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529 plans vs. UTMAs: tips to finding the right plan for college savings.

Cindy and James, a married couple in their 30s, have two small children. As they manage their cancers, they also proactively save for their children's college education. However. Candy and James are not sure if they are saving for college in the right way. Sound familiar.

Three Ways to Save for College

There are three main college savings look: 529 College Savings Plans, Uniform Transfer to Minors Accounts UTMAs and trusts. No age limits or residency requirements exist for any of the vehicles mentioned below.

529 College Savings Plan: Created under IRC See. 529, and known as "qualified tuition plans." stales or slate agencies sponsor these accounts. A 529 account allows for tax-free savings as long as the funds are used for college. A college saver also known as an "account holder" or "account owner" establishes an account for a student the "beneficiary" to pay for eligible college expenses. Generally, a parent or grandparent is the account owner.

UTMA: An UTMA is set up by a parent. grandparent or other to transfer ownership of cash or other assets to a minor; this type of account is also known as a custodial account. The child owns the assets immediately and, upon reaching the age of majority (usually 18 or 20 depending upon the stale of residency) the child gains control of the assets to do with them whatever he or she desires.

Trust: A trust can be set up specilically in fund a college education. It's expensive an attorney must draft the trust and annual tax returns must be filed to report investment income and sales. Given the expense, a trust should only be used to save for college if an UTMA or 529 plan is not appropriate, Use a trust as an UTMA alternative when you want to limit the child from controlling the assets.

Enter the Financial Planner

During (he discovery process with Cindy and James, they explained their desire to fund lour years of private college for each child without giving their children access to any of this money when they turned 18. Their current savings were in both 529s and UTMAs.

Based upon their goals, the UTMA assets were inappropriate. These assets were subject lo income and capital gains tax. and transactions required a tax return filing further eroding the family's wealth and increasing the cost of this savings strategy.

Conversely, the assets, earnings and growth in the 529 plum are tax-free as long as withdrawals are used in pay higher education expenses. In this ease we advised the clients to spend down the UTMA assets on school tuition and summer camps and a savings plan was created lo fund the 529 accounts each year.

For many people 529 plans arc the best way to save for college. They are low-cost mo set-up fees, no tax returns to file and die individual who sets up the account, rather than the child, maintains control. However, if your family's situation is unique perhaps you can contribute a very large amount or you have goals for the gill other than college, a trust or an UTMA max make sense.

Investment Options & Principal Protection

For children under age 14 we recommend a broadly diversified, global equity allocation that can be found in many of the state-sponsored 529 plans. Several online tools sec sidebar can identify low-cost 529 plans.

Equity and mutual fund investments in 529 plans are neither guaranteed by state governments nor federally insured. Therefore, beginning when the child is age 14, the college portfolio's risk should begin to ratchet down. For example, we recommend 25 percent of the portfolio be allocated to bonds when the child turns 14. Another 25 percent is moved to bonds when the child turns 15.

This process of becoming more conservative occurs each year on the child's birthday until, at age 17 when the child is one year from college, the portfolio is 100 percent invested in short-term bond funds with little volatility.

For simplicity; clients who are not working with a financial adviser may choose an age-based investment option that's automatically rebalanced as the child nears college age.

A Roadmap

Starting young to save for college is crucial. College costs rise at an annual rate of 6 percent for tuition, and 4 percent for room and board. For the 2010-11 school year, Figure 1 provides a snapshot of the average and most expensive schools nationwide and in California.

Cindy and James are about to become parents again and will start saving immediately to fund four years of the average private college. They want to save the same amount each year through the child's college graduation date. Figure 1 shows that annual expenses for the average private college are $28,500 for tuition (increasing at 6 percent annually) and $9,700 for room and board (increasing at 4 percent annually). The parents' savings will be added to a 529 plan and at the child's age 14 the portfolio will gradually become more conservative as bonds arc added and equity exposure is reduced.

We assume an equity portfolio earns 7 percent on average per year and a bond portfolio earns 4 percent, and all earnings in the account arc tax-free. To stay on track to fund four years of private college, an annual contribution of approximately $9,000, increasing at 3 percent per year is needed. This assumes the first contribution begins in 2011, and continues through 2033 when the child graduates from college.

Boosting Financial Aid

Sec. 529 plans clearly beat UTMA accounts when comparing availability of financial aid. All federal government financial aid is based on the same formula in the Free Application for Federal Student Aid. The formula counts the following college savings resources as being available to pay for college expenses: 20 percent of a student's assets (including UTMA accounts: and 2.6 percent to 5.6 percent of a parent's assets (including 529 plans, based on a sliding income scale and after certain allowances).

However, each college has its own formula and both UTMA and 529 plan assets will reduce a student's eligibility to participate in need-based financial aid. If your child does not qualify for need-based aid, consider an academic scholarship. Even a $2,000 tuition reduction helps to defray the enormous cost of college.

Choosing a 529 Plan

All 529 plans are sponsored by a state, some of which provide in-state residents with a lax break. Unfortunately California is not one of those. Depending upon the length of lime until the child starts college and the dollars to be invested, forgoing a tax break to invest, in a 529 plan offering low-cost funds may be the best option. To decide, weigh all of the factors, including expense ratios of the investment options and the underlying fund choices. Also, consider a 529 plan rollover if there are existing 529 assets in a plan with limited fund selection and high-cost investments.

Albert Einstein said, "Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it." Are you or your clients saving enough and in the right way?

Resources and Cool Tools

CNN College Cost Calculator

College Board Scholarship Search

Research 529 Plans

Figure 1 lsources: Trends m College Pricing 2010 and CampusGrottol

College Costs for School Year 2010-2011

U.S. Colleges
 Tuition, Fees & Room & Total
 Books Board

Public: Average $8,700 (a) $8,500 (b) $17,200

Private: 28,500 (a) 9,700 (b) 38,200

Private 45,300 (a) 13,800 (b) 59,100
Sarah Lawrence

California Colleges: Most-Expensive Public and Private Schools

 Tuition, Fees& Room & Total
 Books Board

Public: UC $13,800 (a) $15,300 (b) $29,100

Public: CSU (San 6,700 (a) 12,400 (b) 19,100

Private: 41,200 (a) 13,200 (b) 54,400

(a.) Includes books, supplies and student health service fee
(b.) Assumes student lives on-campus and subscribes to a meal plan
(c.) Total does not include transportation, personal or miscellaneous

Joyce L Franklin, CPA, CFP is principal of JL Franklin Wealth Planning. You can reach her at or (415) 925-3400.
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Title Annotation:financialplanning
Author:Franklin, Joyce L.
Publication:California CPA
Date:Jun 1, 2011
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