by Dr. Larry Hungerford, Money Manager at Woodard & Company Asset Management Group, Inc.
There are many ways to save for a child’s college expenses but only two are totally tax‑free: 1) Coverdell Education Savings Accounts, and 2) State 529 plans. Both are never taxed if used for education.
Coverdell Education Savings Accounts (formerly called the Education IRA)
The puny $500 Education IRA has been raised to $2,000 this year and the new law allows Coverdell ESAs (Education IRAs) assets to be withdrawn anytime tax‑free for any educational expense for grades K‑12 and college. It can be used for elementary and secondary private‑school tuition, computers and software that have an educational purpose, and, the usual college expenses. It’s too late to contribute to an ESA for 2001, but from now on ESAs can be funded until April 15, the same deadline as IRAs. All kids become ineligible for ESAs the day they turn 18. Income limits for donors to max out the $2,000 contribution are $95,000 for singles and $190,000 for married couples. If that is a problem, find someone in the family to give the money to; he/she can then deposit the money into the child’s Coverdell ESA. Corporations are also allowed to contribute money to ESAs and ESA recipients may be switched between family members ‑‑ parents to children, siblings and cousins.
STATE 529 PLANS
In the massive 1997 federal tax law that created the Roth and Education IRAs was provision 529 that allowed each state to set up a plan to provide a savings vehicle for college expenses. Like Roth‑IRAs, money in 529 plans now grows tax‑free, unless the money is not used for college expenses. Most states have limited fund choices (usually about five) and 529s are usually considered parents’ assets unless donated by grandparents. Most state 529 plans permit individuals to give to family members up to $50,000 in one year for college expenses. Under the new law all 529 money may be withdrawn tax‑free. Unlike Education Savings accounts, there is no recipient age 18 limit; most states, including NC, permit the money to be used by older adults to return to college or for graduate studies.
North Carolina’s new 529 plan has four investment options:
1) A fixed income option run by the NC treasurer paying about 5%
2) A Wachovia‑managed stock/bond balanced fund
3) A blue‑chip all stock fund from Legg‑Mason
4) A series of 22 Seligman‑managed portfolios that gradually move from 100% stocks at birth to bonds and cash at college age.
Unfortunately, unlike 401(k) plans, NC allows donors to pick only one choice. However, once per year, the investment option may be changed. Unless a child is 15 or older, we believe the only logical choices are the Seligman and Legg‑Mason options.
For more information on North Carolina’s 529 plan, call 800‑600‑3453 or checkout www.cfnc.org. Other state 529 plans are also open to Tarheels, see www.savingforcollege.com. (California, Iowa, New Hampshire, and Utah have excellent 529s.)
Two Other Low‑Tax Ways We Recommend To Save For College
Roth and Traditional IRAs: There is no longer a 10% tax penalty if parents or grandparents use IRA money before age 59½ to pay for college expenses and, unlike other college savings plans, IRAs do not count against college aid. Roth IRA contributions may be used tax‑free at any age and, if over 59½, the gains are also tax‑free.
Saving and Gifting: Steve Hungerford buys individual stocks in his own name with no or very low dividends to avoid taxes. He can then gift them to his nieces and nephews when they reach college age, if they go to college. The federal capital gains tax is now only 8% in the 10% and 15% tax brackets for stocks held at least 5 years.
