For the last few posts, I been talking all about Kids Education savings plans by starting with a detail analysis on why its really important to early, continuing with talk on different investment routes to consider. This post I am going to elaborate various savings plans available for education savings and which one is better compared to others.
What savings plan to select?
Of course, you might have heard a lot about different plans in existence for kids educations. 529’s aren’t the only savings accounts that allow parents to shelter their investments from taxes and to withdraw money tax free for college. You also got Coverdell, UTMA&UGMA plans. Lets see one by one.
Coverdell The so-called Coverdell education savings accounts unlike funds in 529s can also be used to pay for primary and secondary school costs. So you can use the funds invested in Coverdell plan for K – 12 expenses which is really good tax break. But the catch, you can only invest a maximium of $2000 per year to this plan.
Also Congress conspicuously did not extend some attractive features of Coverdells, which are due to sunset at the end of 2010. The benefits include the ability to contribute up to $2,000 a year into these tax-advantaged accounts. After 2010, maximum annual contributions into a Coverdell will fall to only $500.
What’s more, K-12 expenses will no longer qualify. As a result, parents now investing their kids’ money in Coverdells “need to give strong consideration to the enhancements of 529s,” says an analyst from Putnam Investments.
While there are chances federal government could extend these beneficial Coverdell provisions, there are no guarantees. But many anlayst still advocates “putting the first $2,000 into a Coverdell and then putting your remaining savings into a 529.” Because under current law, money invested in Coverdells can still be used for K-12 expenses. And unlike 529 assets, Coverdell money is permitted to purchase equipment like computers for kids between kindergarten and 12th grade.
If the K-12 option does sunset in four years, as scheduled, the IRS allows Coverdell owners to roll over their accounts, tax free, into a 529. So why not preserve your options by first funding a Coverdell and then putting the bulk of your money in a 529?
UTMA and UGMA
Let see 2 other plans before I jump into my favorite 529 plan which are UGMAs and UTMAs plan. The Uniform Transfers to Minors Act (or Uniform Gifts to Minors Act) provides an alternative that may be simpler, cheaper and faster than a trust to transfer asset or give gifts to child. It is a custodial account which can help save taxes because this asset is considered as kids and not those of parents. Since kids won’t have tax obligations, they don’t end up paying taxes for this account. This type of plan is mainly used to give as gifts and transfer assets to avoid big Uncle Sam taxes and not really as route for education savings.
There are lots of disadvantages to this type of accounts according to many analysts.
1. Once you’ve transferred assets into a custodial account, you’re not permitted to take them back. Those assets belong to the child. You probably can’t take the assets back even with your child’s consent, because your child isn’t old enough to give valid consent on such matters.
2. When your child turns 21 (or an earlier age, in some states), the custodian must turn the assets over to the child. Some people are mature and thoughtful at age 21 or earlier; many are not. Do you really want all that money in your child’s hands at that age? How will you feel if he/she uses it to buy equipment for her boyfriend’s rock band?
3. This is important concern. Some people think of a custodial account as a good way to save for college, and learn only later that the account causes a reduction in financial aid. Under current law, assets owned by the child count much more heavily than parental assets in determining how much financial aid the child qualifies for. By law, a custodial account belongs to the child, so having large amounts of savings in an UGMA or UTMA is detrimental for qualifying for aid. Meanwhile, 529 assets are not considered student money for financial-aid purposes, according to recent federal rulings.
I found an article talked about a recent analysis by T. Rowe Price comparing 529 and UTMA’s. Say you put $5,000 a year into a 529 for your daughter, and it earned 8 percent annually through investments in a blue-chip growth stock fund. After 18 years, you would end up with more than $218,000 for her college bills. By using a home-state 529 plan that offers residents a state tax deduction, you’d be likely to amass nearly $224,000, T. Rowe Price found.
Now compare that with what you would save through an UGMA. Under the old rules, a typical parent in the 25 percent federal tax bracket could expect to accrue around $210,000 in the custodial account, according to T. Rowe Price. But under the new rules, you’re likely to save even less: $207,700. Plus, UGMAs and UTMAs are terrible from a financial-aid standpoint. As a rule of thumb, it’s always better to save money in the parent’s name, since Uncle Sam expects only 5.6 percent of parental assets to be used to cover college expenses. By contrast, the government will assume that 35 percent of the student’s money can be used to pay for school (in the 2007-08 school year, this will drop to 20 percent).
If you’ve already started saving through an UGMA or UTMA, don’t worry. Parents can roll over these accounts into a so-called custodial 529. While the money will still technically belong to the child, the assets will not be counted as student assets for aid purposes, even though the account maintains custodial status, the federal government recently said. 529 Savings plan 529 plans are the best of its kind next to Coverdell which can used as a nice vehicle to storeaway reasonable amount of money for your kids education. It’s doesn’t have any drawbacks like UTMA or UGMA but it can only used for College education unlike Coverdell can be used for K-12 expenses as well. There are 2 types of 529 plans. Prepaid plans offered mostly by institutions and states. Saving plans are offered by States and Mutual fund management firms.
The Prepaid plans are getting famous these days. Prepaid tuition plans allow parents to purchase units of future education at today’s prices. Earlier this year, the government gave these college savings vehicles a big boost by improving their financial-aid status. Under the old rules, the value of a prepaid tuition plan would reduce a student’s aid eligibility dollar for dollar. But starting in July, the government put prepaids on a level playing field with 529 savings plan. Both savings vehicles are now beneficial for qualifying for aid since they are not considered student assets. Even if you intend to use a prepaid plan to save for school, though, you will still probably want to start a 529 savings plan, too. That’s because prepaid plans are good only for covering tuition and fees. They don’t typically cover room and board. And in recent years, room and board has become nearly as expensive as tuition at many schools.
The ordinary 529 savings plans on the other hand is a transparent plan which you can signup with a Mutual Fund firm or State sponsored plan supported by a fund management company which manages the funds. It is not necessary that you need to get a state sponsored fund to use it in the institutions in that state. Its just yet another fund specialized in certain criteria.
Why 529 plans?
1. Great tax break. Money grows tax deferred and you can withdraw money tax free when you kid is eligible to use it.
2. You are in control and its your money. It’s not considered as kids money anytime.
3. It is easy to setup and control with underlaying funds managers who control the growth of the fund.
4. No limitations of income and contributions.
One more tip, when you spend your dollars you can put away a part of it to your kids 529 plans. Its a hidden savings when you signup with UPROMISE. There is no catch. You just need to attach your credit cards and is automatically contributed on special purchases to your account.
The bottom line, no matter what type of college savings vehicle you now use, you probably need to consider opening a 529. The recent changes by the government really made the 529 more attractive relative to all other college savings vehicles out there.
I will share my 2 special funds which I started for my son in my next and last post on this series. Watch out..
August 24th, 2008 
Vijaianand 
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