My financial advisor scheduled my midyear review for tomorrow. In addition to our general discussion, I told her that I needed advice on 529 plans and saving for Sam’s college education. I figured it would help if I did a little research on my own so I could speak intelligently about the program and ask the right questions. Here’s what I learned:

Definition of a 529 saving plan: A plan that gives me the opportunity to contribute to a tax-deferred account established for our son (known as the named beneficiary) that’s invested in a savings vehicle, such as stock or a mutual fund.

How much do I need to save:

Child’s Current Age: One year old (or younger)
Average Cost Private College: $257,543
Average Cost Public College: $118,312

Click here to see cost estimates if your child is older. Or click here for World’s Simplest College Cost Calculator and finally click here for a more advanced version with columns for multiple children.

How can we save at least $200,000 in the next 18 years? Using this calculator, I put in the following:

Initial investment amount: $5,000
Annual savings amount:     $4,800 ($400 per month)
Number of years contributions are made: 18
Before-tax return on savings: 8%
Marginal tax bracket: 33%

The conclusion: It appears that by saving in a 529 college savings plan I would accumulate $214,122 vs. $159,945 in a taxable savings account.

Apparently the tax breaks are the key benefit, but there’s a difference between the federal and state tax advantages:

Federal tax benefits: 529 plans offer unsurpassed income tax breaks. Although your contributions are not deductible on your federal tax return, your investment grows tax-deferred, and distributions to pay for the beneficiary’s college costs come out federally tax-free. The tax-free treatment was made permanent with the Pension Protection Act of 2006.

State tax benefits: Your own state may offer some tax breaks as well (like an upfront deduction for your contributions or income exemption on withdrawals) in addition to the federal treatment. You should research what benefits residents receive for investing in your own state’s 529 plan… here. If you don’t get any benefits from your state, you have the pick of every 529 plan on offer… so compare plan features… here.

I learned that we don’t have to invest in a California plan. Other states may offer one that performs better and with lower fees. This is where I hope my financial advisor can offer guidance about the tax advantage of a California plan vs. elsewhere.

Another thing I learned is that Sam can attend college in any state. So while we live in California, we might invest in Georgia’s plan and send him to a college in New York. By investing in Georgia’s plan we’d miss out on any state tax benefits though, so I need to learn what is the specific state tax advantage with investing in a California plan.

Then of course, there’s the question of direct-sold vs. advisor-sold 529 plans. Half of all 529 plans are sold through brokers and of course, there are benefits of using an advisor – which I’m sure I’ll hear all about tomorrow!

One final note: Awhile back, one reader wrote in and asked if he could set up a 529 for his niece? He wasn’t planning on having kids, but wanted to start one for her. I replied that I didn’t know the answer… but now I do. You can even set one up for yourself if you think you might want to go back to grad school in ten years or he could reclaim the funds if his niece grows up and he changes his mind about helping. There’s a catch of course:

Donor retains control of funds: You, the donor, stay in control of the account. With few exceptions, the named beneficiary has no rights to the funds. You are the one who calls the shots; you decide when withdrawals are taken and for what purpose. Most plans even allow you to reclaim the funds for yourself any time you desire, no questions asked. (However, the earnings portion of the “non-qualified” withdrawal will be subject to income tax and an additional 10% penalty tax). Compare this level of control to a custodial account under the Uniform Transfers to Minors Acts (UTMA) and you will find the 529 plan gives you much more say in how your investment is used!

Any readers have other thoughts to add? Please feel free to comment below.

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