| Are You Ready for College
Sticker Shock?
Every August for the last 5 years I have
been experiencing College August is the month when tuition payments for college start coming due, and I have to write a couple of big checks. (Photo: Dartmouth, an Ivy League college, is a hotlink.) College costs are rising at an outlandish rate. The national average is around 7%. That means the cost of college is doubling about every 10 years. If you have young children and are thinking about college for them, you better be putting money aside, starting yesterday. Writing those checks is never easy, no matter how long you have been saving. Fifteen years ago parents didn’t have the options that are available today when it comes to saving for college. Back then about all that was available was a custodial account, which offered relatively few tax advantages. A few years back the geniuses writing the tax code decided to give parents a real incentive in the form of an educational IRA. With that innovation you could put a whopping $500 per year away for college and not have to pay tax on the growth as long as it was used for educational purposes. Big deal! With that kind of savings plan you stood little chance of avoiding College Sticker Shock. You also had the option of invading your IRA or 401k to cover college costs. The attraction there was you could the 10% early withdrawal penalty if the funds were used for education. That about covers the college funding options you had back then. In their infinite wisdom the lawmakers who touted the value of education and pontificated on its long-term benefits failed miserably to provide working parents with any significant incentives to save for their children’s college expenses. New ways to save That has all changed now and fortunately they finally created some wonderful savings programs to take some of the sting out of College Sticker Shock. One of those tools is the 529 Plan. If you are wondering where they got the name, it refers to the section of the IRS code that describes how the plans operate. There are actually two types of 529 plans: the prepaid type and the savings type. I will cover the savings type. The concept behind these plans is very simple. Every state offers a plan and you can pick from them to find the one that works best for you. You can establish a plan for virtually anyone thinking about going to college. From the youngest child to the oldest adult, there is a 529 plan out there for you. If you are thinking about setting up a plan for yourself or another “older” student, just be careful that you find the right plan. Plan design varies from state to state. The beauty of the 529 is that you can put money into it and not pay any tax on it as it grows. When you withdraw money to pay college expenses, you don’t pay any federal income tax then, either. The states sponsoring the plan also offer some state income tax relief that varies from state to state. There are limits to the amount you can put into a 529 plan and right now many states allow up to $200,000 per beneficiary. Don’t be concerned if your student is not going to need all of the funds in the plan. You just designate another beneficiary that is a qualifying family member, and the plan continues on. Some plans allow you to keep any unused funds for yourself, but there are income taxes and penalties on the growth portion of the account. Managing plans and financial aid Management of the funds in the plans is also pretty simple. The assets are managed by institutional firms such as mutual fund families or professional asset managers. The owner of the plan really has very little to do in the way of day-to-day management of the funds. In some states the amounts in the plan are moved into more conservative investment funds as the student gets closer to the age when the funds will be needed. This helps protect the value of the account at the time when it is needed most. One question about 529 plans that comes up regularly deals with financial aid. Before any college will consider your student for need-based assistance you have to complete a bunch of forms from the Department of Education. Again parents these days have it much easier when it comes to completing the Free Application for Federal Student Aid (FAFSA). You can do it all online. When considering available assets this process assumes that 35% of the student’s assets will be used in the coming year for college, but only 5.6% of the parent’s assets are figured in. Since the owner of the 529 plan is the person setting it up and not the beneficiary, 529 plan assets are assessed at the lower rate. Distributions from 529 plans in subsequent years are a tricky. When it comes to calculating need based assistance there hasn’t been a lot of guidance provided as to how these funds fit into the financial aid calculations. Just as every state has a different plan, every college looks at the assets and distributions from 529 plans differently when determining how much need-based aid they will grant. As you can imagine this can get complicated quickly. The important thing to remember about 529 plans and saving for college is that you want to start saving as soon as you can. There are enough choices out there to find a plan that will work perfectly for you. Sunset caveat As a final thought. If you are thinking these plans are too good to be true, you may be right. Again in their infinite wisdom our lawmakers wrote into the law that created these plans a termination date. Currently these plans go away after 2010. The general consensus is that this period will be extended. These plans are just what we have needed for years to help reduce College Sticker Shock. Even the lawmakers should be able to see that. Next month I will cover my other favorite college saving vehicle: The Coverdell Education Savings Account. Contact Mark Neil at:
© 2003 Mark Neil |
