Smart New Ways to Save for College

Fast becoming one of the most popular ways to save for college, 529 plans are state-managed investment accounts open to anyone, regardless of residency or income level. In a 2004 survey conducted by the Investment Company Institute, the national association of US investment companies, 63 percent of parents would choose a 529 plan over a Coverdell Educational Savings Account if they had $2,000 to save for college. One reason for making this choice is the flexibility that a 529 provides.

Funds from a 529 plan can be used for any qualified education expenses, such as tuition, room and board, fees, and books at most accredited public or private colleges, universities, community colleges, and graduate schools. Depending on the state, some plans will allow funds towards vocational and international colleges. Additionally, 529 plans allow large contributions, unlike other plans with annual caps. Another flexible feature is that the account holder controls the money for the duration of the account even after the beneficiary turns 18 and allows parents to change the beneficiaries of the plan.

Most parents prefer the tax treatment of 529 plans. Earnings and withdrawals are federal tax-free, and you can contribute up to $11,000 annually without paying gift tax. Most 529 plans do not impact a student’s ability to receive financial aid, as savings are treated as an asset of the parent instead of the student, and only 5.6 percent or less is used to calculate the Expected Family Contribution (EFC).

Because 529 plan accounts are managed for you, there are account manager fees that can be as much as one to two percent of annual earnings. Another downside to consider is your tolerance for risk; these plans are not guaranteed to make a profit and are subject to the highs and lows of the stock market. Always make sure you choose your investments in a 529 plan with your risk level in mind. The tax benefits could cease in the future as federal tax exemptions on withdrawals may expire by December 31, 2010, unless Congress extends them—and it is likely that it will. Before investing in a 529 plan be sure to compare various investments and plans.