Use tax-planning strategies to save for college

Most San Diego families with school-age children will face the daunting task of paying for college education.

Some families plan for college costs by saving money in a designated account over time; others simply plan to pay the bills when the time comes. In either case, most families I know are not taking advantage of one of the most beneficial tax-planning strategies available. A Section 529 College Savings Plan will allow your college savings to grow tax-free. Even if you were not planning to save money in advance of paying for tuition, this is a great time to start. The 529 Plan is what I call “free money.” If you fail to take advantage of it, you are passing up the chance to have some free money.

You contribute money to a 529 Plan to pay for a designated child’s college education. It doesn’t have to be your child – any child will do. If you are a grandparent, contributions to a 529 Plan make wonderful gifts.

Unlike IRAs, there are no income limits for the contributor. Your contributions to a 529 Plan are generally treated as “gifts” for federal estate tax purposes. Under certain circumstances, the initial amount placed into a child’s plan by a married couple can be as high as $120,000 without incurring gift taxes. You should consult your tax advisor to review your specific situation.

During the years the money sits in a 529 Plan account, it is invested according to your directions, and all of the gains and earnings accrue tax-free. The best part of the plan is when you take the money out to pay for college. As long as the withdrawals are used to pay for bona fide college expense, you owe no taxes on the withdrawn amounts. Zero taxes on earnings, zero taxes on withdrawals. This is free money, my friends. Permitted expenditures include tuition, fees, books and room and board.

If the child for whom you have set up the account ends up getting a scholarship to school, you are permitted to withdraw any excess funds by paying only normal income taxes on the gains, and no penalties. Alternatively, you can change the beneficiary of the account to a sibling or cousin. If your child decides to go to a service academy or to forgo college entirely, you can designate the balance in the account to a sibling or cousin.

The money in the account can be used to pay for virtually any college or vocational school, in any state.

The federal law authorizing 529 Plans requires that each individual state establish its own plan. This requirement has confused more than a few families, as different brokerage firms are marketing different states’ plans. For example, California residents will get a recommendation from representatives of Charles Schwab to set up a college savings account in Kansas. This is because the State of Kansas chose Charles Schwab to manage the Kansas plan. The Utah plan is run by Vanguard.

Life doesn’t need to be that complicated. I have reviewed most of the plans out there, and I generally advise my clients to open an account in the California plan, called Scholarshare. It is managed by Fidelity investments and offers the key features you would want. The state of California has negotiated an attractive fee structure with Fidelity and the account setup process is easy. If you enjoy painstaking research on every state’s plan to make your choice, go to for a comprehensive comparison of all plans available.

The California Scholarshare program offers a number of very straightforward investment options. I like the “Age-Based Asset Allocation Option.” The Age-Based investment program will automatically shift the investment assets into more liquid and conservative investments as your child moves closer to college age. This can help to ensure that the money is there when you need it.

The web site for the California 529 Plan is You can set up an account on-line and begin funding it immediately.

Even if you had planned to pay for college out of current income when the time came to write the check, you should set up a 529 Plan. Rather than have your family’s savings income taxed every year, you can have a tax-free savings account. When free money comes my way, I tend to take it. You should, too.

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Posted by Staff on Apr 18, 2007. Filed under Archives. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry

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