. Some parents of greater means may want to make sure that they have provided enough college funds for all of their children to have all of their tuition, room, and board covered, for all the years they are in school. Other parents may choose to have their kids go through the same financial aid and loan process that they went through, and not cover all of their tuition for them. Your values and goals have to start the process.

Time is on the side of those who are able to begin saving for college funding early. Lump sum contributions up-front will receive the benefit of "compounding." Of course, many do not have current excess funds sitting around to contribute toward college saving goals, so ongoing monthly contributions will need to suffice.

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For years, parents used UGMA/UTMA accounts for college savings (also known as "custodial accounts"). These vehicles were taxed more efficiently than if the funds were in the parents' names, and allowed for outsiders to contribute (such as uncles and grandparents). The downside to these accounts are two-fold, relative to a new vehicle available: (1) There is still some taxation on the investment income and earnings, and (2) The money is irrevocably the property of the child at age 18.

While all of us want to believe that our children will be able to handle receipt of these funds at age 18, wise parents may at least want to plan for the possibility that this will not be the case. While custodial accounts maintain flexibility in how the funds are used (i.e., a house down payment, college expense, etc.), they are an imperfect college savings vehicle. The money becomes the child's money, no matter what, at the age of maturity. However, 529 College Plans (named after Section 529 of the IRS revenue code) provide parents additional options.

These accounts are newer vehicles that provide far greater tax features and control benefits to parents and grandparents. In a 529 plan, substantial funds can be saved for college (the exact dollar amount varies by state), and 100 percent of the income and growth of the account will be tax free, if the funds are used for qualified college expenses. Additionally, the funds are always at the control of the parent. The beneficiary can be changed by the parent, and all decisions related to the funds remain the right of the parent to make.

A few caveats: Which 529 plan you choose should depend on what state you reside in, and what plan offers the best investment features to you. There are some particulars state-by-state you should be aware of before proceeding. Additionally, if your goal in saving for a child is not related to college (such as private elementary school, or future real estate assistance), a 529 account is not the vehicle for you.

But for college saving, 529 accounts provide far greater advantages than did vehicles available in the past. For parents who lack the resources to contribute to their children's college savings, a future article will deal with the plethora of opportunities available in the world of financial aid and grants.

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