Take heart. This grind of a course just got a lot easier. The $1.35 trillion tax cut President Bush signed last week may be loaded with numbing nuances on a broad range of tax fronts. But on the issue of saving for college, it's perfectly clear: so-called 529 plans, which allow tax-free withdrawals for college expenses, are a no-brainer for just about everyone.
Named after a section of the tax code, 529 plans are run by the states, and soon all 50 will have a version. These plans are open to everyone. Contributions are often deductible at the state level, and you can sock away as much as $250,000 per child. The plans are so popular that fund company American Century, one of the first to offer a tailored college-savings vehicle, scrapped its once popular program last year in favor of Learning Quest, a national 529 plan run through Kansas.
Yes, 529 plans reduce chances of getting financial aid, some charge high fees, and there is a penalty if you don't use the money for tuition, books or room and board. No, you don't have a lot of control over how the money is invested. Yet look at the upside: you retain total control over the money--unlike that in a custodial account, which becomes the property of your child at age 18 or 21. Better still, the savings have always grown tax-deferred before being taxed at the child's rate upon withdrawal. And here's great news: starting next year, there's no tax on withdrawals, tipping the scales in favor of 529 plans for most people.
Fund company T. Rowe Price found that the same $5,000 yearly investment by a taxpayer in the 28% bracket over 18 years resulted in total savings of $287,704 in a new 529 plan, $250,157 in a custodial account (under the Uniform Gift to Minors Act) and $224,527 in a taxable account, based on a 10% rate of return. The gap narrows over shorter durations. After just five years, the same investment produces $38,520 in a 529 plan, $37,368 in a custodial account and $34,587 in a taxable account.
If you have just a few years, 529 plans may not be best, given their relative inflexibility. Go with a taxable account invested in a broad stock index. That enhances your ability to get college aid and to use the Lifetime Learning and Hope Scholarship credits freely. It also puts you in full control of your money. But for early starters, you can't beat the new 529 plans, which make it even easier now to move assets among extended family members.
Note that Congress can giveth--and taketh. Critics view the new provision as a freebie to the rich and charge that the easy money will lead exclusive universities to raise rates, putting the very best education further out of reach. So the tax-free nature of 529s may not last. But don't let that stop you. Saving somewhere--anywhere--is the key to passing this class.
E-mail Dan at email@example.com. See him Tuesdays on CNNfn at 2:15 p.m. E.T.