and author of The Best Way to Save for College: A Complete Guide to 529 Plans (Bonacom Publications; $22.95). Hurley notes that the benefits of investing in 529 plans are that, unlike most other tax-advantaged savings plans, you can start out making very small contributions, there are no age or income limits, and they allow extremely high contributions. But many plans charge management fees, some higher than others, and many plans have limited investment options. And an added wrinkle is that several state plans invest in mutual funds that have been implicated in the federal government’s investigation of mutual fund trading violations. Strong Capital and Putnam Investments are among those companies implicated in the scandal. (See “Caught in a Storm,” this issue.) But parents shouldn’t be dismayed, says Hurley. To get the most bang for their buck, “they just have to understand how 529 plans work and how to manage them,” he says.
SIZING UP 529 PLANS
There are two kinds of 529 plans, which get their name from section 529 of the tax code: prepaid tuition plans, which let you lock in the price of your child’s future tuition by prepaying at today’s rate now, and college savings plans, which are investment programs that let you make account contributions toward a beneficiary’s qualified higher education expenses (tuition, fees, room and board, books, and supplies). The IRS imposes a 10% penalty as well as income taxes on gains for unqualified withdrawals.
With a prepaid tuition plan, parents, grandparents, and other interested persons can purchase units that can later be redeemed for a percentage of tuition at any of that state’s eligible colleges or universities. The maximum contribution is the amount necessary to prepay the number of years the child is expected to attend that state’s institution of higher learning. Tuition credits can also be applied if your child chooses to go to an out-of-state school.
What if your child is drafted by the NBA and forgoes college altogether? With a 529 college savings plan, you can change the beneficiaryâ€“it can even be yourself. Most states allow contributions in excess of $200,000. As of 2002, you can contribute up to $55,000 in one year for each beneficiary ($110,000 a year for couples) as long as no further gifts to or for that particular individual are made in the ensuing five years. Funds in 529 college savings plan accounts are generally invested in securities managed by outside investment specialists. The rate of return of each plan is based on the performance of the investments it holds.
Kyle F. Winkfield is the vice president at Greenbelt, Maryland-based American College Funding Association, an education financial consulting firm. He says that many parents who invest in 529 college savings plans think they have their child’s tuition covered, but many parents don’t understand the inherent risk involved in investing. “Even if you start saving for a newborn’s education now, because of market fluctuations, you may not have an adequate nest egg when it’s time to liquidate those funds for college,”