Many options for funding college

By Bob Moeller
WEAC Member Benefits

March 2006

Financial Planning Seminars
Achieving Financial Independence

WEAC members often ask me for ideas on how best to save money for college. With some recent changes in the EdVest program, this is a good time to review the options.

Following is a quick look at three popular avenues to funding college costs: 529 plans, Coverdell Education Savings Accounts (CESA), Uniform Gift to Minors Act, plus my suggestion of Roth IRAs. Each is a possibility, depending on your circumstances.

529 Plans (EdVest is Wisconsin's 529 Plan). This program is the responsibility of the Wisconsin Treasurer's office. In a 529 plan, you or grandparents can invest. Whoever does the investing remains the owner of the funds. The child is a beneficiary. The owner can change beneficiaries. The child has no "rights" to the money. It is not considered the child's money when applying for financial aid. That means it might be easier for the child to get aid. There are no state or federal taxes on growth of the investments. If used for higher education, there are no state or federal taxes on withdrawal. The child can attend college in any state.

You can contribute up to $60,000 from each spouse the first year, and Wisconsin residents can deduct new investments up to $3,000 per year per child from their Wisconsin income taxes. If you use a different state's program, you cannot deduct from your Wisconsin taxes. EdVest can be purchased directly for no commissions or through a financial "adviser" with commissions. There is no reason for you to pay commissions. Buy direct only. For information, call 1-888-338-3789.

Managed by Wells Fargo mutual funds, EdVest also has some excellent outside fund choices, including the Vanguard Institutional Index Fund and the Vanguard Wellington Fund.

Wells Fargo charges 30 basis points or 0.3% if you use outside funds; 20 basis points (0.2%) if you use Wells Fargo funds.

Vanguard Index Fund charges 5 basis points ($5 per year charge on a value of $10,000). There is no enrollment fee. Recent changes eliminated a $10 annual fee. Total fees are the 0.2% or 0.3% mentioned above plus the mutual fund fee.

The main negative is that if the money is not used for education you will pay taxes and a 10% penalty when withdrawing the money. But remember, you can change beneficiaries. All in all, it's a good choice.

Coverdell Accounts. Here, your limit is $2,000 per year per child. Grandparents can fund. There are no tax deductions. The main plus for some people is that funds can be used for grades K-12 costs, but most WEAC members don't have kids in private schools so this is of little benefit. You can invest the money anywhere, and assets stay in your name for financial aid applications.

Because of the limitations on amount, I don't consider this the best option for most members.

Uniform Gift to Minors. You can contribute large sums (up to $12,000 per year per child per contributor - i.e. two parents with two kids can deposit $48,000 per year.) The money can be invested anywhere; the kids own the money, you control the investments. The money will be counted as the kids' when applying for financial aid. Earnings are taxed at kids' rate generally.

With the advent of 529 plans I do not recommend UGMA. It is frequently to parents' advantage to withdraw the money and spend it on such items as a computer for the child so it is not counted in the financial aid formulas.

Roth IRAs. With a Roth IRA, each parent can open an account in his or her name. You can contribute up to $4,000 each year if under age 50, $5,000 if 50 or older. Limits frequently increase. If you leave the money in until you are 59? (or for at least five years if you are older), there will never be any taxes on the earnings, even if the money is not used for college. If parents wish to withdraw the principal - for college or any other purpose - they can do so with no tax penalties and no income taxes.

If you are under 59?, the earnings can be withdrawn with regular income taxes if used for education, but I recommend you do not do that. The money can be invested anywhere. It is the parents' asset so it doesn't hinder the student's financial aid request. It is not available if family income is more than $160,000 for married couples or $110,000 for singles. It is partially available if income is $150,000 to $160,000 for married couples or $100,000 to $110,000 for singles.

This is a very attractive method if you aren't certain how or if you might fund college or if you're not sure a child might go to college. It also serves as a nice retirement fund if it is not used for education. If funds are limited, I'd start here.

Posted March 8, 2006