College Planning & Savings

October 8, 2007

Points of Consideration for Education Planning
Many of you have written to ask that I provide some guidance on education planning and I have stayed away from the subject because education planning is one of those subjects that has a limited audience. I always try to do the Money Guy show with the understanding that we have listeners that are new to investing and personal financial planning as well as tried and true weathered investors that I can still enlighten from time to time with my insight.

I have also stayed away from the subject because I worry that some may be putting their children first when it comes to their future financial independence. As a parent I know that statement sounds harsh, but what I mean is that there are many individuals that are not saving what they need to for retirement, but they are still contributing to Junior\’s college account. For clarity on this issue consider this… Your child can go get a student loan that has a moderate interest rate meanwhile once you hit retirement there is no such product on the market that will allow you to borrow for retirement. Keep that point in mind when determining how much to allocate to education savings. I think that a completely financially independent parent is just as important to your child\’s future as college savings because if you doing everything you are suppose to in order to create financial independence you will not be a financial burden on your children in the future.

Now with all of that said I will tell you that I was fortunate enough to graduate from college (University of Georgia – Go Dawgs!) without any education debt because I was able to pay for my education expenses with scholarships and I had loving parents that were able to help me out with living expenses while I was in college. By graduating without student loans to pay back I had a huge advantage financially. I was able to immediately start saving for my own retirement and financial independence and that discipline and appreciation for good money management led me to where I am today, on the radio spreading the good word of hard work and good personal financial management.

Education Funding Vehicles

Coverdell Accounts:
Contribution Levels = $2,000 subject to earnings limits of $110k for single filers and $220k MFJ
Income Tax Breaks = Earning not taxed federally if used for education expenses
Use of Money = Books, supplies, equipment, tuition, room and board (if at least half-time student; Elementary, secondary, and/or college costs
Who has Control = Any balance left when child turns age 30 will be distributed
Negatives: Low Contribution limit, income limit, adverse effect on financial aid, and could reduce ability to claim certain education tax credits

UTMA/UGMA (custodial Account)
Contribution Levels = $12k per persona annual gift tax limit
Income Tax Breaks = Be careful of kiddie tax changes (in other words not as tax advantaged as in the past)
Use of Money = Any purpose, except parental obligations
Who has Control = Child controls at age of majority
Negatives: Probably least tax advantaged savings option and loss of control once the child reaches adulthood. Detrimental to financial aid eligibility. If account balance is small your investment options can be limited and expensive.

IRAs (including ROTH accounts)
Contribution Levels = $4k, but must have earned income to contribute
Income Tax Breaks = No 10% penalty if withdrawal for qualified expenses; Roth contributions (not earnings) can be withdrawn without penalty anytime
Use of Money = Tuition, fees, books, supplies
Who has Control = Account owner
Negative = Very few children have enough earned income to be effective

Savings Bonds (I Bonds & EE Bonds)
Contribution Levels = $30,000/ year for I-Bonds; $15,000/ year for EE-Bonds
Income Tax Breaks = Tax-exempt income if used for tuition and fees (be careful there are income/earnings limits)
Use of Money = Tuition and fees
Who has Control = Owner of bonds
Negative = Strict eligibility rules and only modest potential tax breaks

529 Prepaid Tuition
Contribution Levels = Varies by state
Income Tax Breaks = Earnings not tax federally; Contributions may be state-tax deductible; 10% penalty on earnings if withdrawn for non-qualified purpose
Use of Money = Tuition and fees
Who has Control = Donor usually has control
Negative = Same limitations as 529 Savings Plans

529 Savings Plans
Contributions Levels = Varies by state; can go as high as $300k; no earnings limit
Income Tax Breaks = Earnings not taxed federally; Contributions may be state tax deductible; 10% penalty on earnings if withdrawn for non-qualified purpose
Use of Money = Tuition, fees, books, supplies, equipment, room and board
Who has Control = Donor owns and controls
Negative = Too many plan choices and complicated structures, can only make cash contributions (no stock), could hurt financial aid eligibility

Best and Worst 529 Plans

Best 529 Plans – My opinion based upon investments options, cost/fees, and plan provider
Utah Vanguard Plan(click here for link)
Reason Picked = Low Costs, Excellent Investment Options, Good Investment Flexibility, and Excellent Shareholder Friendliness

New York Vanguard Plan(click here for link) Pr
Reason Picked = Same reasons as Utah Plan

Alaska T. Rowe Price College Plan(click here for link)
Reason Picked = Excellent Investment Options, Good Investment Flexibility, and Excellent Shareholder Friendliness

California\’s Fidelity ScholarShare Plan(click here for link)
Reason Picked = Low-cost investment options, can work with the Fidelity College Rewards American Express Card (1.5% of purchases go to fund college savings)

Georgia T. Rowe Price Plan(click here for link
Reason Picked = same reasons as Alaska plan

Worst Plans according to MorningStar®
Alabama Higher Education (Van Kampen)
Arizona PF 529 (Pacific Funds)
Arizona SM&R Family (SM&R/Alger)
Nebraska AIM (AIM)
North Carolina (Seligman)
North Dakota SAVE (Morgan Stanley)
Wyoming College Achievement (Merrill Lynch)

You have probably noticed that states can have multiple plans so be very careful to make sure that you are choosing the best state plan. I also recommend that you not open a college savings account through your broker or advisor. I think you should invest directly with the state plan and then consider choosing the age based portfolios. This investment option will provide professional money management and allocation and the investment mix will adjust as your child gets closer to college.


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