Plotting your savings strategy
Pamela and Peter Gonzalez are probably better equipped than most parents to make sense of the alphabet soup of ESAs, UGMAs, IRAs, and the like that make up the nation's college savings system. For starters, Pam, 45, and Peter, 38, are air traffic controllers. So the Plantation, Fla., couple knows a little something about making complicated decisions under pressure. Moreover, Pam is interning at a financial planner's office because she's thinking about working in that field after she retires from her current job. Still, she says, "the sheer number of options is overwhelming. For each one, you have to figure out 'what does it all mean to me?' "
Parents saving for college today have more options--and better options--than ever before. But the creation and evolution of new savings vehicles in recent years, coupled with changes to the federal tax code, have made the array of savings plans more difficult to digest than ever before. In fact, saving for college has become a bit like participating in an Iron Chef competition. Without much prep time, you're given some mystery ingredients to work with, some of which you may never have heard of. And while the clock is ticking, you're somehow expected to whip up a sophisticated financial plan that keeps pace with ever growing college costs. Last year, for example, average tuition at private colleges rose 6 percent to $19,710, according to the College Board, while the average cost at public institutions jumped 14.1 percent to $4,694.
The Gonzalezes recently began setting aside $1,000 a month for their daughter, Rachel, 11, and son, John, 9. But the funds are sitting in a money market account earning around 2 percent a year as they weigh their choices. Pam wants a plan that offers maximum flexibility, since she's unsure where her kids will go to school or whether they'll earn scholarships. The family could try a 529 savings plan, a 401(k)-like account that allows for federal tax-free withdrawals for qualified educational expenses. With more than $43 billion invested nationwide, these plans are fast becoming the most popular tax-advantaged savings plan for college. The Gonzalezes are also thinking of investing in a regular brokerage account, which is taxable, where they can have more control over investment decisions and fees (box, Page 56). Or, they can opt to save in an individual retirement account like a Roth.
"It may be a case where more than one is appropriate," says Geordie Crossan, president of NBS Financial Services, a financial planning firm in Westlake Village, Calif. Indeed, there is ample evidence that most parents are starting to use more than one type of account; 13 percent are using three or more different types.
Special blend. Some are relying on a mix of brokerage accounts--an option that has improved in recent years, thanks to lowered rates on long-term capital gains and qualified dividend income--alongside tax-advantaged college savings plans like 529 savings accounts, offered by virtually all 50 states, or Coverdell education savings accounts (Coverdell ESA s). Others are stirring together brokerage accounts and traditional custodial accounts like Uniform Gifts to Minors Act accounts (UGMA s), where assets are put in the child's name and are taxed at the child's lower rate to shield money from Uncle Sam. But these plans have become less popular in recent years with the rise of 529s.
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