Paying for school with 529 college savings plans
Early this year Congress passed a sweeping financial aid law that aims to increase students' access to grant money and reduce the burden of federal loan repayments, but for many the prospect of paying for higher education remains daunting.
In the past decade, tuition and fees at four-year public colleges and universities grew nearly 5 percent per year beyond inflation, which is more than the previous two decades, according to the nonprofit College Board.
So how can you cope with climbing costs? Many parents, grandparents and others are turning to 529 investment plans because they offer tax-free growth, state tax benefits and flexibility. College savings plans known as "529s" get their name from the Internal Revenue Service tax code that sanctions them.
Member Michael Tanquary of Park Ridge, Ill., opened Illinois Bright Directions College Savings 529 accounts for his three children, aged 7 to 13, this year.
"A lot of people were saying Nevada had the best plan," Tanquary says.
But he wanted the tax benefits he'll receive next year with the Illinois plan, which allows married residents filing jointly to deduct up to $20,000 of contributions on their state income taxes.
"It got my wife off my case; I got a tax deduction," Tanquary says.
Two ways to save
There are two types of 529 plans and every state offers at least one, though the details vary.
"Savings plans" allow you to invest money in mutual funds or other investments whose value is subject to the performance of the market, much like a 401(k) plan. "Prepaid plans" allow you to pay in advance for all or some of the costs associated with an in-state school at a locked-in rate. As long as the funds are removed for qualified educational expenses, they won't be taxed.
"Right now, [529 savings plans are] the best way for parents to save for their children's college education," says Jason Crace, an accountant with the highly rated Comer, Nowling & Associates in Indianapolis.
Crace recommends his clients invest in Indiana's CollegeChoice savings plans, which he's using for his own children, in part because the state began offering a generous tax break for residents in 2007.
When investing in a 529, you're not restricted to your state. For example, if you live in Missouri, you can invest in a 529 savings plan offered by Utah and send your child to school in Vermont.
Experts say flexibility is what makes 529s an attractive investment.
"You, and not the beneficiary, decide when to take distributions and for what purpose," says Kenneth A. Pikor, a certified financial planner in Westerville, Ohio. "Any concern you may have about losing control of significant assets is greatly diminished."
With a prepaid plan you can also lock in a rate for public institutions of higher education when your child is young and not have to worry about tuition increases.
In-state tuition and fees at public four-year schools averaged more than $7,000 in the 2009-10 school year, up 6.5 percent from the year before, according to the College Board. Total charges were more than $15,200, a 5.9 percent increase from the year before.
Prepaying locks in rates
Member Joann Grisetti and her husband Stephen of Winter Haven, Fla., began investing funds about 20 years ago for their three children in their state's prepaid college plan, which is one of the oldest of its kind in the country.
The Grisettis' youngest son, James, was 3 when they began socking away just $17 per month in the program, which would allow their children to attend any of 39 public universities, community colleges and technical schools in the state.
Now 23, he's completing his degree without having to worry about paying tuition at the University of Central Florida in Orlando, the same school his older brother and sister attended.
"If I had to do it again, I would do it again, whether the kids chose to stay here or not," Grisetti says.
Many prepaid plans, including Florida's, can be converted if the beneficiary does not attend an in-state school. However, some states are closing enrollment because tuition increases are outpacing investment growth, though Florida and a handful of other states continue to offer them.
The Independent 529 Plan is the only private-college-run 529 and it allows you to lock in tuition rates at more than 270 private schools at a discounted rate.
Savings for the future
If you decide not to go with a prepaid plan and your state doesn't offer a plan with tax benefits, the task of shopping around might seem daunting. But Joe Hurley, founder of SavingforCollege.com, a website that compiles information on 529s, says if you have an IRA or a 401(k) with a company you like, you might consider choosing a 529 with the same firm.
"You can narrow your selection of 529s if you look for plans that have that firm managing them," Hurley says.
Some consumers also worry that 529s savings will adversely affect a student's chances of getting financial aid, but experts say saving for college is always a good idea. Because 529s are considered an asset of the parent or other 529 investor, their impact on financial aid is less than it would be if it were considered the student's asset.
Tom Melecki, director of financial services at the University of Texas in Austin, says the amount students get dinged for 529s is mitigated by the greater benefits of having savings.
"If a family can put away even a few dollars a month, I think it's very useful," Melecki says. "It's worthwhile to minimize the amount of loans a student's going to take on so they don't start life with a huge debt hanging around their necks."