Pragmatic Finance

You’ve probably been told or heard countless times of the importance of a college education, especially in regards to the increased earnings. However, saving for the college expenses of your children is a daunting task. I am reviewing a chapter from the The Boglehead’s Guide To Investing that is titled Savvy Ways to Invest for College as part of the BogleHead Project. It covers some of the strengths, requirements, and tax implications of some of the popular methods.
The plans they cover are:

• Personal Savings
• Custodial Accounts
• U.S. Savings Bonds
• Coverdell Educational Savings Accounts
• 529 Qualified Tuition Plans
• IRA Withdrawals
• Other funding options

I decided to briefly cover each one. Reading this chapter gives you a great overview of the options available. However, remember that overtime laws could be changed or expire so there might be changes in the future in regards to tax benefits, income restrictions, etc. This makes it especially important to keep up to date with them, especially the methods you use.

Personal Savings in Parent’s Names

This is the easiest and most flexible method. You don’t have to worry about any restrictions or limitations. You can also use any extra for other purposes. You can invest it any way you see fit, anything from stocks to CD’s. The downside is that there are no tax benefits.

I think this is the safest way but probably not one I would not recommend unless you are unsure if you’re child is going to college.

Custodial Accounts (UTMA and UGMA)

These two were fairly new to me. They refer to the Uniform Transer to Minors Act and Uniform Gifts to Minors Act. Both are methods of saving funds for your children. Depending on your state laws, at age 18 or 21 the minor will be given control over the account. In the meantime, it grows utilizing several tax benefits.

While the child is under age 14 they are taxed at the child’s rate until they exceed the unearned income limit. After that limit the earnings are taxed at the parent’s rate. After age 14 the earnings go back to being taxed at the child’s own rate.

The main benefit to this is that the gift is taxed at very low rates for most of the life. Assuming you are contributing small amounts regularly, the account will grow slowly and will be starting to be fairly large by the time the child reaches his teens. The idea is that earnings will get low tax rates for most of the life of the account.

There are some bad downsides to this. The first one is that once the ownership changes the child could spend it on anything they wanted. Also, when ownership changes to the child is will greatly effect the child’s financial aid eligibility…in a negative way. 35% of the assets of a child are expected to be contributed to college. The reduction in financial aid received for many families would greatly outway any tax benefits they received.

U.S. Savings Bonds

As long as they are titled in the parent’s name, savings bonds may be able to qualify for tax-free educational benefits. The key is that it can’t be in the child’s name. There are also other restrictions such as income level when you redeem them and the age when you purchase them. The good thing is that if you are concerned that you might be above the income level when you need to use them then you could redeem your bonds early and transfer them to a 529 plan.

The main benefits with these are that you have the flexibility to use the money for other purposes.

Coverdell Education Savings Account

This looks like a roth ira of college savings. You contribute after tax money into an account that grows tax free. The annual contribution limit is $2000 and what qualifies as an educational expense is much broader. The funds must be used by the time the beneficiary turns 30 or be passed onto someone else.

It seems like a pretty good deal for those who qualify, at least up to the first $2000 you want to put away yearly.

529 Qualified Tuition Plans (QTP)

The first type of 529 plan is a savings account. You can purchase these directly from a state or go through a broker. Each state has its own set of rules and benefits. You can get a plan from any state but some allow tax benefits to residents of that state.
The benefits to these plans are that the contribution limits are much higher, as much as $55,000 at a time(for a five year contribution). Also, they grow tax free as long as they are used for educational expenses. The only real downside listed is the sunset of the tax benefits in 2011. However, I believe Congress recently extended it permanently.

The other type of 529 is a prepaid tuition plan. You pay the cost in todays dollars. If you decide to go to a private school or to another state’s school then your investment can be used there. It will have grown at the rate of your school’s tuition inflation. With the very large increases in tuition over the last decade or so this type of plan could be enticing.

IRA Withdrawals

You can withdraw funds from your IRA for educational expenses at any time without a tax penalty but this option should probably be avoided if at all possible.

Other Options Available

A few other options are listed. Most of them deal with non-investment ways to save such as scholarships, financial aid, tax credits and deductions, etc. These should be thoroughly researched even for those that are investing using some of the previously mentioned options.

Overall, the Boglehead’s Guide To Investing gave a pretty good summary and explanation of the different plans available. It also gave more details and explanation that I provided. Anyone who is investing for college should keep up to date on all of these options as laws, especially tax ones, are constantly changing.

Each chapter of the book is being reviewed by other bloggers. So far I think the book is great, especially for the beginning to intermediate investor. The next chapter is How to Manage a Windfall Successfully. If you have ever read of those lottery winners who are broke after several years then this might be interesting.