We receive inquiries constantly about saving priorities. Should I save for retirement? What about a home or a condo? How about college? Saving for all of these combined may appear to be a daunting task, but goals for savings should be planned and monitored at least once or twice per year. The one rule of thumb to remember is this: you can borrow money for college, but you cannot borrow for retirement. We have written about how you can make up the money but you cannot make up the time.
In this space, I wish to focus on 529 plans,
which are college savings plans sponsored by the government and offered by many financial institutions.
529 plans have finally given parents and grandparents alike a systematic program to save for college.
There are a number of differences between 529 plans and more traditional savings plans, the most popular being the “UGMA” (Uniform Gift to Minors Act) account. Under the UGMA format, the parent was acting as the custodian for the child; it was the child’s money, and theoretically, the parent had to give the asset to the child once he or she reached age 18. A 529 plan is totally different. The owner (which can be either a parent or grandparent) controls the asset, the child is the beneficiary, and because of this, there are many financial aid advantages. When reviewing a student’s eligibility for financial aid, colleges will not count the 529 asset as an asset belonging to the child. Consequently, he or she should be eligible for more financial aid to supplement what the 529 plan will pay.
There are also tax advantages to 529 plans.
All monies invested are invested on an “after tax” basis, however, all growth will be tax-free and all withdrawals will be tax free if used for qualified expenses. Assets from 529 plans are strictly to be used for college related expenses, such as tuition, room and board and books. 529 Plan monies are not to be used for purchasing a red BMW so Junior can look like BMOC driving to class.
There are also less publicized advantages to having a 529 plan.
Assume a family has two children with two separate 529 plans. If one child goes to a state school (with presumably less expensive costs) and the sibling goes to a private university with higher costs, one 529 plan can be used to subsidize the other with NO penalty. In addition, there need not be TWO separate plans, as the asset is interchangeable between siblings. In the event that neither of the beneficiaries goes to college and the grantor does not wish to access the funds for another use, the owner will pay ordinary income taxes on the growth, as well as a 10% penalty. The goal of these assets is to fund college expenses, and as long as they are used for that purpose, there is a true tax advantage. We would expect that, over time, these plans would become as popular as 401 (k) plans have, as this gives parents and grandparents alike a true systematic method to accumulate college related expenses.
The question of where to invest 529 assets can be a bit more cumbersome.
Many states have tax advantages if invested in their state sponsored plan. Typically, these consist of nominal deductions on state taxes. A consumer should see if his or her state offers such a deduction. In the event one is offered, analysis should be done to see if there is value added in going with the state sponsored plan, or choosing a more cost effective plan. For instance, both Maine and Rhode Island offer incentives to use their respective state sponsored plans. Please remember the higher the costs, the less potential returns you may receive. It is advisable to try to keep the management fees close to 1% per year. Are the underlying investments worthy, or would a consumer residing in both of those states be better off using, for example, the Massachusetts plan offered by Fidelity, the Maryland plan offered by T Rowe Price or the Virginia plan offered by the American Funds?
Asset allocation for the assets can be another area of intense discussion.
Many companies use a “target date” approach, meaning the overall allocation becomes more conservative the closer the child is to age 18. The problem is; all companies have different target date philosophies with different models. Check with your advisor or mutual fund company to receive disclosure, which is necessary. Many companies will allow you to”create” your own model. Care should be exercised in designing a model, which is neither too aggressive nor conservative. The investor should revisit the mix annually.
There are many other web sites, which will go into detail regarding 529 plans. Check out www.savingforcollege.com or any of the major mutual fund families for more detailed information.