Helping the Grandkids with College Costs
By: Lynn O'Shaughnessy Source: AARP The Magazine Date Posted:
Runaway higher-education prices are nudging many grandparents into exploring how they might help chip away at the costs. Creating a 529 College Savings Plan not only gives you a tax break, but it may also improve the child’s chances of qualifying for financial aid since grandparents’ contributions aren’t counted as assets in the federal student aid formula.
A 529 College Savings Plan allows parents and grandparents to sink college money into tax-free accounts. As long as the money is used for a family member’s college expenses (even your own), the cash can be pulled out without triggering federal taxes. Every state offers at least one plan, and the student can go to any college in any state. Inside each plan are a variety of mutual funds from such companies as Fidelity Investments, Vanguard, T. Rowe Price, Merrill Lynch, and American Funds.
Since you aren’t limited to investing in your own state’s program (as you are with most 529 prepaid tuition plans), the choices can be paralyzing, with forty-nine states offering roughly 85 savings plans, many of which contain two dozen or so investment choices. Here are some shortcuts to make the hunt easier.
Begin with your own state
Although you can open a 529 savings plan in any state, “take a look at the tax break in your state first,” suggests Joe Hurley, founder and chief operating officer of Savingforcollege.com, which provides a wealth of 529 materials. At least 26 states sweeten the pot by giving parents and grandparents a tax deduction on their state income taxes for contributions to their own state programs. You shouldn’t, however, seal the deal just because your state is waving a tax carrot. If the 529 plan is stuffed with mediocre mutual funds, it’s best to look elsewhere unless your grandchild is on the verge of entering college and the money will be in the account only briefly. “If a child is young, the state tax breaks won’t overcome a poorly performing plan over a long period of time,” says Hurley.
Check costs
Watch out for Porky Pig fees. “If you don’t use a relatively low-fee program, a 529 will not be a particularly favorable way to invest,” warns Susan T. Bart, a law partner at Sidley Austin LLP in Chicago. Bart favors 529 plans that use low-cost mutual funds, such as the programs with Vanguard funds in Utah, Nevada, and Ohio.
If, like many people, you rely on brokers and commissioned financial planners to select a plan, you will typically pay up to a 5.75% commission each time you invest. Yet most people, Bart suggests, should be able to pick a plan on their own. In addition to Savingforcollege.com, Morningstar.com also provides plenty of free tools and educational materials for self-starters.
Keep your eye on the calendar
While 529 investors enjoy tax-free withdrawals for college, this perk is scheduled to expire on Dec. 31, 2010. Many experts believe the benefit will be extended, but Congress, although it appears quite willing to do so, hasn’t yet acted.
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