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The Honolulu Advertiser
Posted on: Thursday, December 21, 2006

Contributing cash to a college-tuition plan is a smart gift

By Sandra Block
USA Today

A contribution to a 529 college savings plan won't make your child or grandchild squeal with delight this holiday season, but it won't put his eye out, either.

And years from now, he'll thank you.

In the meantime, you can take comfort in the knowledge that your gift will reduce the amount of money your child or grandchild will need to borrow to attend college. A recent survey by AllianceBernstein Investments of college graduates with student debt found that nearly 40 percent expect to take more than 10 years to pay it off.

For the donor, contributing to a state-sponsored 529 plan offers benefits you won't get by giving a PlayStation 3.

Reasons to consider a 529 plan contribution:

  • You can change your mind. If a financial crisis occurs after you contribute to a 529 plan, you can withdraw the money, says Elaine Sullivan, director of educational savings for Putnam Investments. This isn't a step you should take lightly because you'll have to pay taxes on earnings and a 10 percent penalty. But the ability to withdraw money gives 529 plans an edge over custodial accounts, such as Uniform Gift to Minors Act accounts, which are irrevocable.

    "If you were to make a gift to somebody in a UGMA, you can't take the money back because the money becomes earmarked for the beneficiary," Sullivan says. With a 529 plan, she says, "If an emergency comes up, you can take the money back."

  • You maintain control. With a custodial account, the child can do whatever she wants with the money once she reaches the age of majority, which is 18 in most states. With a 529 plan, you maintain control of the money and can make sure it's used for college expenses.

  • You can front-load your contributions. Federal law lets taxpayers give up to $12,000 a year, per beneficiary, without triggering gift taxes; a married couple can give $24,000 a year. For 529 plans, though, you can exceed the annual limit if you elect to make five years of contributions in one year, says Joe Hurley, founder of www.SavingforCollege.com.

    This provision is particularly useful for wealthy grandparents, Sullivan says. A grandparent could contribute up to $60,000 to a grandchild's 529 plan all at once (or $120,000 for a married couple). Front-loading will give the money invested more time to compound and grow.

    And the contribution will immediately reduce the size of the grandparents' estate.

    So suppose you're a doting grandparent with a large estate, and you want your grandchild to have an Ivy League education. You could contribute $12,000 by the end of the year or $24,000 if you're married exhausting this year's gift-tax exclusion. In January, you could make a $60,000 gift for the next five years, or $120,000 if you're married. With this strategy, Sullivan says, "You get six years of gifts in two months."

  • Your child still may be eligible for financial aid. Under the federal formula, a 529 plan has a minimal effect on financial aid.

    If the parent owns the account, only 5.6 percent of the assets are included in the amount the family is expected to contribute toward the child's education. And if the 529 plan is owned by a grandparent, Sullivan says, none of the assets are included in the financial aid formula.

    CHOOSING A PLAN

    More than 100 529 savings plans are available, but that doesn't mean you need to spend the holidays searching for the right one.

    Start by looking at your own state's plan. Most states with a state income tax offer a tax deduction to residents who contribute to their own state's plan. Some of the tax breaks are generous, particularly for parents and grandparents who plan to make large contributions. New York offers a $5,000 deduction for contributions to its state plan; married couples who file a joint return can deduct up to $10,000. Mississippi offers a state tax deduction of up to $10,000 or $20,000 for joint tax returns.

    A tax deduction may not compensate for a plan with poor investment returns and high fees. If you live in a state that doesn't offer a tax deduction or has no state income tax, you should look outside your borders. Look for a plan with low fees and good investment options.

    Fortunately, finding a low-cost plan is getting easier. This year, Fidelity Investments, Vanguard, American Century, TIAA-CREF and T. Rowe Price reduced fees on the 529 plans they manage.

    To research 529 plans, check the Web site for the College Savings Plans Network, www.collegesavings.org. You can compare plans' features and investment returns at www.savingforcollege.com.

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