Article:
College Savings Plans For Everyone
by Robert K. Roskoph
July 1, 2006
Since 529 College Savings Plans were first enacted by Congress, they have gone from relative obscurity to a "must-do" move for parents putting away savings for their children's higher education. Section 529 of the Internal Revenue Code provides tax benefits for state college or any college savings plans that allow anyone, regardless of income level, to open an account and invest a substantial amount of money in stock and bond funds. The money placed in these accounts can then be used by the beneficiary at any school in the country. Best of all, the money grows tax deferred and, thanks to recent changes in the tax law in 2001, the money may now be withdrawn for education income tax free. Today, over 40 states operate Section 529 Savings Plans and at least 30 of them are available to residents of any state. Many of these plans are operated by well-established money-management firms, including TIAA-CREF, Fidelity Investment, Merrill Lynch and Salomon Smith Barney.
There are many benefits to these plans. First, there are no income limits to the donor and savings can be substantial. Donors have the ability to make monthly contributions, or make contributions using their annual exemption (currently $12,000 per donor per donee per year) and may aggregate up to five years of annual exemptions ($60,000) in a single year, using in advance the exemption over the following five years. This enables many parents and or grandparents to start the savings early and achieve greater returns during the first years or early years of a child/beneficiary's life.
The investments in these accounts are conservative, and are based upon the child's age and date when the funds will be needed for college. This investment practice may be viewed as both positive and as a drawback. As the prospective student ages, the investment allocation will shift. For instance, a newborn's account may be allocated 75% in growth stock funds and 25% in bond funds. By the time the child is in junior high school, 45% of the account will be invested in stocks and 55% in bonds. This allocation is further altered when the child attains high school age, when 15% may be in stocks and 50% in bonds and 35% in money market funds. Obviously, the objective of this conservative approach is to protect the assets for availability when the child attains college age. It may, however, reduce the available return.
To some parents, the above stated allocations are too conservative and the likely returns are too skimpy when stocks can be earning double digit returns during a bull market. However, the investment advisors and financial professionals will tell you that college savings should be invested more conservatively in case the stock and bond markets take a dive. (History speaks for itself.)
In addition, if the child/beneficiary decides against college or there is money left over after graduation, the money can be saved for graduate school or passed along to another beneficiary.
There are other factors and issues to consider as well. On one hand, the "participant" (the individual establishing the college savings account) has control of the account and the funds until the time they are needed for the child/beneficiary's college. A 10% penalty may apply to an early or non-education use withdrawal, but the participant could withdraw the funds.
There is some question with respect to the funds contributed and their inclusion in the donor's estate for estate tax purposes. On the one hand, the funds have been "gifted" for the benefit of child/beneficiary and have, therefore, been removed from the donor's estate. However, if the donor retains control over the account, it may be argued by the Internal Revenue Service that the funds in the account are includable in the donor/participant's estate (by retained controls). This has yet to be tested by the courts. From an equity and common sense standpoint, it does not appear that these funds would in fact be held to be includable in the participant's estate. However, it does raise the issue.
There is also some question as to the impact of these plans on potential qualification for financial aid. The standard financial aid formula requires students to spend 35% of their own assets on college bills, while parents are liable only for 5.6%. It has yet to be determined whether 529 Plan accounts will be counted as an asset of the student or the parent/participant. There have been several instances where the accounts were considered to be the parents.
Ultimately, however, these plans offer a tremendous tax saving vehicle for paying college tuition. They should be considered just like any other investment, however, and each plan should be considered in light of the individual's means and expectations.
For further information, see www.savingforcollege.com for a complete list of college savings accounts and their particulars.
If you would like further information, please contact our office by email or at (650) 470-5300.
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