A 529 plan primer

January 25, 2001: 6:23 a.m. ET

Financial planners like the flexiblity 529 plans give people saving for college
By Staff Writer Alex Frew McMillan

NEW YORK (CNNfn) - When it comes to saving for college, some financial planners think 529 savings plans could be as hot as 401(k) plans are for retirement.

"As a planner and a dad, I think it's wonderful," Brian Orol said of using the plans. The Raleigh, N.C.-based certified financial planner not only recommends the plans for clients, he uses them himself. "I'm doing this for both my boys."

But the plans aren't widely understood. Their proponents often recommend them over other college-savings vehicles. They can also be a handy estate-planning tool.

Offered in almost all states
What are they? States have had guaranteed-tuition plans since the mid-'80s. They are also sometimes called prepaid-tuition plans. Kentucky led the way.

"They were really the model for the savings plans we see today," explains Joseph Hurley, a CPA who writes a 529 newsletter. He also runs a well-regarded Web site devoted to the plans at SavingForCollege.com.

Now 44 states have at least one 529 plan in place, and many have more than one. Of those, 27 are open to residents of other states.



	As a planner and a dad, I think it's wonderful.



	Brian Orol Certified financial planner

The other plans require the account holder or the beneficiary to have a connection to the state. Residency certainly qualifies you, but owning property in the state may well be enough.

Four states – Hawaii, Idaho, Minnesota and North Dakota – have plans under development. Only two states, Georgia and South Dakota, have no 529 legislation. But residents of those states can participate in other states' plans.

Investment options vary by plan. But they are typically more aggressive the younger the child, switching to fixed-income instruments as a child gets nearer college.

Some planners fault the lack of control – once you pick a track, you're locked in. But having professional management is an advantage for many not-so-savvy investors, Hurley noted.

Advantages over prepaid plans
Guaranteed-tuition plans are technically 529 plans, too. But they are very different from the newer qualified-tuition plans – typically called 529 savings plans. Those started rolling out in 1997, after the Internal Revenue Service clarified the rules on them.

In guaranteed-tuition plans, state residents pay a regular fee over years as their child grows up. The state vows to cover college in return. So tuition is paid for, whatever happens with the stock market. But the plans aren't particularly flexible.


		Planners like the flexiblity of 529 savings plans -- the idea being to produce better returns than a prepaid plans.

They limit you to in-state colleges, unlike savings plans. They also have low investment returns – between 2 and 4 percent a year, according to Orol.

While college costs aren't guaranteed with a savings plan, planners like Orol like the investment aspect – the idea being to produce better returns. Savings plans can be used for any recognized college, too.

A higher limit than an Education IRA
In an Education IRA, the donor can contribute only up to $500, maximum, each year. With a 529 plan, you can contribute up to $10,000 a year, when gift tax kicks in.

There is also no income cap for 529 plans. Like other forms of IRA, there is an income maximum for an Education IRA. Make more than $110,000 as a single person or $160,000 as a couple, and you're cut off.

The main advantage of an Education IRA is that the money is tax-free when withdrawn. In a 529 plan, investments grow tax-deferred. But the money is taxed when withdrawn.

So Uncle Sam gets a cut. But it's not as bad as it sounds. Withdrawals count as income for the beneficiary – normally a college kid with little earnings. That's a savings over tax at the rate of the account holder – normally a parent -- in a higher tax bracket.

People can also open 529 accounts for themselves, or make themselves the beneficiary. Perhaps you are saving for grad school, say, or even for as-yet-unborn kids. If you withdraw the money for your own use, the tax is obviously at your own rate.

But since you are likely to stop working or have reduced income in school, your tax bracket will probably be lower than when you were working full-time.

Investors can open both an Education IRA and a 529 plan, but they can't contribute to both in the same year.

More control than a gift to a minor
Another good side of 529 plans, financial planners say, is that money not yet withdrawn counts as an asset of the donor or account holder. That helps if a child is trying to qualify for financial aid, where a child's assets are counted at a higher rate.

But the account holder keeps control of the 529 plan assets. That's an advantage over money in a Uniform Gift to Minors account, for instance. UGM assets transfer to the minor when he or she comes of age.

If an account holder withdraws 529 plan money for anything other than "qualified educational expenses" – tuition at an accredited institution, books, room and board – there's a 10 percent penalty.

	SHOPPING LIST
		TIAA-CREF's Timothy Lane encourages you to comparer the following four points when shopping for a plan: 1. Is there a tax credit?. 2. What are the investment options? 3. What are the fees? 4. What are the contribution limits?

But the account holder controls whether that happens. So a parent can stop a wayward kid from taking the money and going surfing.

Planners also like the way that people who open 529 plans can change the beneficiary easily. If plans change – a child gets a full scholarship, say, or decides not to go to college – the account holder can designate any other relative of the original beneficiary as the new beneficiary.

There's no limit on how many times you change the beneficiary. So using a two-step process, planners say an account holder can normally make the beneficiary whomever they want.

Factors to consider when shopping for 529s
A donor can also contribute $50,000 in one year, if they then make no gifts the following four years. The IRS treats the money as if it's paid in on a pro-rated scale. If the contributor were to die after one year, $40,000 would revert to the estate, for instance.

Timothy Lane is vice president of tuition financing for TIAA-CREF, which runs nine state 529 plans, including the plans in California, New York, Connecticut and Michigan. He encourages people shopping for a plan to consider the following four points:

1. Tax credit: Does your state plan offer a tax credit? Some states let you deduct 529 contributions against state tax. If so, what is the limit? It may be worth staying "in-state" for the credit, a guaranteed "return" of state tax, even if another plan has more investment options.

2. Investment options: Does the administrator offer you the investment flexibility you want? Some states have all-stock plans, or all-fixed-income plans, or blended plans that change over time. Plans are offering more and more choices. What you pick depends on the beneficiary's age and your risk tolerance. Once you've picked a 529 investment option, you have to stick with it for the life of the account.

3. Fees: What is the expense ratio for managing the account? Expenses range from 0.5 percent a year on the low end up to 2 percent or more on the high end. One percent is around average, Hurley said. A fraction of a point might not seem a big deal, but it adds up over time – particularly if returns are lower, in today's slowing economy, or if you build a big balance. Some accounts also have flat annual management fees as well.

4. Minimums and maximums: Contribution limits vary by state and administrator. Companies like TIAA-CREF, for instance, let you open an account with as little as $25. But if you do contribute just a little, make sure annual fees don't eat it up. Rhode Island has the highest cap – each beneficiary can have 529 accounts worth up to $246,000. It's the beneficiary who has the limit, even if Mom, Dad and Grandpa opened accounts. One investor can contribute more than $246,000 by opening multiple accounts with different beneficiaries.