Saving for a child's college education today is not an easy task. Many parents, upon the baby's birth, start some type of fund for their child so s/he can be set for the future. However, with the astronomical rise in tuition, room and board and other fees, parents can barely afford to save enough for the first year, let alone all four. What is a responsible parent to do?
The possibilities can seem endless, and meeting with a financial adviser is often confusing and overwhelming. Therefore, it is best for the parent, prospective student or graduate student to do a mutual fund comparison. This way, the choice is in the hands of the investor, not a third party.
A popular plan is the 529. But how does it work and what are the benefits and drawbacks?
401K Benefits, a Cashing Pension Option and More
A 529 plan helps families set aside money for future educational expenses. It is a savings plan operated by either a state institution or university. From state to state plans differ, so a parent or student must check with the individual state. However, if a student is from one state, for example New York, on the student's behalf, the investor (the parent) can donate to a plan in another state, for example California. The student must attend an accredited college or university.
Just like a 401K, the investment grows tax-deferred. And unlike cashing out on a pension early, the investor will not receive penalties when taking money out of a 529 plan for educational expenses. The cost is federally tax-free.
By state, the investor may also receive more tax benefits. For example, Savingforcollege.com says, "Contributions to any of New York's 529 plans of up to $5,000 per year for an individual taxpayer, and $10,000 per year for married taxpayers filing jointly, are deductible in computing New York taxable income. Only contributions made by the account owner, or if filing jointly, by the account owner's spouse, are deductible."
What also appeals to many parents in particular is the donor or investor of the fund remains in complete control of the money. The beneficiary, meaning the student, has no rights. Additionally, for those with a busy schedule, this saving plan is very "hands-off." In other words, the plan is managed by the state or an outside adviser. Parents only have to sign up and contribute.
Mortgage-backed Security Equals Investment Losses
The "hands-off" approach does not appeal to many investors though. The 2008 housing crash deterred many investors because they found out their plans were of the mortgage-backed security type. This means that when the housing market crashed, so did investors' money. They watched as a good portion of their savings for their children's college education dwindled to less than half or even worse.
Therefore, many investors have pulled out of the 529 plans. The Wall Street Journal reports that, "after tucking some $15.5 billion into 529s in 2006 and an additional $15.2 billion in 2007, investors contributed an estimated $5.2 billion last year, according to Financial Research Corp . . . so far this year, investors have put an estimated $4.8 billion into the plans."
For many investors, the "hands-off" method did not work and they believe they learned their lesson the hard way. Thus, many Americans are returning, or for the first time, managing their money on their own.
Another drawback of the plan is if a student does not go to college, to pull out the money the investor will pay taxes and penalties. However, the investor can change the beneficiary; for example, if the donor's daughter decides to forgo a higher education, the beneficiary can be changed to another child, a niece, nephew, grandchild, etc.
The bottom line is investors (usually the parents) must decide what is the right choice for them. A 529 plan can offer great savings* for education, but also a great financial risk. To decide what is the best choice for a family, weigh the options carefully and ask a financial adviser lots of questions.
These three articles, Stafford Student Loans, Student Loan Interest Consolidation and Obama Money for College, discuss the ways in which students can receive tax credits and a federal education stipend and lower interest on loans.
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