college savings plans: advantages and disadvantages

Posted : May 2, 2003
Last Updated : July 20, 2016
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college savings plans: advantages and disadvantages

The earlier you start saving for college, the more money you will accumulate. However, keep in mind that it's never too late to begin!

When you start saving for your/your child's education, you can choose from several different options. These college saving methods have advantages as well as disadvantages and can often be difficult to understand, as many fine details exist with each one. The following information will give you some basic knowledge to help you choose a savings avenue, but you may want to consult with your own accountant or personal financial planner for further assistance.

Qualified Tuition Programs / 529 plans
The most popular method of saving for college is through Qualified Tuition Programs (QTPs), also known as section 529 plans. These programs are administered by individual states and allow a custodian to either prepay or contribute to an account for paying a student's qualified education expenses at a postsecondary institution. Eligible education institutions may also establish and maintain programs that allow a custodian to prepay a student's qualified education expenses. Two types of Qualified Tuition Programs are available: Qualified Prepaid Plans and Qualified Savings Plans.

Qualified Prepaid Plans allow a family to lock in the current price of college for future use. For instance, if a family purchases shares worth one year's tuition, those shares will always be worth one year's tuition even after several years when tuition rates have increased.

Advantages:

  • Risk-free way to pay for college. Invested money cannot be lost.
  • Possible tax breaks. Qualified Prepaid Plans are exempt from federal income tax and are often exempt from state and local taxes, as long as they are used to pay qualified education expenses.
  • Guaranteed. Many state-sponsored plans are guaranteed by state governments.

Disadvantages:

  • Limited enrollment period. Most Qualified Prepaid Plans have a limited enrollment period.
  • Limited to state residents. Most state-sponsored plans require either the owner or the beneficiary of the plan to be a resident of the state.

Qualified Savings Plans allow a custodian to set aside money for a student's education and let it grow tax free. Investments are subject to market conditions.

Advantages:

  • Tax breaks. Investments grow tax free for as long as money stays in the program, and when money is taken out for education purposes (i.e. tuition, room and board, books, etc.), the account holder won't pay federal taxes on any part of it.
  • Flexible. For most plans, the beneficiary (student) can attend any accredited college in the United States and many institutions abroad. A benefactor can change beneficiaries as often as he likes. Accounts can be opened for any number of people regardless of age.

Disadvantages:

  • Potential to lose money. Since the investment is directly related to the stock market, Qualified Savings Plans have the potential to lose money.
  • Possible penalties. If money is taken out of a QTP for purposes other than education, the account holder will be charged a 10 percent penalty on the earnings and have to pay federal taxes on the earnings.

UGMA and UTMA Custodial Accounts
Custodial accounts, such as the Uniform Gift to Minors Act (UGMA) and the Uniform Transfer to Minors Act (UTMA), allow parents, grandparents and others to transfer and invest money to pay for education or any expense that benefits a child. To create a custodial account, the benefactor must select a beneficiary and then gift the money to the account. The money belongs to the minor, but the benefactor controls the rights on the account until the minor reaches 18 or 21, depending on the state.

Advantages:

  • Flexible spending. Money from a custodial account does not have to be spent on school, but it still has to be spent for the benefit of the child.
  • No contribution ceilings. Custodial accounts have no ceiling on the amount one can contribute.

Disadvantages:

  • Parental loss of control. When the minor reaches adulthood, he/she can use the money for any purpose without permission from the benefactor. Because of this, there is no guarantee that the child will use the money for educational purposes.
  • Transferability of the account. Since the beneficiary's name is on the custodial account, the funds are not transferable to another beneficiary.
  • Asset of child. Because custodial accounts are considered to be an asset of the child, they could negatively impact the child's eligibility for financial aid.

2503(c) Minor's Trust
A section 2503(c) Minor's Trust holds gifts in trust for a child until the child reaches age 21. This trust was established so that gifts to minors in trust may qualify for the gift tax annual exclusion. For a gift to qualify for the annual gift tax exclusion, the recipient must be able to receive the gift immediately. The 2503(c) Minor's Trust is an exception to that rule.

Advantages:

  • Tax break. The recipient can receive the trust in the future and still qualify for the gift tax exclusion.
  • Flexible investments. Generally the trust property may be invested in any manner, including stocks, bonds, mutual funds, cash accounts, etc.

Disadvantages:

  • High setup and administration costs. Because an attorney is usually involved in the drafting of a trust document, there are high setup and administrative costs.
  • Limited flexibility. A 2503(c) trust may only have one beneficiary, and the beneficiary must be under age 21 when the trust is established.
  • Asset of child. Because minor's trusts are considered to be an asset of the child, they could negatively impact the child's eligibility for financial aid.

Coverdell Education Savings Accounts
Coverdell Education Savings Accounts are plans that allow account owners to save annually up to $2000 (depending on income) per beneficiary for college-related expenses.

Advantages:

  • Tax benefits. All earnings in the account accumulate on a tax-deferred basis and can be withdrawn from the account tax-free if used to pay for qualified education expenses, such as tuition and fees, required books, supplies and equipment, and qualified expenses for room and board.
  • Transferability of accounts. Account(s) can be transferred to another family member of the beneficiary.

Disadvantage:

  • Withdrawal time limit. The account must be fully withdrawn by the time the beneficiary reaches age 30, or else it will be subject to tax and penalties.

Credit Card Rebate and Affinity Programs
Affinity programs offer a rebate to consumers in exchange for buying certain products/services, shopping at certain retailers, or using a designated credit or debit card. Some of these programs provide rebates in the form of tuition benefits, such as credits to a Qualified Tuition Program/section 529 plan. Affinity programs that offer college saving rewards include: Upromise and SAGE Scholars Tuition Rewards Program.

Advantages:

  • Flexible contributions. Aunts, uncles, grandparents, etc. can easily contribute to educational costs.
  • Keep same spending habits. Because the retailer networks associated with these programs are reasonably large, most families will earn some rebates without changing spending habits.

Disadvantage:

  • Supplemental savings route. The money earned from these programs will not likely cover the entire college expense.

Due to the extent of this article, these are only some advantages and disadvantages of college savings avenues. Each of these plans has multiple investment options and their own set of rules and/or restrictions. To find out more information on your options, visit www.nasfaa.org or talk to your accountant/financial planner and start saving for your/your child's future.


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college savings plans: advantages and disadvantages






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