529 vs. ESAs- questions

Re: 529 vs. ESAs- questions

• hoffse member

  

  November 2013

  Well...  if you're planning on using these funds for grade school (private school) you have to go with an ESA (Coverdell account).  529's are only for college.  But if you are planning on only using this for college, I would go with the 529 over the ESA.  Here is why:

  
  

  1) ESA's turn ownership over to the child at age 18.  No offense to anybody's children, but I don't think an 18-year-old has any business gaining access to that kind of money.  You don't know if your child will be a parent-pleaser at age 18 or rebellious and ready to move out just to prove a point at age 18.  You can't prevent them from gaining access to those accounts, so I wouldn't open them to begin with.  

  
  

  529's, on the other hand, allow the parent to maintain control over the account for the entire life of the account.  Grandparents, relatives, etc. can all contribute to the same 529.  

  
  

  2) Also, ESAs have to be used by the age of 30.  That can create problems if your child takes a break to work for awhile and then wants to return to school.  529's have no age limit.

  
  

  Some highlights of the 529 accounts:

  
  

  -Contributions are made with after-tax dollars, and they grow tax-free as long as they are used for education expenses (including room and board).  Graduate school also counts.  In other words, you can think of them as Roth accounts for education.

  
  

  -You can use an investment bank (Fidelity, Schwab, etc.) to manage these accounts and make your contributions grow.  Most have age-targeted funds that get you investing more aggressively when they are young and then taper off to safer accounts as they approach college age.  So if you don't want to worry about what to invest in, these are always a great place to start.

  
  

  -If your child decides s/he doesn't want to go to college (though, personally, I would have words with my child if s/he announced such a decision to me), you can transfer the funds to another beneficiary (even yourself).  

  
  

  -If your child gets a scholarship, you can typically remove funds from the account in an equivalent amount and only pay income tax on that withdrawal, rather than also paying the penalty.  You just have to be careful with this to make sure you're not taking it out in years when the scholarship hasn't yet been credited.  Most universities "credit" scholarships on a semesterly-basis, and the spring semester's credit might happen in December or it might happen in January.  If it's not matched to the correct year, you will owe a penalty.

  
  

  -Taking out money from a 529 for non-educational purposes subjects that withdrawal to a 10% tax penalty.  The exception is a scholarship withdrawal, which I noted above.

  
  

  -Most 529 accounts have limits of $300,000.  Odds are, this will increase in future years because this wouldn't be enough to pay for 4 years at private school if prices continue to increase as they have been. 

  
  

  -Grandparents, etc. can contribute to 529 plans on behalf of the beneficiary.  You just have to give them the account info.

  
  

  -Finally, and most creatively, 529 accounts are a pretty good estate planning tool.  That's because funds in a 529 plan that you own/control don't count as part of your estate.  So if you are going to have more than the estate tax exemption amount in your estate at death, you can set up various 529's that name your heirs as beneficiaries.   After your death, your heirs can then use those funds for anything.  The funds will be subject to the 10% tax penalty, but it beats the 25% estate tax.  Even better?  Since you control those funds until you die, you can always take the funds back if you need them or if you decide to disinherit somebody.  Again, that would subject the funds to a 10% penalty, but it's better than giving money to a relative that you later learn is a crappy human being.

  

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• d3esika member

  

  November 2013

  Thanks.  That's a lot to consider.  Also, were can I find norms for fees, minimum opening balances etc.? 

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• smerka member

  

  November 2013

  Don't start college funds for your kids until your debts are paid off (except the mortgage) and your retirement is funded. I would start with $5,000 in a Roth for you and DH unless you get a match in a 401k, which you would do first. I know it feels wrong to not put your kids first, but in this case you are because if you save for retirement, your kids won't have to worry about you. The nice thing about a Roth is that when the time comes, you could theoretically take out the contributions without penalty to pay for college, but you would be losing out on future earnings. At least this is how I think about it when I'm feeling crappy about not being able to start college funds now while I stay at home.

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• hoffse member

  

  November 2013

  Smerka has a good point.  Your retirement should come first.  However, if your parents want to contribute to your kids' college funds, there's no reason to stop them!

  
  

  As for fees, etc., that's going to very based on the bank you choose and the investments you pick.  

  
  

  Hope I didn't overwhelm you with the other bit.  It's a lot to consider, but once you start it will all fall in place.  The big choice is picking ESA vs. 529 to begin with.  After that, just pick your investment bank and they will walk you through it.

  
  

  Personally, I like Fidelity because you can get an American Express card through them that automatically deposits 2% of everything you spend into a designated account... and 529s are on the list.  Of course, don't do this until your other debt is under control and you feel you can pay your cards off in full each month... but once you get to that point, it's a pretty sweet option.  There's something about getting credit card companies to help pay for college that I find very appealing.

  

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• maple2 member

  

  November 2013

  Here is a basic article about 529s with some useful links http://www.fool.com/college/college04.htm
  
  These sites let you compare the different 529 plans to see what one might be right for you.  We went through this process recently and found it a bit overwhelming to wade through all the information because there are so very many plans.  We ended up choosing a plan with low fees, good returns, the ability to transfer the plan, and that was managed by the same company that has most of our retirement savings to make it easier for us to keep track of everything.  We did not pick our state plan even though it offers some tax advantages because we didn't feel like the tax savings would offset the differences in cost and performance of the state fund relative to others.
  
  http://www.savingforcollege.com/college_savings_201/
  http://529.morningstar.com/state-map.action
  

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