Saving for College

Executive Summary:
Go with the 529 if you plan on contributing more than $2000/year and you're not interested in opening both a 529 and a Coverdell (you can do that).

Go with the 529 if you're terrified the kid will spend it unwisely when they turn 18.

Go with the 529 if you want the absolute easiest option.

Otherwise, check out the Coverdell vs. 529 points below to determine which is best for your situation.

Saving for College:
Believe it or not I had a request to post about boring stuff that I love! I would have posted this anyway - for torture purposes - but now I know that at least 1 person is going to read it.
First off, there are lots and lots of options for saving for college. Taxable accounts, 529's, Coverdell (Education Savings Account), Savings Bonds.... on and on.

However, under current laws (and that's a big assumption) you can knock out some of these almost immediately. Savings bonds don't have much of a chance of keeping up with inflation. Taxable accounts... are taxed. True, situations could be imagined where a taxable account would work out as better than a non-taxed account like the 529 or Coverdell.. but you need to both know what you're doing investment-wise and tax-wise and you need to have some good luck with federal tax laws that are subject to change. I'm just not willing to bet that capital gains will always be as tax favored as they are right now. Math isn't the only consideration though. How much you want the kid to pay for their own education? How tight of control do you want?

In general though, if you're trying to save for college the two best considerations right now are the education IRA and the 529. Here's are some good comparisons:

http://www.younginvestor.com/pdfs/529CoverdellCompare.pdf
http://bammorgan.blogspot.com/2006/10/coverdell-vs-529-educational-savings.html
http://www.fool.com/college/compare.htm

Some important points that 529's and the Coverdell have in common:

• Contributions are taxed (as your income) when they go in.
• Earnings are withdrawable tax-free for qualified expenses like
• Tuition, Room, Board, Fees, Books, Supplies
• If the money is used for non-qualified expenses the withdrawer will pay income tax on the earnings plus a 10% federal fee.
• The money can be switched to a different beneficiary (coverdell might require some extra upfront setup here?)
• Anyone (friends... extended family...) can easily contribute.

The main points where they differ with winner in ():

• (529) You can contribute only $2000 / year to a Coverdell.
• (C) With the Coverdell you control where the money goes (which securites you want to buy) - this also means the return-eating fees will probably be lower.
• (529) The 529 is better for financial aid considerations (need based scholarships) since the 529 is considered to belong to the contributer and the Coverdell is considered to belong to the student.**
• (529) If you use a 529 plan in your state (you can use any state and some have much lower fees) the contributions might be deductible.
• (C) The Coverdell covers expenses for primary and secondary schools. The 529s only work for college expenses.
• (529) In most situations, for the Coverdell the assets are turned over to the student at age 18. For the 529 though the contributer is always in control.
• (529) Coverdells have to be distributed when the student is 30. 529s generally don't have this.
• (529) The Coverdell has income restrictions. 110k for individuals or 200k for families. I think you can get around this though by having the student make the contributions - still subject to the $2000/year limit.
• Both can be setup by extended family and anyone can contribute. However, on the coverdell when you set it up you name a "responsible individual" that has to be a parent of the student and they control the money until the student is 18. For the 529, the person that sets it up is the "contributer" and they get all the tax benefits and control.

** This isn't always true. It depends on the source of the aid and the school (Private schools have different rules). It's "in general" true though with 5.64% counting against if it's in the parents name and 35% counting against if the asset is in the students name... or 0% if the 529 was setup by a grandparent or extended family. This is why opening a taxable account in the students name is also a big no-no... even though the tax they will pay would be fairly low when they are going to school (15-20% under current laws depending on the state and the amount of withdrawal).

What are we going to do?
I already have a "taxable account" and Megan and I both have Roth IRAs. Funding education from either of them was actually a major consideration for me. I assume our daughter will get great financial aid on her own. I also am of the school of thought that having some responsibility for paying your way or deciding to take on debt is good for a kid. This wasn't my situation so that's a bit unfair. But that's the way it is. So with those assumptions I was tempted to just keep track of any contributions anyone wanted to give and eventually (on my terms) give that money to my daughter. The biggest reason not to do this is that I think it's nice for the grandparents (and anyone else that wants to contribute) sake to have a separate and distinct account.

Between the 529 and the Coverdell.... tough choice. I'm a bit worried about the $2000/year cap on the Coverdell. But if it was a problem we could always open up a 529 (in addition).

I see three main reasons most people go with a 529. (1) So the kid doesn't have control of the account at age 18. I'm not so worried about that. If you can't tell, I plan on giving incorporating financial education early and often. (2)For financial aid considerations. But I'm not so worried about that either. Megan had a full ride, for instance, and I don't think her having a savings account in her name would have affected her scholarship much since her scholarship (and the ones I got too) was mostly academic-based (as opposed to need-based). (3)You don't have to be financially saavy at all with a 529. Most states are managed by good firms that give you limited choices. In simplification, you tell them how conservative you want it invested, you throw the money in, and they put it to work how they see fit (they charge a fee, of course). I consider myself pretty "up" on where to put money so that fees are low and risk is appropriate for the length of the investment.

So in general, I'm leaning Coverdell.

Other Links:
Great comparisons of each State's 529 plans: http://www.savingforcollege.com/
More info on 529s: http://money.howstuffworks.com/personal-finance/financial-planning/529.htm