College Savings Plan Tips: Where to Start

Denise Martin, CFM at Merrill Lynch

U.S. families will spend about $3 trillion on higher education over the next 20 years.  College costs increase higher than inflation, running about 5% a year, or in the projected range of $130,000 (public schools) to $320,000 (Ivy League schools) in 20 years.  What are the solutions for parents with some time to save for these future expenses?

• Open a savings account and contribute on a systematic basis. Investing in high quality growth stocks or mutual funds should outpace college inflation and build equity in an education nestegg.  There is no limit on how much can be invested, by any number of interested parties, and full choice into any investment product.  Regular investing on a schedule has the advantage of dollar cost averaging and no tax liability on stocks until they are sold.  Furthermore, the money is fully accessible for other needs, should they come up over time, and not locked up specifically for education.  Any taxes incurred through the years are taxed as earned.
• Open an Education IRA and contribute up to $500 per year, if you meet the income guidelines (under $150,000/year adjusted gross for a married couple filing jointly)  The money grows tax-deferred and comes out tax-free when used for educational purposes (non-educational distributions incur a 10% penalty).  There is full investment flexibility on what vehicle to use to invest the money.
• Transfer/Gift up to $10,000 per year per person to the future college student(s).  This removes the money from the donor’s estate, but like a true gift, it is irrevocable and the property of the minor, held in trust until the child comes of age.  The earnings from the money is taxed at the child's tax rate when withdrawn.  There is full investment flexibility
  and no income guidelines to be able to contribute.  However, the money is not specifically locked up for education and can be used by the minor as desired when s/he becomes of age.
• Open a traditional IRA or ROTH and contribute up to $2,000 per year, if you meet the income guidelines.  The money grows tax-deferred and is taxed upon withdrawal as regular income.  Higher education expenses are considered a qualified distribution so there is no penalty to withdraw the money for college expenses.   There is full investment flexibility and full control of the spending of the funds.
• Open a prepaid tuition plan at the college of your choice that offers such a plan.  By buying tuition units at the determined price, the units grow over time to lock in the cost of tuition.  However, if the school chosen turns out not to be the student's ultimate school choice, the prepaid units must be traded at another school that will accept them.
• Open a 529 State college savings plan and contribute up to $50,000/$100,000 per couple with no income restrictions.  (Contributing the full amount initially prevents future contributions for 5 years thereafter.)  Any interested party can contribute, up to a total of $225,000 per student.  The money grows tax-deferred and qualified withdrawals are taxed at the student's tax rate (non-educational distributions incur a 10% penalty).
  Additionally, for Maine residents, all earnings are state tax-free when used for education.  This plan removes the money from the donor's estate but the donor, not the beneficiary, retains control on how the assets are used. There is great flexibility within the plan to change beneficiaries, invest on any desired schedule, withdraw funds when needed to any accredited post-secondary U.S. school.  The monies, by IRS law, must be professionally
  managed and not freely chosen by the investor.  In Maine , the program manager is Merrill Lynch and the 529 plan is called Next Gen.