Send Your Grandkids to College and Avoid the Tax Man

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Paying for a college education may be the greatest gift you can give. However, it may also be the most costly. It is no secret that college expenses have been rising at an alarming rate.

According to The College Board’s report, “Trends in College Pricing” tuition has increased at twice the rate of inflation over the past 20 years (2001). This means in another 18 years parents can anticipate paying approximately $115,000 for total expenses at a 4-year public college or about $250,000 at a private institution (See chart below).

529 Chart

Here’s what you can do now to help with the rising costs of a higher education in the future — it’s called the 529 College Savings Plan. Named for a section of the Internal Revenue Code that permits very favorable tax treatment, this state sponsored college savings plan can bewithdrawn completely tax-free if the money is spent on qualified educational costs.

Account owners can generally write-off up to $55,000 ($110,000 for married couples) per beneficiary once per five-year period without incurring a federal gift tax. For example, an affluent couple can potentially send their 4 grandchildren to college and immediately eliminate $440,000 (4 x $110,000) from their taxable estate.

Besides the tax incentives, there are some additional features that make 529s a logical choice for college funding. There are no age or income limitations and the contribution limits are high, some reaching $268,000. Account owners keep control of the assets. If, for any reason, the owner must close the account, a penalty of 10% will be assessed on the earnings and the balance may be used at the owner’s discretion. In addition, 529s offer the ability to change the plan’s beneficiary. So if little Johnny decides to skip college the account can be reassigned to his little sister. If she wins a scholarship, the money can even be withdrawn without a penalty.

Each state’s 529 plan has its own features and benefits. All state plans are not created equal; some state plans are better than others. (Be cautious, some state plans do not offer diversified portfolio options.) Fortunately, most state plans allow you to invest across state lines, meaning that if you don’t like the plan your state has to offer, you can look to other states and go with a plan that you’re comfortable with. Currently very few states offer tax breaks on their 529 plans, so investment selection and management experience should carry more weight when choosing a plan.

With a college savings plan, you may select investment options based upon your goals and time horizon. One of the more common investment choices is based on the current age of the beneficiary. Investment allocations will change over time, so that the older the child gets and the closer he/she gets to college age, the more conservative the underlying investments become.

Figuring out the various tradeoffs among the different plans can be quite confusing. No particular type of account or investment option is appropriate for every investor. Make sure you consult with a well- informed investment advisor prior to investing.