College Saving 101: Sorting through the choices

One of the simplest ways to retain full control of college savings is a so-called Coverdell Education Savings Account. These plans, which work much like Individual Retirement Accounts, let you set aside money in tax-deferred investments. That means your savings will grow faster because you won’t owe taxes on gains or income until you withdraw the money. And if you use the account to pay for education expenses, in most cases, you won’t owe any tax.

Coverdell accounts also give you more spending flexibility: You can use the money for any education expense — from books for kindergarten to high school band uniforms.

Alas, these accounts have a few major limitations. For one thing, you can only set aside $2,000 a year for each child — which will leave you considerably short of that $325,000 bill for 4-year private college. Coverdell accounts also have income-based eligibility limits. If you earn more than $110,000 a year ($220,000 if you file jointly), you’re out of luck.

529 plans
For parents (or other friends and relatives) who are convinced that their savings will eventually end up in a college bursar’s office, so-called 529 plans offer the most targeted tax savings with the least limitations on how much you can save — up to $260,000, depending on the plan.

Investment in 529 plans has more than doubled in the past two years to $55 billion as of the first quarter of this year, according to the College Savings Foundation.

These plans have become increasingly popular as the number and variety of plans has increased. Some let you “pre-pay” tuition at current prices, avoiding the uncertainty of price increases. Other “age-based” plans gradually shift your investments from stocks to bonds as your child approaches college. Others offer you the choice of investing in a variety of conventional mutual funds.

The downside of the 529 plans are that they are not just one plan: They’re really an entire category of over 100 savings options offered by each state. You can invest in any state’s plan, but many offer special perks to state residents. But each plan includes its own strengths and drawbacks. So once you’ve decide to find a 529 plan, your real work has only just begun.

Start by looking at the plan or plans available in your state. More than half the states also offer you a deduction on your state tax return, an option you won’t find with an out-of-state plan. Check on your state’s penalties for withdrawing the money for non-educational expenses. And ask if there are any restrictions on changing the account beneficiary should you decide to designate another child or family member if the original beneficiary doesn’t go to college.

Then look at the investments offered by the specific plans. Some states offer you the choice of individual mutual funds; others set up funds specifically created for 529 investors. You’ll usually find a range of investments suited to your preferred level of risk -– from conservative to aggressive. Check to see how the performance of the 529 fund you’re considering compares to benchmark indices for similar funds.

And last -– but by no means least -– find out how much of your money will go to pay the fees for the fund's management. These can vary widely: Some funds allow you to invest directly, avoiding the advisor fee or sales commission you’ll pay if you go through a broker.

If you do sign on with a broker, pay special attention to fees if you get steered to an out-of-state plan. Last year, the National Association of Securities Dealers issued an “investor alert,” warning that some brokers were recommending out-of-state plans even though their clients could have found lower fees with an in-state plan.

One other caution: The tax advantages of these plans are currently set to expire in 2010. Congress has recently moved to make those tax advantages permanent. But until those changes become permanent, there is a risk that 529 withdrawals after 2010 could be taxable.

MORE FROM SCHOOL INC.

School Inc. Section Front

Tutoring firms score well on rising demand College Saving 101 Bad grades mean good profits School Inc. Section Front   Add School Inc. headlines to your news reader: