Government Sponsored College Savings Programs

Our intent, with this article, is not to divulge the minutia of government college savings programs; we simply want to point out the pros and cons of the most popular ones, in use at this time.  You will come to realize the inflexible aspects of these plans far outweigh any benefits promoted.

529 College Savings Plan

This is an education savings plan operated by a state or educational institution designed to help families plan for future college costs.  They are usually established as either prepaid or savings accounts; some plans have elements of both. Every state now has at least one 529 plan available. It's up to each state to decide whether it will offer a 529, and what it will look like. Educational institutions can offer a 529 prepaid plan but not a 529 savings plan.

Pros

· Income tax breaks at the state level for contributions

· Funds grow tax-deferred

· Distributions to plan beneficiary are made federally tax-free

· Plan donor (usually parent or family member) remains in control of the plan

· Anyone is eligible to set up a plan

Cons

· Contributions not deductible at federal level

· Plan savings will reduce financial aid monies awarded

· Non-qualified withdrawals of funds result in income taxes and 10% tax penalties owed

· Donors are encouraged to ‘set and forget’ when they establish a plan

While funds do accumulate tax-deferred, this plan is limited in its ability to really supercharge a college savings plan.  When you apply for financial aid, you must note the 529 as an asset so the appropriate deductions from awards can be made.  If you need to access your funds at any time during the savings process or while your child is attending college, you will be taxed at your ordinary income rate and you will be assessed a 10% penalty; much like an early withdrawal from an IRA account.  This is, after all, a government sponsored plan.  You are restricted when you contribute and when you take distributions. 

The most astonishing aspect of these plans is the fact that families are encouraged to set up a plan and forget about it!  When has forgetting about your finances ever produced good results?  It is not likely that it ever will.

Coverdell Educational Savings Account (ESA)

If you know how a Roth IRA works, then you have a pretty good idea of how an ESA works. They both allow you to make an annual, non-deductible contribution to a specially designated investment trust account. Your account will grow free of federal income taxes, and if all goes well, withdrawals from the account will be completely tax-free as well. You will need to meet certain requirements in the years you wish to make the contributions, and in the years you take withdrawals.

Pros

· Funds are contributed after-tax – no looming tax burden

· Funds can be set aside for private school costs

· Funds accumulated federal income tax-free

· Withdrawals from the account are tax-free

Cons

· Limits on contributions of $2,000 per child, annually; penalties will be assessed if exceeded

· Cannot fund ESA once beneficiary reaches age 18

· Maintenance fees charged to ESA account can impact overall investment returns

· Funds eventually distributed to child, if not used for college – plan donors not in control

· ESA holdings can reduce federal financial aid – it is an asset of the plan donor

· Coordinating withdrawals with other tax benefits can be cumbersome

· Account must be fully withdrawn by beneficiary’s age 30 or taxes and penalties assessed

· ESA benefits set to expire after 2010 and K- 12 expenses will no longer qualify

· In 2010 annual contribution limit will be reduced to $500.00 per child

All in all, Coverdell plans allow you to save for college in a tax-free manner, but they are becoming more limited in their benefits each year.  Why struggle to save, when we have a plan that allows much more flexibility and provides many more benefits.

When you read“Create Wealth on Auto-Pilot” you will understand why you want to maintain control of your savings plans.  Do not give away control of your savings to government sponsored plans.  We have an eye-opening example in this book that demonstrates why it is better to pay taxes on contributions to a plan and avoid a huge tax bill later.  This is always possible when you establish your own private savings plan.  It is, perhaps, one of the most critical components of amassing wealth.

We have a savings plan that dispenses with all of the limitations we have discussed here and the benefits of our plan far outweigh any apparent advantages noted above.

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