Getting Them To College: Investing to Pay for Your Child' s Higher Education

The spiraling costs of higher education are among the biggest concerns, and the most formidable challenges, facing parents today. Sending a child to college already costs a fortune, and unfortunately there's no end in sight to the rising costs of tuition, room and board, and miscellaneous expenses.

Financial planners recommend beginning the college savings during baby's first years. Unfortunately, simply pouring money into a savings account won't go the distance - a structured investment plan is necessary. Fortunately, there are already investment plans and tax shelters specifically created to deal with college savings.

The 529 Plan: A Definition

Created and enacted to provide relief for families with college-bound children, the 529 Plan is a tax-advantaged savings structure offered by state governments or individual educational institutions such as colleges, universities, and others degree-granting institutions. If the particular 529 satisfies some very basic requirements, federal tax law protects all funds put into the plan from state and federal tax eligibility. The funds are usually structured mutual funds that perform according to market variations.

The exact structure of the savings plan is determined by state. While most if not all states allow investors from out of state, many state governments have enacted powerful incentives and enticements for in-state investors, including matching grant and scholarship opportunities and immunity from creditors and state financial aid calculations.

The plans offer the strong advantage that they are relatively maintenance free once the initial paperwork is completed. Once the plan is put into action, all contributory withdrawals and funding are handled automatically. There are also no age limitations, and the caps on funding are usually very large. (Well over $300,000 in some states.) The funds can be used to pay for any all and college related expenses: tuition, room and board, textbooks, and transportation. The plan draws its name from Section 529 of the Internal Revenue Service Code.

Types of 529 Plans & Their Disadvantages

There are typically two varieties to 529 Plans. A prepaid plan allows the investor to purchase tuition credits, at current rates, to be used at some point in the future. Because tuition costs usually increase over time, the prepaid plan's effectiveness varies with inflation.

Savings 529 Plans are dependent upon the growth of the investments set up as part of their structure. Most 529's schedule more conservative investments as the beneficiary grows closer to age, minimizing the possibility of financial calamity. Some also offer a stable value, which protects the investor's initial principal.

Prepaid savings plans are back by the state they are enacted within; savings plans, however, carry no state guarantees. Investments, as on the open market, are subject to fiscal risk. Prepaid plans have a limited enrollment period, while savings plans may be started at any time.

The 529 Plan is not without its critics. A 2002 article in Slate magazine pointed out that high maintenance and service fees effectively undermine the plans' tax benefits. The fees will vary by state and financial institution, so some research is necessary before committing to a particular investment firm or schedule.

Coverdell Education Savings Accounts

A Coverdell ESA is the "530 Plan" that's very similar to a 529, in that funds may be withdrawn tax free to cover educational expenses. However, the Coverdell offers one important difference: The definition of qualified expenses includes primary, elementary, and secondary schools funding, not just college or university.

Coverdell ESA's allow virtually every type of investment, from stocks and bonds to mutual funds; by comparison, 529 funds are only qualify certain state-approved allocation choices.

There is something of a time limit on the Coverdell: all funds must be disbursed on valid educational expenses by the time the beneficiary is 30 years of age; any leftover funds can be gifted to another family member without tax or penalty.

The Coverdeall ESA is named for its chief booster in the United States Senate, the late Senator Paul Coverdell of Georgia.

Socially Responsible Investing

A relative newcomer to education investment planning, socially responsible investing entails financial investments in companies or organizations which promote, either through policy or additional initiative, to produce a social good. Such investing is currently largely associated with "green" industries and companies devoted to environmental stewardship or the efforts to fight global warming.

Recently a number of states, including California, Illinois, and Pennsylvania have begun incorporating socially responsible investment options into their qualified tuition plans, either as part or in place of traditional 529-type structures. Because presumably green industries will continue to grow through the next few decades, they offer an enticing, pragmatic investment option to parents looking to invest in their child's future.

Michael Kabel is senior staff writer for http://www.cornerstorkbabygifts.com.