A long-term plan for paying for college involves more
than just racking up investments and accruing savings. There are
other things you and your parents need to think about. In just about
every area, the earlier you start thinking about college, the better
off you’ll be.
Your number one asset when it comes to paying for college
is your approach to school. If college is still three or more years
away, your long-term plan has to include strategies that will help
you improve your grades, diversify your activities and volunteerism,
and identify the scholarships that will help you pay for your education.
Don’t think of scholarships as a short-term strategy.
The truth is that you can “win” many scholarships years before you
even apply for them. Every hour of community service and every tenth
of a grade point you earn as a freshman, sophomore, and junior in
high school count toward potential scholarship money.
The 529 Plans
Section 529 plans essentially allow you and your family
to pay now toward your future tuition. As of 2002, every state,
plus the District of Columbia, has a Section 529 plan. “Section
529” refers to the corresponding part of the Internal Revenue Code.
Any 529 plan must be part of a long-term strategy since it takes time
for money to accrue. The earlier you start saving money through
a 529, the better.
Since 529 plans are now available nationwide, you’re only
a phone call or mouse click away from finding the one in your state.
Contact the College Savings Plans Network (CSPN) by logging on to
their Web site, www.collegesavings.org, or calling their toll-free
number, 1-877-277-6496. CSPN can put you in touch with a plan nearby.
There are two kinds of 529 plans: Prepaid Tuition
Plans and College Savings Plans.
1. Prepaid Tuition Plans
Prepaid tuition plans allow you and your parents to pay
for college now, at current costs, rather than waiting and facing
skyrocketing prices. A prepaid tuition plan guarantees that if you
buy four years’ worth of tuition right now, at current costs, you’ll
be able to attend four years of college later on without having
to pay the increased cost of tuition. This is a significant savings.
In the past decade, private college tuition has risen 42 percent
and public college tuition 47 percent. Tuition will likely rise,
on average, 5 percent each year for the next decade.
When you redeem the tuition credits you’ve purchased,
their maximum value depends on the average tuition of in-state public
colleges. If you decide to go to either an in-state private college
or an out-of-state college, you can usually apply the tuition you’ve
bought toward that college’s tuition. However, you’ll have to make
up the difference between the value of the average public college’s
tuition and the cost for tuition at the private or out-of-state
college. The exact details of these plans vary from state to state.
Though prepaid tuition plans are a great deal in some
ways, you’ll see in just a moment how they can adversely affect
your chances for need-based aid.
2. The College Savings Plan
A 529 college savings plan allows you, your parents, or
anyone else to contribute to the future costs of college and get
some tax benefits in the process. Unlike the prepaid tuition plans,
the college savings plans don’t come with any guarantee on returns.
Like regular investments in the stock market, there is a chance that
you could actually lose the money you’ve invested in them.
College savings plans often allow contributors to choose
how their money is invested. Options include higher-risk equity
funds for potential long-term growth or safer fixed-income investments
when college is fewer than five years down the road.
Whereas you can use the prepaid tuition plan only for
tuition and mandatory fees, you can use college savings plans for
any COA expenses, including room, board, books, and supplies.
- Earnings grow tax-deferred.
- Distributions are tax-exempt when used for college costs.
- Accounts benefit from state-tax exemptions or deductions.
- You can open 529 accounts for both relatives and friends.
- You can choose how your money is invested in a 529 college
- Accounts can be transferred to other family members.
- Accounts can be refunded, albeit with penalties.
- There are no income limitations for who can open a 529
- IRS gift-tax rules offer an accelerated giving benefit.
- You have fewer time limits for use than other college
- 529 plan fees may make this a poor choice
for short-term planning.
- Withdrawing funds results in a 10 percent penalty.
- Funds for anything but school will be taxed.
- Tax benefits are set to expire in 2011, barring legislation.
- Prepaid tuition plans may reduce eligibility for other
- College savings plan accounts in your name will be assessed
at 35 percent.
- Prepaid tuition plan funds must be used within a limited
- Time extension may come with a penalty.
- Funds can’t be used for most foreign schools.
- Funds can’t be used for schools not considered “eligible
institutions of higher education.”
The Coverdell Education Savings Account, formerly known
as the Education IRA, is another option for long-term college savings.
These accounts are extremely flexible and offer marked advantages
over the 529 plans. Of course, they also come with their own unique
- Unlimited investment options.
- Few limits placed on where funds may be used.
- May be set up at virtually any brokerage firm.
- No expiration date for Coverdell tax benefits.
- Tax-free withdrawals for qualified educational expenses.
- $2,000 annual contribution limit.
- Varying setup fees and other administrative costs.
- Income limitations on who may participate.
- Counted as a student asset in the needs-analysis formula,
which greatly reduces other aid eligibility.
- Generally must be used before the student reaches 30 years
Other Savings Plans
Besides the 529 plans and Coverdell ESAs, and, of course,
your own investments, you have two additional options for long-term
If your parents really like living on the edge, they might
opt for a custodial account. Also known as Uniform Gift to Minors
Act (UGMA) accounts or Uniform Transfer to Minors Act (UTMA) accounts,
these plans can be set up with just about any brokerage firm or
mutual fund company and have some tax advantages. The main advantage
has to do with the rate at which custodial account earnings are
taxed. The first $750 is exempt, the next $750 is taxed at the child’s
lower federal rate, and anything beyond is taxed at the custodian’s
federal rate. In order to qualify for this benefit, you must be
younger than 14.
Once you reach the age of majority, anywhere from 18 to
25 depending on what state you live in, all funds within the account
become your property. At this point, you’re legally entitled to
spend the money on anything you want—not just college. Of course,
if your parents set up a custodial account with the intention of your
using it to pay for college, you’ll probably want to do just that.
Your parents might view your freedom of choice as a risk.
Ah, yes, backed by the full faith and credit of the United
States government, savings bonds have been around since 1935. Alas,
like many things that have been around since 1935, savings bonds
just don’t seem as cool as all these new programs, with their fancy
acronyms and code numbers. However, they do have many of the same
benefits, including tax exemption when used to cover the costs of
education. And of course, the full faith and credit of the United
States government never really goes out of style, does it?
The Long Haul
Wise planning and careful thinking can make all the difference
when it comes to paying for college. The more time you have to save
and invest, the better. Not everyone thinks so far ahead, however.
Read on for tips on how to pay for college if you don’t have years
to get yourself in gear.