PDF

Saving for College: Addressing a Significant Financial Challenge (First of a Three Part Series)

With an inflation rate for college costs that has averaged double that of the Consumer Price Index, investors face a substantial headwind.

College Saving
Part One
 |
 Part TwoPart ThreeCollege Saving Analyzer

Saving for a child's college education is inarguably one of the most important objectives for an investor's financial capital. With an inflation rate for college costs that has averaged more than double that of the Consumer Price Index (see chart below), investors face a substantial headwind.

See the chart at the bottom of this article.

One increasingly popular savings vehicle is the state-run 529 plan which can take the form of a prepaid-tuition plan or a college savings account with either age-based or static investment options. One important advantage of the 529 plan is that the donor maintains control of the account and decides when the funds can be disbursed. Furthermore, the donor may change the investment option or even the beneficiary of the account at any time. Perhaps the most significant advantage of the 529 plan is the large amount (over $300,000 per beneficiary in many state plans) that can be set aside in this tax-advantaged vehicle. Although contributions are not deductible, the gains are tax-deferred and the distributions (if used to pay college expenses) are tax-free at the federal level, and in over 30 states, contributions are either tax deductible if you're a resident of the state sponsoring the 529 plan or you can receive a tax credit for contributions. A list of these states which were taken from this Investor Alert from FINRA is shown below. The Investor Alert has a lot of other valuable information about 529 plans and is the primary source for this article.

States Offering Tax Deductions or Credits to In-State Investors

Alabama Louisiana Ohio
Arizona Maine Oklahoma
Arkansas Maryland Oregon
Colorado Michigan Pennsylvania
Connecticut Mississippi Rhode Island
District of Columbia Missouri South Carolina
Georgia Montana Utah
Idaho Nebraska Vermont
Illinois New Mexico Virginia
Indiana New York West Virginia
Iowa North Carolina Wisconsin
Kansas North Dakota

 

Regarding California investors, qualified plan distributions for a California resident are not taxable in California regardless of the state in which the 529 plan is held.

When shopping for a 529 plan, it is crucial to perform proper due diligence. A few points to consider, according to the FINRA Investor Alert, are:

  1. Contribution limits vary by state.
  2. State tax advantages vary from state to state and may depend on whether you are a resident of the state sponsoring the plan. Furthermore, the federal tax rules that apply to college investing options are complicated. Before investing, you may want to check with your tax advisor about the tax consequences of investing in college savings plans or read Internal Revenue Service Publication 970, Tax Benefits for Higher Education. It is important to note that the tax liabilities (if any) apply to the donor and not the receiving student.
  3. Fees and expenses vary significantly, even among plans offered within the same state. FINRA warns investors to take extra caution with respect to "Broker-Sold College Savings Plans" which often contain sales loads and higher fees and expenses than direct-sold plans. To complicate matters further, the broker-sold plans can utilize different share classes of the same mutual funds, including Class C shares which usually have higher annual fees than Class A shares. Lastly, going with a broker-sold plan may cause investors to miss out on the potential advantages of an in-state plan.
  4. The investment options can vary substantially among plans. In our opinion, the better plans utilize passively managed funds from reputable companies like Dimensional Fund Advisors, Vanguard, Fidelity, and TIAA-CREF.

Other options beyond the 529 savings plan worthy of consideration are Coverdell Education Savings Accounts and custodial accounts, which have the maximum flexibility regarding how the funds can be utilized. However, investors who are concerned about qualifying for financial aid should be aware of the rules regarding eligibility and how they relate to different types of accounts. In the next segment of this series, we will take an in-depth look into two 529 plans that IFA finds particularly attractive, the West Virginia Smart529 Select plan and the Utah Educational Savings Plan.


Part One
 |
 Part TwoPart ThreeCollege Saving Analyzer

Related Material


Feedback

Leave us your questions, comments and/or feedback:


Name: Email:

Feedback