Families

As the cost of a college education continues to rise, outpacing the rate of inflation, it is becoming beyond the reach of most people unless they have planned early on. For people starting a college savings plan today, questions arise as to the best way to save. For such an important and long term goal, it pays to do some research when selecting a plan.

There are many factors to consider when selecting a college savings plan. As with any savings goal, individual factors such as time horizon, risk tolerance, investment preferences and tax situation need to be considered and weighed in order to select the most suitable savings plan. In addition, special consideration needs to be given to who will actually own the college funds as the decision is likely to impact the availability of financial aid in the future.

College Savings Plan:
 

Traditional Savings Methods

College savers can opt for the more traditional methods of accumulating college funds such as savings accounts (CDs, money market funds), tax-free municipal bonds, U.S. Treasury securities, or mutual funds. If the time horizon is long, savers may be able to afford the higher risk of investing in vehicles that offer potentially higher returns. As the time horizon shortens, they could gradually move their funds into more conservative savings of investments.

Tax Advantaged Methods

As an incentive for families to start early with their own college savings plans, the federal tax laws provide for tax advantaged methods to pay for college expenses. The methods involve different tax rules so they can be somewhat complicated. The best approach is to seek the guidance of a qualified tax or financial professional to help determine which method is most suitable.

IRC Sec. 529 Qualified Tuition Plans

These plans are designed to help a family cover the cost of college by taking advantage of tax incentives provided through the federal tax code. The plans may vary between the individual states and educational institutions that offer them. Contributions are not tax deductible, however, the accumulation is not subject to current taxes. Also, if certain requirements are met, the distributions that pay for qualified higher education expenses are not taxable.

Coverdell Education Savings Plan

These plans enable college savers to contribute up to $2000 per year on a tax-deductible basis. The distributions from a Coverdell Plan are free from taxes if used to pay for qualified education expenses.

U.S. Savings Bonds

The interest earned from series EE and Series I savings bonds may be excluded from income if it is used to pay for qualified education expenses in the year that the bonds are redeemed. The same exclusion applies to the interest earned from these bonds that are contributed to a 529 qualified tuition program.

Financial Aid

When saving for college, special consideration should be given to future eligibility for financial aid. Most needs based financial aid programs base eligibility on the amount of assets that are owned by the child. Generally, assets that are owned by the parents are not considered for financial aid eligibility. If assets are held in the child’s name, or in a trust for the child, they could negatively impact eligibility.