Saving for college has never been a one-size-fits-all proposition.
Brad Faulkner, a farmer in northern Illinoishas been stashing $30 a month into a mutual fund for the past 15 years. He and his wife, Holly, hope this will help give them a jump on community college tuition for their three children, ages 12, 11 and 6.
Then there is Matt Trinka of Oak Park, who owns an insurance brokerage. He is depositing $100 a month for each of his kids, ages 7, 4 and 2, into Illinois’ college-savings program,. He and his wife, Bernadette Diaz, anticipate this will help get their kids through a four-year college.
Meanwhile, Kim Mendonsa, food and beverage director at the Midtown Tennis Club, and her husband, Robert, general manager for the Chicago office of Aetna U.S. Healthcare, are contemplating plunking $50,000 in bonus money into another state’s college-savings plan. The Chicago residents hope this investment will grow enough to cover the cost of a top-tier college for their 8-month-old daughter.
What links these Illinois parents–indeed all parents who want to help their kids through college–is that they face a rapidly multiplying array of choices as they attempt to craft a savings plan that fits their particular needs.
The number of state-sponsored savings plans has exploded in the past three years, and the number of state-sponsored prepaid tuition plans has risen as well. And these are just the latest additions to an already large menu that includes custodial accounts, so-called education IRAs and more open-ended options, such as taxable investments, CDs or savings bonds.
“The increasing number of choices is good from a consumer standpoint, but because the programs are all so different, it makes it more confusing to shop around and try to compare them,” said Joseph Hurley, chief executive of savingforcollege.com, a Pittsford, N.Y.-based business that provides information on state-sponsored plans.
But it pays to shop around. Many state-sponsored plans are open to out-of-state residents, so parents can pick and choose among the plans, which can have different rules, different money managers, different investment menus and different levels of management expenses.
“You need to look before you leap, and know the pros and cons,” said Kalman Chany, president of Campus Consultants Inc. in New York.
A good place to start your research is with the two types of state-sponsored “529” plans–college saving plans and pre-paid tuition plans–both named for the section of the federal tax code that authorizes them. (A number of Web sites, including www.collegesavings.org and www.savingforcollege.com, have a wealth of information.)
Since the code was liberalized in 1998, these plans have taken off in a big way, especially the savings plans.
Before the code was amended, just five states offered savings plans. Now, 34 states, including Illinois, offer plans, and nine more are developing them. And many of the plans, including the Illinois plan, are open to residents of any state.
The Illinois program, Bright Start, was launched by State Treasurer Judy Baar Topinka’s office last April 1, with Salomon Smith Barney managing the investment portfolios. The program, which now has $72 million in assets invested in 12,000 accounts, is a well-regarded one and is fairly typical of many plans out there.
With a minimum deposit of $25, parents, grandparents or friends can open a tax-deferred account that offers three basic investment portfolio choices: equity mutual funds, fixed-income mutual funds or an age-based asset allocation.
With the age-based option, the portfolio is adjusted as the child gets closer to college age, shifting over time from emphasis on stock funds to emphasis on bond and money market funds.
“I like those. They’re no-brainers,” said Jim Platania, a financial planner in Mt. Prospect.
Others like the fact that contributions are exempt from federal gift taxes. You can invest up to $10,000 per year (or $20,000 per married couple) per beneficiary without incurring the tax. Or, you can contribute as much as $50,000 ($100,000 for married couples) if you don’t make further gifts to the same beneficiary over the next four years. (The maximum level allowed by all account holders for one beneficiary is $160,000.)
When the child reaches college age, funds can be withdrawn to pay for tuition, books, supplies and room and board at schools nationwide. Earnings on withdrawals will be taxed at the student’s federal income tax rate, which is generally lower than the parents’ rate.
And for Illinois residents, the earnings are exempt from state income taxes. (Further details can be found at www.brightstartsavings.com or by calling toll-free 877-432-7444.)
A switch to Bright Start
These factors, and others, proved so attractive to Trinka, the insurance brokerage owner, that he stopped adding to the custodial accounts he was building up college costs and switched to the Bright Start plan.
“I like the tax deferral and I like the estate considerations,” he said.
And unlike custodial accounts, where account control shifts to the beneficiary at a certain age (21 in Illinois), these accounts remain under the control of the donors, he said.
The Mendonsas, in contrast, are leaning toward investing in Rhode Island’s college-savings plan because their financial plannerlikes the investment options there.
The second type of state-sponsored 529 plan is the prepaid tuition plan, offered by 18 states, up from six states in 1995.
Observers are not as keen on these narrower programs, but say they have appeal for conservative investors (a growing group, given the current market turmoil).
Illinois launched its program, College Illinois!, in October of 1998, and so far participants have invested $120 million.
Under the program, run by the Illinois Student Assistance Commission, participants essentially pay today’s prices for tomorrow’s tuition and fees.
Participants can purchase contracts to pay for one to nine semesters of future tuition and fees. The price is roughly equivalent to the current average tuition and fee cost at Illinois public universities and community colleges, though the cost is slightly higher if you use a payment plan instead of a lump sum.
The return is equivalent to the rise in tuition and fees at Illinois universities and colleges from the time the investment is made until the time the child goes to college.
If the child eventually goes to a public university or college in Illinois, those costs are covered. If the student goes elsewhere, the program will pay the mean-weighted average cost from comparable Illinois institutions. (Details are available at www.collegeillinois.com or by calling 877-877-3724.)
“It’s a very safe investment,” said Platania, the financial planner.
But investors willing to take a little more risk may be able to get a better return elsewhere.
And families that expect to be eligible for financial aid should know that withdrawals from prepaid plans could eat into the aid. This is true for savings programs, too, but to a much lesser extent.
Some drawbacks to 529 plans
In fact, investors should be aware that both types of 529 plans have a variety of drawbacks: You give up choices in how to invest your money, for one thing, and you will likely take a financial hit in the form of a penalty or reduced earnings if funds are not used for educational purposes.
Of course, there are myriad other options that have existed for some time: custodial accounts, education IRAs and self-styled saving in bank accounts or taxable investment accounts. Each has pros and cons.
A parent can give a child up to $10,000 a year without incurring gift tax by setting up a custodial account, noted Brent Lipschultz, senior manager at KPMG in New York. There are no restrictions on how the money can be invested, and there are limited tax breaks on investment income.
One potential downside, as mentioned earlier, is the child takes control of the account at a certain age, 18 in some states, 21 in others, including Illinois.
The accounts also can significantly reduce the amount of financial aid a student can get, noted Chany, author of “Paying for College Without Going Broke.”
Many taxpayers also have the option each year to put $500 per child into education IRAs. While the contributions are not deductible, earnings build tax-free and withdrawals are tax-free if used for education.
But many planners pooh-pooh this option because the annual contribution limit is low.
Whatever route you choose, it is important to start saving early, says financial planner Nadolna, and to make it a habit.
And this can be hard when so many other pressures can weigh on a family.
Faulkner, who farms outside of Davis, Ill., is among those who are in the habit of saving, but still, he’d like to do more, maybe learn about the state’s programs.
But times have been tough for dairy farmers in the last year and a half.
“Your kids grow up every day,” he said, “and in the back of your mind, you think, `Golly, they are going to go to college.’
“But with all the other things going on, it has not been No. 1 on my mind.”
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NEXT WEEK: The cost of college includes a lot more than tuition.
