College Savings Plans

Investing in 529 plans, Coverdell Education Savings Accounts, and custodial accounts requires careful research to find the best plan for your situation.

• Shop carefully for a state 529 college savings plan. Each plan has its own maximum contribution limit and menu of investment choices, including mutual funds with asset allocations based on a child’s age. Some 529 plans have high annual fees of 2.5 percent or more and are sold by brokers while others offer investment choices directly to investors from low-cost providers.
• Over time, differences in 529 plan fees matter and will affect how much savings an investor ends up with. You do not have to live in a particular state to invest in its plan.
• State 529 plans are constantly changing their features and investment choices. Two helpful Web sites for 529 plan investors are www.savingforcollege.com and www.collegesavings.org.
• Current benefits of 529 plans, such as tax-free withdrawals for educational expenses, are available only through Dec. 31, 2010, due to a “sunset clause” in the 2001 tax law. After this date, this benefit will end unless Congress extends it.
• Consider a Coverdell Education Savings Account (ESA), available through financial institutions such as mutual funds. Unlike 529 plans, ESA owners can invest tax-free for any educational level (a private high school, for example) and not just college. Contributions are limited, however, to $2,000 per year (versus a total of $200,000 or more for many 529 plans) and to investors with a modified adjusted gross income under $110,000 for singles and $220,000 for couples filing jointly.
• ESAs provide advantages such as investment flexibility (investors choose where the money is invested), tax-deferred growth, and tax-free withdrawals. Unlike tax-free withdrawals for 529 plans, which are scheduled to expire in 2010, ESA earnings will remain tax-free for qualified expenses regardless of when a child is ready for college.
• Consider a custodial account to set aside money for a child’s education. Depending on your state of residence, there is either a Uniform Gifts to Minors Act (UGMA) or a Uniform Transfers to Minors Act (UTMA). These laws determine the type of account that is available.
• Assets held in UGMA/UTMA accounts are controlled by the custodian, typically a parent, and must be used for the minor child’s benefit. Deposits to a custodial account are considered an irrevocable gift.
• One disadvantage of custodial accounts is that the money saved is in a child’s name, which could affect financial aid eligibility. Another is that, upon the legal age in the state where a custodial account is established (either age 18 or age 21), a child gains control of account assets and may or may not decide to use them for college.