A survey done by the College Board in New York found that the cost of college is going up faster than the rate of inflation. Between 1993 and 2003, for example, the average cost of four years of tuition and fees at public colleges went up by 47% and at private colleges by 42%.
So, says Stuart Ritter, a certified financial planner at T. Rowe Price, an investment management and mutual fund firm in Baltimore, parents should start saving for college as soon as possible. He says that one way to do this is to use 529 college savings plans set up by the state.
These plans are becoming more popular as a way to save for college because they offer some of the best tax benefits, like not having to pay federal income tax on withdrawals made for qualified education expenses, and have high contribution limits to help save for college.
Ritter says that because of this, a 529 plan may be able to provide more money for college than taxable accounts and Uniform Gift to Minor Acts (UGMA) accounts, which are another way to give assets to a minor for investment purposes. Most of the time, an individual or a family can put more than $200,000 into a 529 plan.
At the moment, all states offer some kind of 529 plan, and about half of them offer incentives to people who live in the state. So, it may make sense for some parents to look first to their home states for a plan, but families are not limited to the plans in their own states. "It might pay to shop around," says Ritter, who adds that parents should look at the fees, expenses, and investment options as well as any state tax breaks that might apply to their contributions.
The College Savings Comparison Calculator is another tool that lets you compare saving for college in a 529 plan and in a UGMA account.
One thing to keep in mind is that, because of how the tax laws are written, the federal tax exemption for qualified educational expenses will end in 2010 unless Congress decides to keep it going. After that, the beneficiary's earnings would be counted as income. This is usually still a good thing, though, because most 18-year-olds are in a low tax bracket. Also, earnings from a distribution that aren't used for qualified expenses may be subject to income taxes and a 10% federal penalty.
It can be hard to figure out which 529 plan is best, but experts say it's important for parents who want to get the most out of their savings.
