College Savings Plans: How to find the plan that best meets your needs

It’s said that the average family has saved just $5000 for their children’s college education. That’s a little less than half of the average cost of a year at a public institution and a sixth of what it costs to attend a private institution. That means most families are in for a bit of a finanical shock when it's time for their children to attend college.

There are many reasons why families are so unprepared for the expense of college. Much of the problem centers on the fact that people just don’t know what options there are to save for college.

This report is designed to clear up some of the misconceptions about college savings plans. It’s our goal to help you move forward with a clear and straight forward college savings plan that meets your needs and your present financial situation. Please note that the details below are subject to change. Please talk to your financial and tax advisor about your choices in college savings plans.

What is a College Savings Plan?

In 1997, the US Government created the 529 Plan. It’s actually named after a section in the IRS tax code – section 529. These are designed to help families save for college by offering tax advantages.

These college savings plans are sponsored by the state, which offers additional benefits because each state can offer its own perks and bonuses.

Here are just some of the benefits a 529 College Savings Plan can offer you:

529 College Savings Plan Benefits

No Federal Tax on Earnings – The 529 plan grows tax free. That means any interest you earn over the life of the college savings plan, you don’t have to pay taxes on. This is perhaps the single biggest benefit of the 529 plan.

State Tax Deductions – Because 529 plans are regulated and controlled by the state, the state tax deductions also vary. Some states offer a tax deduction if you invest in a 529 plan.

Gift Tax Benefits – Normally, you can gift someone $13,000/year without them having to pay taxes on the money. With a 529 Plan you can contribute up to $65,000 without them incurring gift taxes. However, you can’t gift that amount again for four more years.

Anyone Can Contribute - 529 plans offer a wide open participation. Anyone can contribute to a 529 plan. This means if you have friends, parents or relatives who want to help, they can contribute to the 529 plan.

No Age Limits - In most instances, it doesn’t matter how old the recipient is. That means if someone is 30, 40, 50 years old and wants to save for college, they can use a 529 plan to do it.

Generally Low Fees – Many savings accounts charge such high fees it almost doesn’t seem worth it. However, most 529 plans have fairly low fees and a low expense ratio. A low expense ratio means you save money on fees. There are often no sales or commissions paid out.

Low Start Up Enrollment Requirements – If you’ve ever looked into an investment plan you may have been shocked to see the enrollment requirements. We’re talking about enrollments of $25,000, $50,000 or more. Most 529 plans have a seriously low enrollment fee. Some you can even start for as little as $25.

High Contribution Ceiling - Depending on the sponsoring state, you can contribute up to $370,000, though some states top it off at $200,000. However, that’s still a significant amount of tax free money and while you cannot contribute beyond your state’s cap, you can continue to earn interest on the account beyond that limit.

Complete Control - The account owner always has complete control of the assets regardless of the age of the beneficiary. And you can change the beneficiary. That means if your oldest child doesn’t go to college, you can transfer the account to a younger child, a niece or nephew or even to your spouse if they decide to go back to college.

Myths and Facts about College Savings Plans

There are many myths about college savings plans. These myths prevent people from taking action to save, tax free, for their child’s education. We’re going to break these myths down so there are no barriers, only good solid facts to help you decide if a 529 plan is right for you.

Myth #1 - You can use 529 plan assets only for a school in your state.

Fact - You can use your 529 plan assets at federally accredited institution. That includes four year colleges, two year institutions, vocational schools and even some schools overseas. And you can use it for any level of degree, from associates to PhD.

Myth #2 - You can use 529 college savings accounts only to pay for tuition.

Fact – Your 529 assets can be used room and board costs, books, and even computers and school supplies. And of course you can use it toward tuition.

Myth#3 - If my child decides not to go to school, I lose the assets in my account.

Fact - You can transfer the 529 plan account you set up for your child to another eligible family member with no income tax penalty. If you do withdraw the assets then interest is subject to federal and state income tax and there is a 10% penalty tax applied,

Myth #4 - You have to jump through a lot of hoops and red tape to open a 529 account.

Fact – You can jump online and open a 529 account today in just a few minutes.

Myth #5: If you don’t use it, you lose it.

Fact – False. If you don’t use all of the money in your account then you can transfer it to another eligible beneficiary or you can withdraw it and pay the penalty and taxes.

Myth #6 - 529 investments dramatically reduce financial aid eligibility.

Fact – This is a biggie because the last thing a person wants to do is reduce their ability to get financial aid. Unfortunately, 529 investments do limit financial aid but it’s not by much. In truth, less than 6% of the money in these accounts is considered when filling out the FAFSA, Free Application for Federal Student Aid. And you can get around it if the account is owned by a grandparent because they are not considered when evaluating financial aid.

Myth #7 - Only account owners can contribute to a 529 plan.

Fact – Anyone can contribute.

Myth #8 - You can make too much, or too little, to qualify.

Fact - There are no income restrictions or limits to be eligible to participate in 529 plans.

Myth #9 - Only financial advisors sell 529 plans

Fact – You can jump online and enroll today without the help of a financial advisor.

Myth #10 - I cannot change my investment strategy once I’ve opened the account.

Fact - You are allowed to make changes to your account. Each state supported plan will have their own rules and regulations regarding how many investment changes you can make each year without penalty. If you decide you want to take more or less risk with your investments, you can change your strategy.

Myth #11 - It’s too late to start saving in a 529 plan

Fact - It is never too late to start saving.

How Much You Need To Save and Other Considerations.

So where do you start?

There are generally four main things to consider before you start a 529 savings plan. Let’s break them down:

How Much Do You Want/Need to Save?
If your child is 14 and headed out the door in four years, this is a lot easier to know than if your child is still in diapers or even elementary school. It can be tough to predict how much your child’s education is going to cost.

They say, the average four year public institution is around $7,000/year for tuition and fees for in state tuition and around $11,000 for out of state. Add in room and board, transportation, and books and you’re probably looking at another $11,000 in fees. This is based on national averages reported by CollegeBoard.com:

* Books and Supplies $1,122.

* Personal Expenses (Phones, internet, laundry, etc…) $1,974.

* Transportation $1,079

* Room and Board $7,000

However, then you also have to figure in inflation, grants and scholarships and financial aid. The end result can leave your head spinning. And if you’re looking at private colleges, average tuition is around $30,000/annually not including all the extras.

The best advice is to use a college expense estimator, you can find many of these online or at your local financial institution. Aim for the higher end of the spectrum. If you end up saving too much, you can always assign a new beneficiary.

How Much Time Do You Have to Save?
This plays a key role on deciding both how much you can/should save each year but also risk level you choose to take. If you have 18 years to save then you can afford to take a higher risk right now and adjust it as your child grows.

How Much Money Can You Afford To Save?
You have a number of options here. You can allocate a certain amount to the account each month. You can also put any windfalls into the account, say tax returns, bonuses, or gifts. Additionally, you’ll want to consider how you’re going to start or open the account. Do you already have a lump sum of money you can invest in the account?

Take a look at your budget and determine how much you can save toward college each month or year. It may be a matter of cutting back on other spending. Dig deep and find a way to make it happen.

How Much Risk Should You Take?
There are two parts to this question. The first is, are you going to manage your 529 plan yourself or seek the guidance of a financial advisor? If you already have a financial advisor, then it may be a simple question. They already know your financial status and your plans and goals.

If you don’t already have a financial advisor then you’ll want to go through the process of finding one that meets your needs and goals.

If you’re comfortable making the investment decisions on your own, then you can absolutely hop online, choose your 529 plan and start saving.

What Type of Plan Should You Invest In?

Because each state sponsors their own plans, we cannot go into the different types of plans, there are hundreds. However, these plans are generally based on risk. A low risk plan would invest in “safe” slow growth stocks and bonds. Whereas a higher risk plan would invest in new or growing stocks where they might be more volatile in the market.

The general rule of thumb is to be a bit riskier with your investments, which often results in a higher rate of return, when your child is several years from attending college. Then, as you approach college, you’d modify your investment strategy to be safer. That way you don’t risk losing the savings you have as the child nears college age.

Those are just general guidelines. Some people are risk takers the entire way through, some play it safe and some choose the middle of the road approach. The choice is yours and the good news is, you can change your mind and make adjustments to your investment strategy as you go.

What Does The Enrollment Process Require?

Before you get started signing up for a 529 Plan there are a few pieces of information to have at the ready. Here’s what you need:

Who will be the Account Owner?

This is the person who creates and maintains the account – likely you. You need to have the following information handy:

* Full Name
* Social Security Number
* Date of Birth
* Mailing Address

Who is the Beneficiary?

Who is going to receive the benefit of the account? If you have more than one child, the beneficiary may be the oldest child, the one who is closest to college age. You can change the beneficiary at a later date or you can open a separate account for another child.

You can also transfer a portion of an account to a different beneficiary without adverse tax consequences, provided the two beneficiaries are members of the same family. (You can also designate yourself as the beneficiary). You’ll need to have the following information handy:

* Full Name
* Social Security Number
* Date of Birth
* Mailing Address

Do you want to designate a Successor Account Owner?

You can name someone a successor over the account in the event something happens to you, death. They then become the account owner. Here’s the information you need handy:

* Full Name
* Social Security Number
* Date of Birth
* Mailing Address

How much are you going to open the account with?

If choosing to make your initial contribution electronically or are choosing to establish an ongoing automatic contribution plan, you will need:

* Bank account number
* Bank routing number
* A voided check

If you have savings, college or otherwise, at another investment firm you can transfer your assets into your new 529 plan.


Tips:

Start early. The sooner you begin saving, the more you and your loved ones can profit from the power of compounding interest.

Weigh costs carefully. Research fees, minimum balances and annual investments and tax savings for your state. Even if you live in a state that offers state tax benefits, a plan with low costs could outweigh your state's tax advantages.

Clearly research the alternatives in your state. If you’re not satisfied with the 529 college plan offerings in your state, you can open an account in another date.

Don’t Forsake Retirement. There’s a saying in the financial community, you can take a loan out for college but you can’t take a loan out for retirement. Don’t postpone saving for retirement to pay for college and don’t tap into your retirement savings to pay for college. Yes, college is important but there are other ways to pay for it.

You now have just about all of the information you need to start a 529 college savings plan. But you may be thinking that it’s just not the right option for you. Let’s take a look at a few other options you have to save for college so you can make the decision that’s right for you.

Alternatives to 529 College Savings Plans

If you walk into the door of a financial advisor and ask them about college savings plans, they’re going to recommend or discuss four options with you. We’ve already discussed one option – the 529 college savings plan.

This plan has many benefits, first and foremost is the tax savings, both federal and state, that you can receive. It’s also a very flexible option that can be adjusted and transferred as your needs change. It can also be applied to any accredited institution – there are very few limitations. Finally, it can be used to pay for other educational costs outside of tuition. These costs, we’re talking about room and board, books, and other expenses often cost more than the tuition itself.

The next option your financial advisor may discuss with you is what’s called a Prepaid Tuition Plan.

Prepaid Tuition Plans

If you’re certain your child will be going to a state school then you may want to look into a prepaid tuition plan. These plans are set up so you can lock in college tuition at today’s rates. So for example, you have a child that will be going to college in 10 years. You can lock in the tuition rate for this year and that’s what you pay ten years from now. It saves you the cost of inflation and tuition hikes.

There are a few caveats here.

#1 The school has to participate with the plan. A prepaid tuition plan doesn’t work for any old college or university; they have to be a participant in the plan.

#2 You can choose from a prepaid unit or a contract. With a contract, you commit to a predetermined number of years at that college and the contract often includes room and board. Prepaid units are just that, you purchase a fixed percentage of the tuition. Regardless of which plan you choose, the purchase price is going to reflect the age of your child and how many units you purchase or how long of a contract you purchase. The rate you pay may also reflect how you fund the plan – lump sum versus installment plans. The younger your child is, the better rate you’ll receive because it provides the state more time to invest and profit from your early payment.

Investment Grade Life Insurance

This type of plan is a life insurance plan through and through. In addition to covering all of the basics a life insurance plan would cover, this type of plan invests your policy payments to earn interest. Now if you die before your child goes to college, they would receive a lump sum payment to pay for college. And assuming you don’t die, you can borrow from the account to pay for their education.

The downside here is that you’re borrowing from your life insurance account which of course comes with fees and taxes. And most of these types of accounts are not immune from federal and state taxes. Also between the management fees and the commissions paid to your financial advisor, they may not result in as much benefit as you’d like.

Standard Investments - Stock Market, Bonds & Mutual Funds

The other approach to college savings may be the good old fashioned way. Invest your money in bonds, the stock market and mutual funds. The downside here is that there are no tax benefits. Of course, if you think you can manage your portfolio better than a 529 plan can, then it may be worth it to you to save for college this way.

Of course, you could do both. And if you end up making a fortune in the stock market, well you don’t have to spend it on a college education.

Saving for college is important. The 529 College Savings Plan offers you a number of options to save, tax free, for your child’s education. Consult your financial advisor or jump online and see what’s available in your state. If you already have a 401K or IRA, you may want to start your search there. Most major financial institutions have information about your state’s sponsored 529 programs. It’s easy, you don’t have to invest much each week to see a true return on your investment and it’ll make your life so much easier once your child heads to college.