By: Investor Solutions, Inc.
Where will you get the cash to send your child or grandchild to college? According to the College Boards annual 2004 survey of college pricing, the average tuition and fees for the 2004/05 school year increased 10.5% at public four-year universities, 8.7% at public two-year colleges, and 6.0% at private four-year colleges. If youre a gambling man, one thing that you can safely bet on is that college costs will continue to rise. Sending your kid to a four-year public school during the 2004/05 term will cost you an average of $10,659 in total annual charges (tuition, fees, room, and board). And if public college costs continue to rise at 10.5% annually, youll have to dig deep into your pockets 18 years from now to foot an annual $64,304 college bill.
Suppose you had a newborn baby this year and you wanted to fund a four-year public college education 18 years from now, you can expect to pay well over $300,000 in total charges if education continues to rise at the 10.5% level. Well, dont sweat it; there are some solid solutions currently available to help you reach your goals. Such as the Coverdell Education Savings Account, Prepaid College Tuition Plans, Roth IRAs and 529 College Savings Plans to name a few. All of which are great college savings tools, but only the 529 College Savings Plan can actually make it possible for you to accumulate enough savings to realistically cover the actual total costs associated with the four-year college payment prison sentence.
The 529 College Savings Plan
The 529 Plan was signed into law by Congress in 1996 to provide college hopefuls with a tax-advantaged savings tool that would allow a higher savings rate for those looking to set more aside for future college costs. Provided that the earnings in the 529 Plan are used for qualified educational purposes, they can be withdrawn free of federal income tax. And to top that off, the earnings may also be free of state taxes, and get you a state income tax deduction for contributions as well. So, if you and your spouse invested $75,000 in a 529 plan over 18 years and the account grows to $200,000 the full $200,000 can be withdrawn tax-free provided it is used for qualified educational purposes (tuition, fees, books, supplies, and equipment required).
According to the Wall Street Journal, total 529 Plan savings grew 49% in 2004 to $52.3 billion, so its obvious that Americans want to save more to prepare for the effect of rising college costs. A major attractive feature of the 529 plan is the ability to use them as an effective estate planning tool. A grandparent wanting to protect some of their estate can invest up to $55,000 per grandchild at one time (which is the $11,000 annual gift exclusion for five years). Although 529 Plans are scheduled to lose their tax benefits in 2010, most investment professionals believe that Congress will extend the plan benefits.
How they are Flawed
One of the problems with 529 Plans (like many other investment products) is that there are good plans and bad ones. Some of the critics are irritated because of disparities among state tax laws, common misinformation among the broker population, puzzling and high fees associated with the plan, and pressure on investors to use 529 plans when other sources are available. The various fees such as: maintenance, fund expense, annual distribution, front-end or back-end sales charges and enrollment fees connected to the 529 plans have gotten way out of hand in some of the plans. In some plans, the fees alone can be as high as 3 to 4 percent of the total account value annually, and that can be after the state, the mutual fund company, and the broker have taken their fees.
The good news for investors is that the National Association of Securities Dealers (NASD) and the U.S. Securities and Exchange Commission (SEC) are realizing that there may be some problems with the plans. The NASD has conducted its own investigation of more than a dozen broker-dealer firms that have sold 529 plans to investors. Why? Mainly because brokers still have the incentive to steer a client towards the 529 plan that pays them the highest commission, while avoiding the plan that is best suited for the client. At a minimum, Congress is expected to propose that 529 plan fees be more clearly disclosed.
Even those who are decisive of the plans believe that the tax savings associated with 529 plans must continue. Some other plans have annual contribution limits such as the $2,000 annual limit (may be subject to AGI limitations) on the Coverdell Education Savings Accounts, which makes it difficult to accumulate significant savings. The 529s continue to promote people to keep investing, and give parents hope that they can save enough money to stay ahead of rising tuition costs.
What You Can Do
Its no secret, index funds are a low-cost smart way to own entire market segments. And some states are getting wise and offering these funds within their plans. Most index funds offer a no-load, low expense fee approach which enables investors to achieve higher returns by putting more back into their pockets. The State of Arkansas (currently with Mercury-a Merrill Lynch affiliate) got smart and will be switching plans over to the Vanguard index funds this year to take advantage of this strategy.
Check out the plan offered by your state as well, since some states have encouraged their residents to invest in their own states plan by offering state tax credits. Be aware when utilizing the state tax deduction, changing plans to another state might trigger your former state to come back after you to recoup the refund you received in years past. But this should not be your principal buying point anyway, the total fees charged, investments available, and understanding of the plan should be your primary concerns when selecting a 529 plan. Check out http://www.savingforcollege.com to see how your states plan matches up with those available in other states.
Three common misconceptions about 529 plans sometimes leave investors hesitant to set them up for a child. These include that the child/grandchild must go to college in the state for which the plan is funded, savings are lost if not used by the child, and that you can only participate in the plan offered within your state of residence. Well, the great news is that you can chose a plan from any state that best fits your needs, and the funds do not need to be used for a college within that state- they can be used for qualified education expenses at the college of your choice. Should your child opt not to go to college, then the beneficiary may be changed to help someone else support the costs of college. Funds can be withdrawn for personal use, but the IRS frowns upon this and will impose an income tax penalty.
When comparing college graduates to those with a high school diploma, American workers 25 and older with a bachelor’s degree earn 93% more, are 48% less likely to be unemployed, and are 72% less likely to be receiving public assistance (Institute for Higher Education Policy). This is not rocket science; we all want our children/grandchildren to have the opportunity to seek a higher education should they desire to take that step. The real issues are developing a solid and disciplined approach to accumulate enough savings to keep up with the rising costs of college education and finding a plan where the best interests are yours and not making the state, the mutual fund company, and the broker rich.
The College Board, Trends in College Pricing 2004 (http://www.collegeboard.com)