Paul Ferraresi

There are a multitude of ways to solve for the funding of a child’s college education. Each method has its pro’s and con’s. Family income, the desired college and tax breaks all have an influence on the track you take. No one method is the only route. You can mix and match to fit your needs. Here is a summary overview to assist in your decision making. I have broken it into two parts so as not to overwhelm you.

529 College-Saving Plan

Plus

 Tax-free asset growth.
 Tax-free distributions for qualified education expenses.
 Some states give tax breaks on contributions or matching grants.
 Can claim HOPE and Lifetime Learning Credits for qualified expenses not paid by plan.
 Donor controls the account.
 Anyone can contribute. No earnings restrictions on donor.
 Can gift up to $60,000 a year per child without triggering gift tax, if election made.
 Account owner can change beneficiary to another member of the family.
 If owner is a parent or dependent student, financial aid will only count 5.6% in the family contribution formula.
 Account owner can reacquire funds.
 Some states offer credit protection.
 Federal bankruptcy protection, with limits.

(Account owner can reacquire funds.)

Minus

 Limited investment options.
 Layer of fees adds to investor’s expenses.
 States must have a cap on account size or contribution amounts.
 States can change features of plans and place savings with new managers.
 Account owners can only invest cash, not appreciated securities.
 Nonqualified withdrawals are taxed as income and may incur 10% penalty; also counts as income for financial aid.
 Plan may be tapped by Medicaid if account owners needs nursing-home care and does not have other funds available.
 Not all states have protections against account owner’s creditors.

529 Prepaid Tuitions

Plus

 Prepaid tuition credits lock in future tuition cost at today’s rates.
 Benefits are federally tax-exempt if used for qualified expenses.
 Some states give tax breaks for contributions.
 No income restrictions on donor.
 No investment risk, unless the state mismanages the funds.

Minus

 Fees may apply.
 Limited number of schools participate.
 May have a limited enrollment and contribution period.
 Account owner or beneficiary is generally required to be resident of state offering plan.
 If child attends out-of-plan school, some costs may not be covered.
 Room and board usually not covered.
 If owner terminates plan, state usually only returns original contribution and levies cancellation fees.
 States may encounter shortfall risk.
 Ability to change beneficiary may be limited.

Coverdell Education Saving Account

Plus

 Tax-free asset growth.
 Tax-free distributions for qualified education expenses.
 Can claim HOPE and Lifetime Learning Credits for qualified expenses not paid by Coverdell account (until 2011).
 Great flexibility of investment choice.
 Expenses may be lower than that of some 529 plans.
 If owner is a parent, financial aid will only count 5.6% in the family contribution formula.
 Funds can be used for primary and secondary school costs (until 2011).

Minus

 The Pension Protection Act of 2006 did not make features permanent. Contributions will revert to $500 per year starting in 2011, and funds won’t be able to be used for elementary and secondary school costs.
 Contributors face earnings restrictions.
 Total contributions may not exceed $2,000 a year per beneficiary.
 No state-income tax deduction for contributions.
 Nonqualified withdrawals are taxed as income and incur 10% penalty.
 Beneficiary takes control of the account at age of majority.
 Beneficiaries must be under age 18 when contributions are made.
 Assets must be distributed by age 30 or earnings are taxed as ordinary income plus a 10% penalty.
 Account owners can only invest cash, not appreciated securities.

UTMA/UGMA

Plus

 Easy to open.
 Less expensive than setting up a trust.
 Can invest in wide variety of investment vehicles.
 Donor can gift appreciated securities and cash.

Minus

 Beneficiary takes control of money at statutory age (usually age 21 for gift accounts).
 Accounts must be terminated once the child reaches statutory age.
 Income subject to “kiddie tax.” Parent responsible for making sure tax return is filed on the child’s behalf.
 If parent is donor and custodian of the account and dies, the UTMA/UGMA becomes part of parent’s taxable estate.
 Because the child owns the account, up to 20% of this money will be counted toward the family contribution when determining financial-aide eligibility.
 Gifts made to UTMA/UGMA accounts are irrevocable.
 No ability to change beneficiary.

2503(c) Minor’s Trust

Plus

 Can invest in wide variety of investment vehicles.
 Trustee can spend money on behalf of minor until he or she reaches age 21.
 Can contribute an unlimited amount, but gifts in excess of $12,000 (most likely $13,000 for 2009) per year per beneficiary may be subject to gift tax.

Minus

 Can be expensive to set up.
 Assets are child’s for financial aid purposes.
 Income taxed at trust rates, which are often higher than individual rates.
 Child gains control at age of 21 unless he or she give up privilege.
 May decrease chances of receiving financial aid.
 Gift to trust are irrevocable.
 Only one individual can be the beneficiary (so there’s no ability to change beneficiary).