Congress Makes Permanent Attractive Features of 529 College Savings Plans

August 8, 2006 at 10:32 pm  ·  Category: College Investing

The Wall Street Journal ran a significant article today, “A New Lease on Life for 529 Plans” (subscription required), for those of you trying to save for college.  Congress has made permanent many of the features that make 529 Plans attractive vehicles for saving for college.

529 plans function like Roth IRA’s: money is contributed after taxes but grows tax free and withdrawals that are spent on college expenses are tax free as well.  That last feature is crucial: when you withdraw, say, $10,000 from your 529 plan to pay for your child’s first year of school that money does not count as taxable income. 

The crucial provision allowing for tax free withdrawals, among others, was scheduled to expire at the end of 2010 and that had caused 529 contributions to slow down recently:

…. the specter of benefits disappearing had given some investors pause.  In fact, the flow of money into new and existing 529 savings plans slipped to $13.71 billion last year from $13.72 billion in 2004, when the inflow surged 20%.

With the new legislation, investments in 529 plans should pick up again.

The other alternative for saving for college is Coverdell Accounts.  These accounts are similar in that after tax money grows tax free and withdrawals spent on education expenses are tax free as well. 

There are, however, a couple of important differences between 529 plans and Coverdell Accounts.  One of the most important differences is that you can contribute much more money per year to a 529 plan than you can to a Coverdell Account.  You can only contribute $2,000 per year to a Coverdell Account while you can contribute up to $300,000 to California’s 529 plan, the Scholarshare program.  So if your child is getting close to college and you haven’t started yet, this is one big reason for choosing a 529 plan over a Coverdell.

The advantage of the Coverdell is that you have complete control over how you invest the money.  Much like traditional and Roth IRAs, you can select the stocks, bonds or mutual funds that you want to invest in.  529 plans, by contrast, give you a range of options.  For example, California’s Scholarshare program is run by TIAA-CREF and gives you 5 different options: guaranteed, age based asset allocation, aggressive age based asset allocation, 100% equity and 100% social equity. 

My recommendation is to start early with a Coverdell Account.  As your child gets closer to college, you can always supplement that with a 529 plan if it looks like you are going to need more money. 

If, however, your child is already 15 or 16, the thing to do is to simultaneously set up both a Coverdell account and a 529 plan.  The Coverdell account will give you control over whatever money you can put in it and the 529 plan will allow you to put away more money so that you have enough. 

Top Gun is an expert in college investing and would be happy to consult with you about the best way to do it.  We can manage the money for you in a Coverdell Account, if you’d like, and/or set up a 529 plan with the Scholarshare program that would then be managed by TIAA-CREF.

Posted by Greg Feirman  ·  Trackback URL  ·  Link
 

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