Saving for College

If you have kids of your own, or if you're looking for that perfect wedding gift for a sibling, consider 529 plans. These plans work a lot like Roth IRAs for education: you can invest money as stocks or bonds under one of these plans, and when you take it out, the gains are tax free. The only catch is that you must spend this money or qualified expenses for higher education. In general, this money is counted as a asset of the account holder, and not of the student, so the it won't have much effect on need-based financial aid.

Each state is allowed to create its own 529 plans with their own rules, and keeps a list of them all. Some of the better plans, such as Arizona's, Nevada's, and Alaska's have many of these features:

  • No residency requirements – the student doesn't even have to go to school in that state.
  • You can change the beneficiary (intended student) once a year. This means you don't have to commit to funding a particular child's education – you can always switch to someone else if out of high school they go straight to work for McDonald's or something. The only catch is that the new beneficiary must be related to the old one (in-laws are generally OK).
  • You can name anyone a beneficiary of the account – even a non-relative.
  • You have a range of good investment options involving index funds, including age-specific, all-stock, and “balanced” portfolios.
  • Low minimum investments – as low as $50 for Arizona's plan.

Some states, including Missouri, Pennsylvania, Wisconsin, and others, have an additional feature allowing residents to deduct 529 contributions from their income for state tax purposes. Some states, such as Maine and Rhode Island, even offer limited matching funds, making their plans even more attractive. If the future student has a relative in one of these states it makes sense to give the relative the money, let them open the 529 account, and have them put the resulting tax savings back into the account.

Another option is a Coverdell Education Savings account, which is sort of a federal IRA for education. Generally, 529s are better, but the Coverdell does have one huge advantage: you can use the money for educational expenses beyond college tuition, room, and board. That means computers, books, or even private elementary school. So if it's boarding school you're saving for, look into that option. The always thorough Fairmark website has more on these.

So, if you're looking for a thoughtful gift for newlyweds or new parents, consider making contributions to a 529 plan. It will be extra helpful if you keep contributing for birthdays and Christmas and such. If you get other family members to pitch in, too, then when college comes around there will be a nice bit of extra financial aid waiting for them.