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Navigating the college savings programs
As a parent, the big financial concern with a newborn is how to
set aside enough money to assist for a college education.
Universities and state governments have developed many different
financial savings plans to encourage parents to save money for
college. Some of the plans include 529 accounts, Coverdell
accounts, Roth IRAs and prepaid/guaranteed tuition costs.
Unfortunately, few of the programs offer every benefit such as
tax deductions, tax deferred savings, unlimited investment
options, self directed investments and no penalties.
Selecting a university is a critical and expensive decision, and
in my view it is foolhardy to make before the last couple years
of high school. A drawback of the university-based or
state-based plans (such as a 529 account) is that they impose
penalties if a child doesn't attend a specific university or in
a specific state. Who knows what aptitudes, skills or interests
your child may develop that necessitate a specific school that
is out of your home state. University and state-based plans also
impose penalties if the money isn't ultimately used for
qualified college expenses; another example where an event that
is out of your control and may cause an unneeded expense. But
the biggest problem with university and state programs are the
financial rule changes they make - after you start the plan.
To me, the university and state-based programs are a lose/lose
savings plan for parents. If the cost of tuition rises faster
than forecasted, in spite their guarantees, they raise the price
and leave you under-funded. Conversely, if tuition rises less
than forecasted, then you end up overpaying for tuition. And the
same applies to the stock market some plans force you to invest
in; when the market fell in 2000 and 2001, many plans broke
their promise to guarantee full tuition funding in spite of
promises to the contrary.
Another drawback of state-based plans is that your investment
options are severely limited to a few mutual funds run by the
brokerage firm operating the account. I have evaluated several:
and they have high fees and poor returns, and I'm wary of the
lack of competition for many of these accounts. The brokerage
firms
blame economics for the lack of investment choices, saying
that most of the accounts are small and not very profitable for
them, so they want as little trading and customer interaction as
possible. More reference material for this article is available
at http://investing.real-solution-center.com.
The federal college savings plans are better because they allow
the widest selection of investments (such as an educational Roth
IRA or other education savings accounts), and can be applied to
most any accredited university. These accounts offer tax-free
growth and withdrawal is also exempt from federal taxes and some
states taxes. Realistically, your situation may call for
multiple accounts. Rules prohibit you from using these if your
income passes certain thresholds.
In my opinion, the best place to start saving college is with
U.S. government ibonds from TreasuryDirect.gov. These bonds
offer the most flexibility and control, and require none of the
paperwork and rules of other savings plans. They accrue a decent
rate of interest every month, the principal is adjusted for
inflation each quarter, the income tax is deferred, and you
don't have any brokerage fees. And when the money is withdrawn
for a university on their approved list, the money can be
redeemed tax-free. (As for limiting rules: you cannot withdraw
the money in the first year, and if you withdraw it within five
years, there is a three month interest penalty - so ibonds are
not the best savings plan after a child reaches about age
twelve). Since ibonds are simply savings not an educational
account, the money can be spent for any type of expense that may
arise.
The government and brokerage firms keep updating these accounts,
so my complaints will hopefully become moot in the near future.
But the criteria that you need to watch for are: many investment
options, few penalties, no taxes and total control. These will
maximize the money you're setting aside for that expensive
degree.
About the author:
Francis Kier has an MBA in finance and shares his two decades of
experience with investing and personal finance. More of his
articles are available at
http://investing.real-solution-center.com.
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