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Thursday, Aug. 31, 2006 | While you’re shipping your children back to school next week, it’s a perfect time to think about how to pay for their college education, especially now that tax exemptions on withdrawals from 529 plans have been made permanent.
That little tax gift was included in the Pension Protection Act of 2006 signed into law by President Bush on Aug. 17. The exemption was scheduled to expire in 2010 and although contributions are not tax free, your investment grows tax-deferred.
Organized under section 529 of the Internal Revenue Code, 529s are operated by states or educational institutions as a vehicle for parents to set aside money for future college expenses. They’ve been an imperfect but popular tool for years. The new law is just one of several advantages making 529 plans an increasingly good bet for college savings. Another great feature is that the plans stay in your name, not the beneficiary’s, so you control when and how the funds are used, and you can withdraw the funds for your own financial needs. Just be ready to pay federal and state income taxes on any amounts you withdraw for purposes other than education, plus a 10 percent penalty to the Internal Revenue Service.
If you’re a California income tax payer, the state charges its own 2.5 percent penalty on nonqualified withdrawals on top of the standard income tax.
Still, 529 savings plans are an easy way to save for college, requiring little more than filling out an application, selecting an investment option and arranging the automatic deposits. You can even do it online. Probably the best thing about 529s – other than substantial tax savings – is that anyone can open an account and there are no income limitations. You can contribute as much as you want up to a maximum balance of $300,000.
In California, you don’t even have to be related to the beneficiary to set up a 529 plan for them. You can open a 529 for yourself if you’re planning a return to school.
The plans come in two forms: pre-paid programs in which money is set aside for in-state colleges at today’s tuition rates, and savings programs in which the money is invested in a mix of mutual funds and can be used for any college or university. Now even prepaid plans allow participants to apply funds toward private and out-of-state universities, although you may not get the full amount depending on where you live.
California’s Golden State ScholarShare savings trust fund allows tax-free growth and state-income tax free withdrawals for educational expenses at any university in the United States including vocational school. And the money can be used for any educational expense including tuition, room and board, and books. Unfortunately, California hasn’t joined the list of states that have made 529 contributions tax deductible.
But you don’t have to select a plan based on where you live, and it’s a great idea to shop around because 529 plans are portable. Just be sure to factor in any in-state tax benefits or incentives you get for going with your state’s plan. You can also open multiple accounts, which allows consumers to take advantage of in-state incentives while also enjoying the financial advantages of an out-of-state plan. Look for low costs and flexible investment options. You can compare plans at several Websites including www.SavingforCollege.com and www.CollegeSavings.org.
You can open a ScholarShare account for as little as $25 or just $15 per pay period up to a maximum balance of $300,000. But you’ll have to contribute significantly more than the minimum if you want to put a dent in your child’s tuition bill. According to ScholarShare’s contribution calculator, an account opened for a child born in 2005 with just the minimum investment will grow to just $11,653 assuming a 7 percent rate of return. That’s just about 5.47 percent of the $213,165 you can expect to pay for over four years for a student entering college in 2023. The estimated tuition is based on the current annual cost to attend a University of California school and projected college cost inflation rate of 5.3 percent. According to SavingforCollege.com’s calculator, parents need to set aside $548 a month to meet the costs of a child entering school in 2023.
The Program is administered by the ScholarShare Investment Board, an agency of the state of California, which contracts with TIAA-CREF Tuition Financing Inc., as the program manager. TIAA-CREF Individual & Institutional Services distributes the securities product.
The ScholarShare offers five ways to have your contributions invested including a “guaranteed” option that protects your principle investment and provides a fixed minimum interest rate of 3 percent, and two age-based plans that divvy up funds according to the amount of time you have to save.
A fourth option for those who don’t mind a little more risk invests 100 percent of funds in stocks and index funds. And for parents who want to instill a little social awareness in their offspring while saving for college, ScholarShare offers the “100 percent Social Choice Equity” option. Money is invested in the TIAFF-CREF Social Choice Equity Fund, which does not invest in companies that “cause significant environmental damage, manufacture weapons, alcoholic beverages and tobacco products, produce nuclear energy, or engage in gaming or gambling operations.”