December 24, 2004 08:32 PM
Pay Now, Learn Later
Excerpt: You can protect yourself against college tuition hikes. But the scheme backfires if your kid goes to the state university.
By now you probably know that earnings of Section 529 college savings accounts are free of federal tax if used for higher education. But taxes are only part of the problem. What if your investments tank? Just ask Laurence and Margo Williams of Alexandria, Va. In 2000 they put $45,000 into the Virginia Education Savings Trust to open accounts for daughters Lea, now 5, and Anne, now 3. Since then their investment has shrunk 5% while the average private college tuition has climbed 18% to $18,300.
So there's sure to be much interest in September when more than 200 private colleges begin offering the Independent 529 Plan--a complicated new scheme that lets you prepay a child's private college tuition at a discount to today's rates.
The Independent plan isn't for everybody. But it should appeal to some affluent parents and grandparents who are gun-shy of stocks and strongly favor private over public colleges. "I think grandparents are going to love it, because they tend to take a conservative approach," says Raymond Loewe, author of New Strategies for College Funding. "People who have been burned in the market--and a lot of them have--will like this approach."
A little history: Starting in the mid-1980s a handful of states began offering prepaid plans for their own schools. These plans had little appeal for parents aiming to send their kids to the Ivy League--or at least give them a wide choice of colleges. In 1996 Congress added Section 529 to the tax code, allowing states to offer the more flexible and popular college savings plans that can be used at any school.
Money in 529 savings plans grows tax deferred and can be withdrawn federally tax free if used for certain educational expenses. Those include undergraduate and graduate tuition, supplies and room and board (on campus or off) at any public or private college or university. Plans typically allow total contributions of more than $200,000, and there are no annoying income restrictions for contributors, as there are with so many other savings breaks.
Moreover, 529s have a gift-tax advantage as well: A couple can contribute up to $110,000 at once to each child or grandchild's account without owing gift taxes. The contribution is treated as five years' worth of annual tax-exempt gifts of $11,000 per year, per parent. After five years all the money is out of a donor's estate, yet he or she can take it back for any reason. (Such noncollege withdrawals are taxed at the ordinary income rate, plus a 10% penalty on earnings.)
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