The Best Ways To Save For College
In the college savings game, all strategies aren’t created equal. The best savings vehicles offer special tax advantages if the funds are used to pay for college. Tax-advantaged strategies are important because over time, you can potentially accumulate more money with a tax-advantaged investment compared to a taxable investment. Ideally, though, you’ll want to choose a savings vehicle that offers you the best combination of tax advantages, financial aid benefits, and flexibility, while meeting your overall investment needs.

529 Plans
Since their creation in 1996, 529 plans have become to college savings what 401(k) plans are to retirement savings–an indispensable tool for helping you amass money for your child’s or grandchild’s college education. That’s because 529 plans offer a unique combination of benefits unmatched in the college savings world.

There are two types of 529 plans–college savings plans and prepaid tuition plans. Though each is governed under Section 529 of the Internal Revenue Code (hence the name “529″ plans), college savings plans and prepaid tuition plans are very different college savings vehicles. There are typically fees associated with opening and maintaining each type of account.

Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about specific 529 plans is available in each issuer’s official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.

529 Plans: College Savings Plans
A 529 college savings plan is a tax-advantaged college savings vehicle that lets you save money for college in an individual investment account. Some plans let you enroll directly, while others require that you go through a financial professional.

The details of college savings plans vary by state, but the basics are the same. You’ll need to fill out an application, where you’ll name a beneficiary and select one or more of the plan’s investment portfolios to which your contributions will be allocated. Also, you’ll typically be required to make an initial minimum contribution, which must be in cash.

529 college savings plans offer a unique combination of features that no other college savings vehicle can match:

• Federal tax advantages: Contributions to your account grow tax deferred and are completely tax free if the money is used to pay the beneficiary’s qualified education expenses. The earnings portion of any withdrawal not used for college expenses is taxed at the recipient’s rate and subject to a 10 percent federal penalty.
• State tax advantages: Many states offer income tax incentives for state residents, such as a tax deduction for contributions or a tax exemption for qualified withdrawals. However, be aware that some states limit their tax deduction to contributions made to the in-state 529 plan only.
• High contribution limits: Most college savings plans have lifetime maximum contribution limits over $300,000.
• Unlimited participation: Anyone can open a 529 college savings plan account, regardless of income level.
• Professional money management: College savings plans are managed by designated financial companies who are responsible for managing the plan’s underlying investment portfolios.
• Flexibility: Under federal rules, you can change the beneficiary of your account to a qualified family member at any time without penalty. And you can rollover the money in your 529 plan account to a different 529 plan once per year without income tax or penalty implications.
• Wide use of funds: Money in a 529 college savings plan can be used at any college in the United States or abroad that’s accredited by the U.S. Department of Education and, depending on the individual plan, for graduate school.
• Accelerated gifting: 529 plans offer an excellent estate planning advantage in the form of accelerated gifting. This can be a favorable way for grandparents to contribute to their grandchildren’s college education. Individuals can make a lump-sum gift to a 529 plan in 2008 of up to $60,000 ($120,000 for married couples) and avoid federal gift tax, provided a special election is made to treat the gift as having been made in equal installments over a five-year period and no other gifts are made to that beneficiary during the five years.
• Variety: Currently, there are over 50 different college savings plans to choose from because many states offer more than one plan. You can join any state’s college savings plan.

But college savings plans have drawbacks too. You relinquish some control of your money. Returns aren’t guaranteed–you roll the dice with the investment portfolios you’ve chosen, and your account may gain or lose money.

529 Plans: Prepaid Tuition Plans
Prepaid tuition plans are distant cousins to college savings plans–their federal tax treatment is the same, but just about everything else is different. A prepaid tuition plan is a tax-advantaged college savings vehicle that lets you pay tuition expenses at participating colleges at today’s prices for use in the future. Prepaid tuition plans can be run either by states or colleges. For state-run plans, you prepay tuition at one or more state colleges; for college-run plans, you prepay tuition at the participating college(s).

As with 529 college savings plans, you’ll need to fill out an application and name a beneficiary. But instead of choosing an investment portfolio, you purchase an amount of tuition credits or units (which you can then do again periodically), subject to plan rules and limits. Typically, the tuition credits or units are guaranteed to be worth a certain amount of tuition in the future, no matter how much college costs may increase between now and then. As such, prepaid tuition plans provide some measure of security over rising college prices.

• Federal and state tax advantages: The federal and state tax advantages given to prepaid tuition plans are the same as for college savings plans.
• Other similarities to college savings plans: Prepaid tuition plans are open to people of all income levels, and they offer flexibility in terms of changing the beneficiary or rolling over to another 529 plan once per year, as well as accelerated gifting.

Prepaid tuition plans have some limitations, though, compared to college savings plans. One major drawback is that your child is generally limited to your own state’s prepaid tuition plan, and then your child is limited to the colleges that participate in that plan. If your child attends a different college, prepaid plans differ on how much money you’ll get back. Also, some prepaid plans have been forced to reduce benefits after enrollment due to investment returns that have not kept pace with the plan’s offered benefits. Even with these limitations, some college investors appreciate the peace of mind that comes with not worrying about college inflation each year by locking in college costs today.

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