You may avoid student loans with these tips for saving for college

Throughout history, parents have used savings, unsecured loans and credit to get their children through college. Since 1996 however, a new savings vehicle has been on the market and growing numbers of parents are utilizing it. Section 529 plans offer tax-advantages for saving when it comes to college savings. One thing to remember is that college costs are not set to decrease any time soon. In fact, since the 80s, they have consistently risen straight across the board. Also, for parents who wait too long to start saving, many older savings options won’t help. For example, the Coverdell Education Savings Account has an annual contribution limit of $2,000. If parents don’t open it until a child is in high school, it most likely will only put a small dent in college funding. Finally, prepaid tuition plans sound good, but children have to go to schools that participate in the plan. That limitation could mean disaster for a student wanting a specific field of study.

The 529 Plan

State-sponsored college savings plans allow flexibility in choosing a school. In addition, parents starting to save later still have the opportunity to make a sizable investment. The Section 529 plans allow people to invest in a predetermined pool of stock and bond investments. Most plans involve dividing investments according to a given asset allocation that is determined by the child’s age. Younger children traditionally have more aggressive asset allocations and older children have more conservative ones.

The lifetime contribution limit for the 529 plan often times is greater than $200,000 and that affords a great flexibility in how much parents contribute. All earnings in the account are tax deferred and for parents living in the state when the plan is used, they also may be eligible for state tax deductions. Once the child reaches college age, the account can be used to pay for qualified higher education expenses. If money remains in the account after paying off college, the balance can be transferred to a younger sibling or other related family member headed for college.

The advantages and disadvantages of a 529

Older methods of paying for a child’s college meant dipping into savings, taking out unsecured loans or family assistance. Today, the 529 savings vehicle is offering a much less intrusive method of saving for college. The biggest advantage of the fund is that the plan is flexible and has few limits. Plus the state-sponsorship means that they are tax-deferred vehicles for saving money. The other big advantage is professional asset management. Each participating state contracts an asset management firm to handle the plan. You can find out what company your state uses by visiting SavingForCollege.com.

Disadvantages

When it comes to the disadvantages of the plan, there are a few to note. First, the plan is funded by various stocks and bond investments. With any stock or bond-funded account, there is a risk to be aware of. When it comes to the 529 Plan, returns are not guaranteed. That means that potentially your account could lose value, or remain the same. Companies cut back on the aggressive stocks and bonds as the child ages, but risk is never completely out of the picture.

Parents also should have a complete understanding of the contribution and withdrawal rules to the plan prior to signing up. Every state has its own rules in terms of procedures, so be sure to read up on what state is applicable. There are also penalties to be aware of if withdrawals are not used for higher education expenses.

Choosing the right plan

It takes some research to find the right savings vehicle for college funding. The Section 529 plan can be extremely helpful, but there are other options to consider. A prepaid tuition plan may make it possible to lock-in on a college’s tuition rate. That can cut down considerably on savings, unsecured loans and credit needed to fund a shortfall. Coverdell Accounts may be useful for parents who start saving early and commit to saving religiously every year. What plan a parent uses needs to be individualized to their specific financial situation. Research is key in finding the right solution to the problem of funding college.

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It can take years to save money for your child's college education (photo: flickr.com)

While 529 education savings plans can’t really promise quick cash for college, in recent years they’ve gained prominence as an effective way for parents to provide for the future higher education expenses of their children. A 529 education savings plan is a tax-deferred investment, similar to an Individual Retirement Arrangement (IRA), except that the qualified withdrawals are related to higher education expenses as opposed to retirement.

Section 529 of the Internal Revenue Code sanctions two types of educational plans: prepaid and savings. The prepaid plans allow participants to buy credits for future, public, in-state education at present-day prices. The savings plans, like many standard investments, are basically mutual-fund investments and are tied to market performance.

2008 stock market crash

Because they’re subject to market trends, 529 savings plans were severely eroded in the crash of 2008, with many of them losing more than ten percent of their value almost overnight. Not surprisingly, the investors who suffered these losses have been reconsidering the wisdom and value of maintaining 529 savings plans.

State offers vs. private offers

529 education savings plans are administered by individual states rather than the federal government, although they may be bought and sold – or re-sold – across state lines throughout the country. This has led to two distinct markets for 529 savings plans: those issued by the state directly and those offered privately by brokers and financial planners.

Private offers

The plans sold by brokers and planners were particularly hard hit in 2008 because many of them were invested aggressively and included a number of additional fees and costs that were added on in the re-sale market. Additionally, the brokers and planners who offer re-sale plans almost always retain the incentives paid by the issuing state. Unless you intend to contribute a lot of money quickly and require a very aggressive investment strategy, these re-sale 529 plans are probably not a good idea.

State offers

Many of the state plans fared better in the 2008 crash than private plans did. In part this was because the state plans were invested more conservatively. But their better performance was also related to their overall expense and state-incentive structure. Many states offer their 529 plans at extremely low rates and also provide the additional incentive of state income-tax credits or deductions. Some state 529 savings plans are tied to offers made by state university systems as well, which provides an additional incentive.

Overall benefits of 529 savings plans

As is the case with a Roth IRA, contributions to 529 savings plans are not deducted from your federal taxes, although they may be deducted from your state income taxes. However, distributions for qualified education expenses are tax-free and earnings within the plan are tax-deferred, even if they are not ultimately applied to qualified education expenses. Coupled with the easy “hands-off” nature of the plans and the maintenance of parental control, 529 plans really can’t be beat as a way to save for your child’s future college expenses.

Should you keep your 529 education savings plan?

Even if you lost a lot of money in the 2008 crash and are now hoping for quick cash to regain your financial footing, maintaining a 529 savings plan for your child’s college education is still a good idea. If your plan was purchased through a broker or planner, you should probably have it transferred to a 529 plan offered directly by your state. Even if you live in one of the few states that do not offer tax incentives, the lower administration costs and more conservative investment strategy will make the transfer worth the effort.