On The Money Trail
Choices abound on how best to pay for college
Last spring, Kevin Smith of Chesapeake, Va., sent detailed family budgets to the top college choices of his oldest daughter, Shannon. "A lot of people seem to be too embarrassed to let people know their personal situation," he says. But he was not ashamed to show how his middle-class family of five couldn't afford to lay out almost $30,000 for college costs. The result: Shannon's eventual choice, Amherst, awarded the family an additional $4,000 in need-based aid.
529 PLANS
For most families, the safest strategy is to start saving for college as early as possible. "We think a great time to start saving is when your child is graduating from day care," says Jeff Coghan of Hartford Financial Services Group. That way, parents can redirect dollars that had been going to child care.
Perhaps the best move is to open a 529 savings plan. These state-sponsored accounts-named for the section of the tax code that gave birth to them-allow families to invest college money in a tax-deferred account, much like an individual retirement account. And money can be withdrawn tax free from a 529, so long as it is used to pay for qualified educational expenses.
Last year, the federal government made this tax-free-withdrawal provision permanent (it was set to expire at the end of 2010). As a result, 529 assets are growing, jumping last year alone from $68.4 billion to $90.7 billion, according to Financial Research Corp.
It's not surprising. The plans allow families to stuff huge amounts of money away for college-in many cases, more than $300,000. And this growing popularity is having a beneficial effect: Thanks to new economies of scale, 529 plan fees are coming down.
For example, Iowa's 529, which is managed by Vanguard, last year trimmed its all-inclusive annual management fee from 0.65 percent to 0.62 percent of assets. At the same time, Maryland's college investment plan, run by T. Rowe Price, dropped its administrative fee from 0.38 percent to 0.28 percent. And T. Rowe Price says it will lower this fee even more once the plan attracts more than $2 billion in assets. T. Rowe Price also did away with a $75 enrollment fee.
Expect fees to continue to drop thanks to another trend. As contracts with financial services providers are starting to expire, states are putting their 529 plans out to bid. The competition on Wall Street to get this business is pushing fees even lower.
Take California's direct-sold 529. The plan used to be managed by TIAA-Cref, but last year Fidelity won the contract. Fidelity has since expanded the investment options and included a low-cost index-fund option that charges just 0.5 percent in annual management fees.
There's at least one other favorable trend that's brewing in the 529 world. For years, many states have offered their residents a tax deduction for contributing money to their home-state plan. But last year, three states-Kansas, Maine, and Pennsylvania-expanded this tax break to contributions made by residents to any 529 plan.
It's too soon to tell if other states will follow suit. But David Pearlman, chairman of the College Savings Foundation, notes that bills have been introduced in several state legislatures to offer similar tax parity. Those states include Arkansas, California, Connecticut, Indiana, Iowa, Massachusetts, Michigan, Missouri, Montana, North Carolina, and West Virginia.
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