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529 Savings Plan for College


Don't underestimate the cost of a four-year education and the burden it can place on a family struggling to get their children through school.

Some parents look at the growing burden of financing a four-year degree and throw up their hands.

The annual cost of a year's tuition, room and board at a private college or university will average about $38,799 this year and will increase about 5% a year. The estimates cost of attending Ohio State University is $20,718 for students living at home during the 2009-2010 academic year. It's $21,640 for students living on campus at Arizona State University. In short, even state schools aren't cheap.

"You should start planning a college savings plan as soon as you're thinking about starting a family," says Doug Chittenden, Vice President of Institutional Client Services at TIAA-CREF. "When saving for any objective, the longer you save, the more successful you will be."

Section 529 of the Internal Revenue Code created the college savings plan much like Section 401 (k) created individual retirement accounts. The 529 Plan comes in two basic types: state-sponsored and independent.

Savings in a state-sponsored 529 Plan can be used at most accredited colleges and universities in the U.S. and many schools abroad. The plan's benefits include tax-deferred growth and federal income tax-free withdrawals when used for "qualified expenses" such as tuition, fees, books, supplies, required equipment and eligible room and board.

The Pension Protection Act of 2006 makes permanent investors' ability to withdrawn earnings from 529 plans free of federal taxes for qualified federal expenses. Without the law, federal tax breaks would have expired at the end of 2010.

The Independent 529 Plan is the first-prepaid plan sponsored by private, or independent, colleges in the United States. Participants can prepay all or part of future tuition at a private college at less than current prices and receive the tax advantages of a 529 Plan. About 250 private colleges and universities participate in the program.

The account owner maintains control over all funds in the 529 Savings Account. Plans offer gift and estate tax planning benefits, one of the major benefits of the savings account.

A 529 College Savings Plan functions much like an open-end mutual fund and is run by professional money managers. All 50 states now offer a 529 Plan and some offer more than one. There is no requirement to use the program in your state and performance varies among the various funds. However, many states offer tax incentives to keep the money at home, so do the math before putting your money into an out-of-state plan.

In general, plan to tilt your investments toward equities if you have ten or more years before you student enters college and shift to bonds and CDs as freshman year draws closer to reduce the risk. If you'll need a portion of the money in the immediate future, transfer some of your savings to a money market account.

"If you start saving when your child is 12 or 13, you'll only have five or six years before college," Chittenden says. "A five-year window makes you vulnerable to short-term drops in the equity markets. But if you have a 15-year horizon, you can ride out fluctuations in the stock market."

View a 529 Savings Plan as part of your family's overall financial plan. Set aside a predetermined amount each month, but pay the bills first. If you've blown past your credit limit on several cards, it makes more sense to pay the bank first because the interest rate of 20% or more can be crushing.

Be sure to read the 529 Plan's disclosure statement and discuss it with your financial advisor. If your kid doesn't go to college or enroll in an approved post-secondary training program, you may be hit with a penalty plus taxes on your earnings.

Withdrawals not used for education expenses are typically subject to income tax and a penalty. However, there are exceptions if your child receives a scholarship or is disabled. You can transfer the funds to another child to cover education expenses.

Caution: Investing in a 529 Plan in the child's name may not be a good idea because the student's assets may count more than the parents' financial status when applying for financial aid.

Talk with your student and divide up college expenses – decide who will be responsible for what bills. Then look at the other side of the equation: financial aid. Don't be bashful – go after every scholarship and grant possible. There are always scholarships for top students. A diligent search will find awards for good, solid students. Don't overlook sports or other special scholarships. Digging for obscure dollars can be time consuming, but remember that about 60% of all students receive some type of financial aid. Scholarships offered through your employer almost certainly aren't as competitive as "genius awards" and can contribute a helpful sum.

Fill any remaining holes in your finances with student loans. Keep the amount borrowed as low as possible so your student isn't making payments ten years after graduation. Some advisors recommend that no more than 10% of college costs should be covered by loans.

Don't underestimate the cost of a four-year education and the burden it can place on a family struggling to get their children through school.

Education is the best investment anyone can make in the future, so it's just a question of scraping together the money. This is best done as a collaborative effort between parents and student because it spreads the financial burden and gives the student a financial stake in completing a degree.

"The basic mistake many families make is assuming they can finance college through scholarships and borrowing and therefore don't start saving early enough," Chittenden said. "People don't look into the benefits of a 529 Program available in their home state – it often comes with attractive state income tax benefits."
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