Ask Karen Gibbs

Veteran business correspondent Karen Gibbs answers your personal money questions and addresses current topics that affect YOUR finances on a daily basis. Karen is the financial expert in your corner--no question is too basic or too small. Karen boils down the issues simply: here's what you need to know, and here's what you need to do. Send your money questions to AskKaren@mpt.org and post your comments below.

6

April

Saving for College

Karen Gibbs

Hi Karen, I have two young sons; ages seven and two, and I want to start saving for their college education.  What are my options? 

  -Thi, Owings Mills

 

Thi, the government has made it easier to start saving for college, but as with everything, you have to do your homework.  There are advantages and disadvantages to every choice you make, and it’s no different when saving for your children’s’ education.

Graduation Piggy Bank

There are two federally sponsored, tax-advantaged education savings plans available; 529 College Savings Plans and Coverdell Education Savings Accounts, named after the late Georgia senator Paul Coverdell.   With both plans you have income limits and contribution limits.  There are also issues of who controls the account – you or your child – that can affect financial aid calculations.  There are limits and restrictions regarding how the funds can be used and penalties may be assessed.

Additionally, 529 savings plans can be either a pre-paid account or an investment account.  The State of Maryland offers its taxpayers a state income tax deduction for each.  The good news is that you don’t have to make an either-or choice, you can employ both strategies.  For more information call 888-4MD-GRAD (888-463-4723) or go online at www.collegesavingsmd.org.

It’s important to know the risks and rewards of each savings plan.  Unlike a retirement account, your time horizon is about 18 years – the age your children reach majority – leaving you little time to recover if investment options aren’t diversified to minimize risk.  Most plans will provide information on how your contributions will be invested.  Make sure the plans’ investment strategy is one with which you are comfortable.  You want to be able to sleep at night.

You also want to be aware that nothing is free – there are fees and expenses associated with each plan that, overtime, can make a difference in the return you get on your investment.

 

Here’s a quick guide to college savings plans, courtesy of Bankrate.com:

Comparing college savings plans

 

 

 

529 savings plan

Prepaid tuition plan

Coverdell education savings account

Uses

Higher education

Higher education

K-12 and higher education

Tax benefit

Earnings grow tax free

Earnings grow tax free

Earnings grow tax free

Withdrawals

Tax free as long as money is used for higher education

Tax free as long as the money is used for higher education

Tax free if they do not exceed the beneficiary's qualified education expenses for the tax year

Who owns account?

Asset of account owner

Asset of account owner

Asset of account owner

Financial aid impact

Parents expected to contribute 5.64 percent of the money toward college expenses annually

Parents expected to contribute 5.64 percent of the money toward college expenses annually

Reduces child's eligibility for federal student aid by a maximum 5.64 percent of the value at the time of application

Rollover status

Can be transferred tax free to the 529 plan of a family member

Can be transferred tax free to the prepaid tuition plan of a family member

Can be transferred into a Coverdell account for a family member

Tax consequences

Contributions qualify for the $12,000 annual gift-tax exclusion
Contributions between $12,000 and $60,000 can be spread over five years

Exempt from federal income tax and often exempt from state and local taxes

No tax consequences if new beneficiary is under the age of 30. If money is not used for education, earnings subject to tax and penalty.

 

 

I hope this gives you a good start.  In my next column, I’ll explore alternatives to college savings plans. Stay tuned!

 

Karen

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