College Savings

In which financial pocket should you put college savings?—5/06/08

INTRO: College costs are skyrocketing. Luckily, we've got advice on how best to save for your child or grandchild's future, and you won't need a Ph.D to understand it.

1. HOW EXPENSIVE IS A COLLEGE EDUCATION TODAY?

A. National average costs for 1 year at a public university are $12,796 and $30,367 for a private school. Many times when you see estimates of the cost of a college education, they simply take the annual number and multiply it by 4, or the number of years it used to take to get a 4-year degree. Those numbers do not reflect current reality; the average number of years it took to get a bachelor's degree at a public school is 6.2 years, and 5.3 years for a private school.

2. WOW, WITH THESE COSTS, IS A COLLEGE EDUCATION WORTH THE INVESTMENT?

A. Yes. According to statistics from the U.S. Census Bureau and the Bureau of Labor Statistics, a college grad will earn on average $2.1 million during their working years as compared to a high school graduate's lifetime earnings of $1.2 million, a difference of $900,000. In addition to higher earnings, college graduates have greater employment opportunities and lower rates of unemployment. The globalization of our economy is only going to make the factors more important.

3. WHAT'S THE BEST WAY TO SAVE FOR A CHILD'S OR GRANDCHILD'S EDUCATION?

A. The three best options are to put money into a 529 Plan, a Coverdell Education Savings Account, or a Uniform Transfer to Minors Act Account. There are pro's and con's to each.

4. WHICH SAVES US THE MOST TAXES?

A. That depends on several factors. In most cases, the Coverdell Account provides the most tax savings if you actually use the funds for higher education expenses or K-12 costs. These include: tuition, books, equipment and room and board.

That's because the money can be invested and grows totally tax free. But if you take the money out for some other reasons, you'll pay income taxes and penalties.

A 529 Plan offers the same tax benefits, but the money can only be used for higher education costs, not K-12.

A Uniform Gifts to Minors Act Account is very different. Here, you put money into an account in the child's name as owner. The investments are then taxed with the first $800 of income tax free, and the next $800 taxed at the child's tax rates, not your usually much higher rate. But here, the money does not have to be used for education.

5. ARE THERE OTHER DIFFERENCES BETWEEN THE PLANS?

A. Yes. While the Coverdell may offer the best tax benefits, you can only put in $2000/year B total from all sources.

For the 529 Plan, you can put in $12,000 per year, up to a total of $321,000. And you can begin by putting in 5 years of contributions ($60,000) at one time.

With a Uniform Gifts to Minors Act, you can put in up to $12,000/year with no gift tax.

6. CAN THE BENEFICIARIES BE CHANGED ON ANY OF THE ACCOUNTS?

A. When you contribute money to an UTMA, those assets can only be used for that child, and when they turn 21 (or 18 depending on how the UTMA was established) those assets transfer to the child and can be used for anything the child wishes. With both 529 Plans and Coverdale accounts, the beneficiary of the account can be changed, at any time, to another family member. Or you could take the money back. The custodian cannot reclaim the assets in an UTMA account.

B. The owner of a 529 plan or a Coverdell can reclaim the assets in the account. If the funds in either a 529 or a Coverdell are not used for qualified expenses, there is a 10% penalty, and the earnings that have accumulated are subject to taxation as ordinary income. But if the original beneficiary of the account is not going to use the money for their education, the owner can select and name another family member as the new beneficiary. This will keep intact all of the tax benefits associated with the account, as long as the money is eventually used for education.

529 Plan: Another family member

Coverdell: Another family member

UTMA: No, irrevocable gift to child

7. FINALLY, HOW DO THESE ASSETS AFFECT FINANCIAL AID?

A. 529 Plans and Coverdell ESAs are treated as assets of the parent custodian, while an UTMA is an asset of the child. Assets of children have a greater impact in the financial aid calculation in determining what the family's expected contribution for education will be. So you'll typically get more financial aid using a 529 or Coverdell.

How do they affect Federal Financial Aid?

529 Plan: Counted as assets of parent or guardian

Coverdell: Counted as assets of parent or guardian

UTMA: Counted as student 's assets

CLOSE: It seems like you need an advanced degree just to figure out which college savings plan will work best!