Qualified Tuition Programs (QTPs), officially referred to as a “529 plan,” is an excellent way to save for your children’s college. This state-sponsored plan, available in every state, lets you, grandparents, relatives, or anybody else contribute at any time. The interest is all tax-free, and when the student draws out money for college, it is tax-free as well.
Types of Plans
Usually there are at least a few different 529 plans your financial services provider will offer, with slightly different investment strategies. Most tend to be conservative in their investment strategies, putting money into things like mutual funds or government bonds. Nonetheless, strategies vary a great deal between plan administrators, and you should treat it like any other investment and due your due diligence. Research the company offering the plan, and look at their investment strategies, and what its track record has been in the past.
Although the idea behind the 529 plan is to allow money to grow tax-free over time, a poor investment strategy can actually diminish your plan’s value. Another major consideration will be the fees involved. Plans sold by brokers are especially likely to carry high fees, which may take a big bite out of your earnings. Plans offered directly by states will charge lower fees. Not all plans charge the same fees, so look for one that offers a reasonable fee structure and a solid, proven rate of return.
Regardless of your state of residence, the funds are exempt from federal taxes. States have different policies regarding the tax exemption, but in general, you should purchase a 529 plan within your own state. If your state grants a tax-exemption for the plan, but you buy a plan from a provider outside of your state, you may lose the tax-exempt status on the interest and withdrawals. The tax-free clause on withdrawals will expire in 2011, however, there is a movement in Congress to extend this tax break or make it permanent.
For the purpose of calculating financial aid when the time comes for your child to attend college, having money in the plan does not have to jeopardize the chance at getting a scholarship. The funds are treated as parental assets.
Forms of Plans
The 529 plan can take the form of either a college savings plan, which can be used at any college or university in any state; or a prepaid tuition plan, which locks in tuition at a specific college in your state. You can start saving early in your child’s life with this plan, even if you’re not sure the child will attend college. If the child chooses to not attend, the funds can be put to another use (although there may be a penalty involved), or it can be transferred to another family member’s educational needs.
Other options for saving for your child’s education include a Coverdell Education Savings Account (ESA), also known as an Education IRA. This lets you put aside $2,000 a year. However, there are income restrictions for participation, and the funds are treated as the student’s asset, which may diminish the possibility of receiving other financial aid.