Understanding Your College Savings Options

This is a guest post from MLR @ MyLifeROI. This is a 3 post series and each post is going live this morning on three different blogs: Bargaineering, Green Panda Treehouse, & Poorer Than You. I will be posting a wrap-up post to tie it all together and summarize each article.

You are 22 years old. You have just spent the past four years paying tuition, room and board, books, food, utilities, transportation, etc. The worst part is that it is all getting more and more expensive beyond peoples’ expectations. Where does that leave you? In a mountain of debt upon graduation. For some of us that means letting our debt dictate a less than optimal career.

However, what are some ways that we could better prepare for our college education? And if it is too late for you, how can we better plan for our children’s education?

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Saving for College – 529 Plans & Coverdell ESAs

Carnegie Mellon FlagI was watching On The Money last week when host Carmen Ulrich touched on saving for college education. She stated that college education costs go up around 8% a year, a figure that was much higher than what I had seen quoted before. She didn’t cite her source but I imagine it was probably, a well-known site that helps families plan for financing education costs, because they state college costs go up between 5% and 8% each year. That outpaces inflation and obliterates prevailing savings account rates… scary thought.

My wife and I are thinking about having kids soon and one of the biggest challenges has been projecting and planning for the cost of college. It’s pretty sobering to use FinAid’s projection calculator. I put in $30,000 a year (just a ballpark figure for a year of private college today), 20 years until matriculation, and left the college cost inflation rate at 7%. The total four year cost? $515,435.35

Half a million bucks for a private college. It’s insane.

Fortunately there’s help available and it comes in multiple forms:

  • Saving for college before college starts: This is the topic of this article, learning more about the ways you can save money by taking advantage tax-advantaged education savings accounts like 529 Plans and Coverdell ESA’s.
  • Tax deductions and credits for when your child is attending college: I won’t be going into detail about these deductions and credits in this article but you can get some assistance through the Hope and Lifetime Learning Credits. They may not exist in 20 years but they’re available today.
  • Financial aid: Also not covered in this article, but financial aid, whether it’s need or merit-based, plays a huge role in helping families pay for college and should always be considered.

Here’s a brief overview of your options (for saving for college) to give you a sense of what your options are. This is by no means exhaustive but should give you a good idea of the landscape so you can do your own investigating.

529 Plans

Named after the section number in the IRS code, the 529 Plan is simply a savings plan for college education and has two options:

  1. Prepay tuition at a qualified institution at today’s tuition rates, or,
  2. Save money in a account where the earnings are tax-deferred to pay tuition at future rates.

All earnings in the account are exempt from federal taxes if withdrawn and used for qualified educational expenses. Your contributions, however, are taxed before you put them in but some states let you deduct a portion of them from your state taxes. The Pension Protection Act of 2006 made the tax exemption permanent.

Coverdell Education Savings Accounts (ESA)

The Coverdell ESA was once known as the Education IRA and was revamped in 2002 with some major changes. Again, the account is like a Roth IRA in that you make non-deductible contributions into an account that can grow tax free if used for education. Like the Roth IRA, your contribution limit is affected by your adjusted gross income. For single filers, the range is $95k – $110k, and for married filing joint, it’s $190k – $220k; the contribution limit for 2008 is $2,000 per beneficiary.

Unless Congress makes changes to the existing law, some ESA benefits will expire in 2010. The key ones are that K – 12 expenses won’t qualify, the contribution limit will lower to $500, and withdrawals won’t be tax free if you claim Hope or Lifetime Learning credits. I don’t know if they acted yet on this and I couldn’t find anymore information about this.

Treasury Bonds

Earlier this year I bought some Series I bonds because of the favorable interest rates. One of the benefits of Series I bonds, and Series EE bonds, is that earnings are tax free if used for education. The rules are that “qualified higher education expenses must be incurred during the same tax year in which the bonds are redeemed.” There are several other requirements but they are all spelled out in the education planning section of Treasury Direct.

The benefit here is that you can get a lower guaranteed return, unlike the stock market investment returns for Coverdell and 529s, on education savings but the rules are slightly stricter. Also, you are limited in how much you are allowed to purchase.

Difference Between 529s & ESAs

There are some major differences, and lots of minor differences, between these plans.

The first has to do with control of the account. With a 529, the owner always retains control and can change beneficiaries at will. With ESAs, the money gets transferred to the benficiary (your child) if it’s not used for education when they reach a certain date. With 529s, the money is returned.

Another difference has to do with contributions, the limit for Coverdell is $2,000 a year subject to the contributors’ modified income. With 529’s, the limit is usually several hundred thousand and depends on the state program you join.

The last major difference is that a Coverdell has to be used up or transferred by the time the beneficiary turns 30, or the funds have to be withdrawn and tax and penalties must be paid. With the 529, there is no age limit. This is significant because that means you can open a 529 for your child before they are born. You simply open one for yourself, contribution, then change the beneficiary when the child is born. You can’t do this with a Coverdell.

As for similarities that may affect your choice, the Coverdell and the 529 are the same for financial aid purposes. They are considered assets of the custodian, which would be you, and the withdrawals are not income when they are tax free. Both plans are transferable, meaning you can change the beneficiary fairly easily.

Have you taken a deeper look at these types of plans? If so, what made you choose one or the other? Are there major differences, advantages, or disadvantages that I overlooked?

(Photo: duruk)


529 Plans: Fees More Important than Deductions

529 Plans: Maryland vs. Nevada PlansUsually. 🙂

My friend just had their first child and began researching 529 plans. A 529 plan is an education savings plan run by a state or an educational institution, it’s named after Section 529 of the Internal Revenue Code. The plan offers tax benefits to individuals saving for future education. In his case, he was looking at a savings plan, rather than a prepaid plan*.

And now he had a choice: an in-state plan with a tax deduction or an out-of-state plan with potentially cheaper funds. Specifically, he wondered if he should open a Maryland 529, which offers a tax deduction to Maryland residents, or a state plan offering Vanguard funds, which is known for lower mutual fund fees. The state plan he found was Nevada’s, which is run by Upromise but offers Vanguard funds. (Plan data provided by Saving For College, run by Bankrate)

College Investment Plan (Maryland)

  • Program Manager: T. Rowe Price Associates, Inc.
  • Residency Requirement: No.
  • Maximum Contributions: No annual limit until account balance for beneficiary reaches $320,000.
  • Account Maintenance Fee: $25 / yr, waived with automatic investments or balance greater than $25,000.
  • Management Fees: 0.28% manager fee, 0.25% once program assets reach $2 billion.
  • Tax Deductions: $2,500 per beneficiary per year by account owner is deductible with a 10 year carryforward on excess contributions.

The Vanguard 529 Savings Plan (Nevada)

  • Program Manager: Upromise Investments, Inc. and Vanguard Group, Inc.
  • Residency Requirement: No.
  • Maximum Contributions: No annual limit until account balance for beneficiary reaches $310,000.
  • Account Maintenance Fee: $20 / yr, waived if account owner or beneficiary is a Nevada resident or assets in account exceed $3,000.
  • Management Fees: 0.65% manager fee, include underlying fund expenses.
  • Tax Deductions: None.

Comparing just the Nevada plan against the Maryland plan, it appears that the Maryland plan is superior. What you’re trading off is the tax deduction versus the mutual fund fees, but the tax deduction is only available the year you contribute. In Maryland, the $2,500 deduction is worth $125 (5% state income tax) making it nearly a wash between the slightly higher account fees in Nevada.

It’s really a choice between T. Rowe funds vs. Vanguard funds. If you’re an index fund type of investor, the T. Rowe Price Equity Index 500 (PREIX) has an expense ratio of 0.35%. Vanguard’s 500 Index (VFINX) expense ratio is 0.15%, meaning T. Rowe’s ratio is more expensive by 0.20%. On a balance of $10,000, that’s a difference of $20 being whisked out of the account each year for nothing. While $20 doesn’t seem like much, that’s a fee taken out each year and one that will erode your investment’s growing potential.

If it were me, I think the Nevada plan is superior of the two because it offers access to cheaper Vanguard funds.

Five Best 529 Plans

Liz Pulliam Weston of MSN money recently looked at the 5 best college savings plans and listed Nevada as one of the top five. The other states included were Alaska, Nebraska, Rhode Island and Virginia. The Virginia plan offers access to some Vanguard funds too.

* A prepaid plan is an option where you “lock in” the price of an in-state public college education right now. You can always convert it to a private or out of state school later on based on some conversion tables.

(Photo: lednew)


MD 529: Prepaid College Trust vs. College Investment Plan

As I wrote this morning, I opted for the Maryland 529 College Investment Plan (CIP) over the Maryland 529 Prepaid College Trust (PCT) when I enrolled and I did so for a variety of reasons. First off, the Prepaid College Trust is like prepaying and locking in the rates of a Maryland educational institution today but for use sometime in the future (at least three years in the future).

Can Only Enroll Beneficiary After Birth

This made the PCT impossible for me because we don’t have any children yet. The CIP lets me name myself as the beneficiary and then roll that over to my child when he or she is born.

However, let’s say I have a child and the PCT was an option, would I still do the CIP? Yes, here’s why.

1. PCT’s “Legislative Guarantee”

With the CIP, my after-tax assets are put into various funds that grow tax-deferred (tax-free if spent on educational expenses). The PCT, it’s like Social Security, I pay into a system that will put it in a group of investments that will guarantee I can get a payout when my child enters college. If there is a shortfall, then the Legislative Guarantee says:

… the Governor to submit a request for the Prepaid College Trust in his/her annual budget if the Prepaid College Trust experiences a shortfall in any given year. As with the entire State budget, this request would require General Assembly approval.

What happens if they don’t approve it? What if there is a huge shortfall and no way to fund it? Those are questions that I don’t see answers for and one of the fundamental problems I have with these sorts of guarantees (like Social Security). I’d much rather prefer to have an account with funds in it that I know is there and isn’t spent elsewhere.

2. CIP: Potentially Higher Returns

With the CIP, I’m banking on market returns on my funds that may be outpaced by the increasing costs in education. According to their math, the University of Maryland’s tuition and mandatory fees increased 90% in 10 years, or 6.6% each year. Johns Hopkins University increased 63% in 10 years, or 5.0% each year. Now, if your think the market will return 11% on average, you’ll want the CIP.

3. Flexibility Over Price

If you’re certain that a Maryland college is where your child will be going (and the Legislative Guarantee placates your concerns over future fundability), then the PCT is probably your best bet because it guarantees the cost. If you’re not so sure, the PCT’s value for a college outside of Maryland is limited to the “Weighted Average Tuitions” of four year colleges. The increase in how much they’d pay per year for a public college outside of Maryland was a paltry 1.6%; that isn’t that impressive considering they spent the first half of the PCT FAQ telling us about the 90% in ten year increase in UMD’s prices.

Ultimately, the guarantee part was what concerned me but the Flexibility over Price issue was a close number 2. The potentially higher returns part wasn’t as big a factor as the other two but I felt is deserved some mention because ROI should always be on your mind when making investment decisions. Talk to a professional because you make any decisions, these are my opinions and I have little experience in this arena. 🙂

For those Marylanders (or outside Marylanders who are enrolled in either program) in 529 programs, how did you pick which plan to go with? For those who are thinking about it, what are the issues on your mind?


I Enrolled In A Maryland 529 Plan

Maryland 529 PlansI’ve talked in the past about the Maryland 529 plan and today I pulled the trigger and enrolled. In Maryland, you get up to a $2,500 deduction each year on your state income taxes (if you contribute $2,500 to the plan) if you are a Maryland resident. It’s not a tremendous amount of money back in our pocket considering it’s a 4.75% tax ($118.75 rebate) but since I’ll be spending money on education in the future anyway, $118.75 for something I should be doing anyway makes it just icing on the cake. Plus ultimately it’s a hundred bucks and that’s not trivial, it’s just seems small percentage-wise.

In Maryland there are two programs, the Maryland Prepaid College Trust and the Maryland College Investment Plan, the latter of which is managed by T. Rowe Price. I’m doing the Maryland College Investment Plan because it gives you more flexibility in terms of where the money can be spent and I figure my kids are all going to be little geniuses and going to the most expensive private school that’s located the farthest away from where we’re living at the time. Whether or not they’re going to be geniuses probably has nothing to do with the expense or distance factor, but I can still dream and Murphy’s Law says the second half of that statement is an absolute certainty.

Signing up for the plan was trivial and took a maximum of ten minutes. I went to College Savings Plan of Maryland, located the Enrollment form for the Maryland College Investment Plan, and was signed up in about five minutes. You simply need to decide on a username, pick a six digit pin, then open up an account. I’ll be naming myself as both the Account Holder and the Beneficiary, as I don’t actually have any kids yet. You can always rollover the account to another beneficiary without tax penalty if the recipient and the original beneficiary are in the same family. If they aren’t, there are some tax penalties.

After setting up an account comes the time to fund it. Simply mail a check or money order of at least $250 and the account is up in a jiffy. You’ll have to specify which funds to put it in but that was pretty simple.

Fee-wise, Maryland was pretty good and they’re getting close to the next tier of assets, $2B, when the fees fall even farther. I was pretty surprised to learn that the fees are related to the assets in its control, something you never see with mutual funds or things like that. In fact, because they had so many accounts and over $1B in assets that they took away the application fee ($75) and lowered a few other fees.

If you’re thinking about a Maryland 529, I’d read over this Disclosure Statement and FAQ. It’s pretty comprehensive and written in easy to understand language so you won’t have to wade through lawyer-speak.

(Photo: lednew)


Introduction to 529 Education Plans

According to the SEC, 529 plans are tax advantaged education plans, legally called “qualified tuition plans,” designed to spur people into saving for future education costs, i.e. kids (don’t read anymore into that!). Sponsored by government agencies, they’re authorized by Section 529 of the Internal Revenue Code, hence their name. The 529 plans come in two varieties – a pre-paid tuition plan and a college savings plan. Prepaid tuition plans are exactly what they sound like, they let you prepay tuition or credits at participant colleges. The college savings plans are a little broader and are essentially plans where the saver can save and invest money for a future student beneficiary, independent of which school they go to. The trade off is of school choice and the ability to lock in tuition in today’s rates, with the savings plan you get choice but not rate lock and with the prepaid plan you get rate lock but limited choices.

The tax benefits of participating in a 529 plan are decent but not incredible. Earnings are not federally taxed and usually not state taxed if you use it for education purposes; if you don’t, they are taxed at your marginal rate plus a 10% penalty (the standard penalty for these types of things). The states themselves may also add in a financial incentive to participate such as grants or matching funds but many of them only do that if you use their state’s 529 plan.

In Maryland, the two different plans are called the The Maryland Prepaid College Trust and the Maryland College Investment Plan. The Prepaid College Trust is the pre-paid tuition plan and the College Investment Plan is the college savings plan, each are managed by T. Rowe Price, more on those two plans in a later article.

No one read anything into this… just looking ahead. 🙂


Introduction to 529 Education Savings Plans

The key to being prepared is to learn about stuff before you need them and learning about 529, for me, certainly falls into that category! A 529 plan is an educational savings plan named after the section of the federal tax code that outlines the rules for them. Basically there are two types of 529 plans, prepaid tuition plans and college savings plans, but they are generally designed to help you save towards college for your children.

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