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Stealing Harvard

The 529 tax-exempt, state-sponsored college savings plans aren't the no-brainer they appear to be

A more obvious advantage to making yearly 529 contributions is that you get more cash on hand to use for other purposes. Lesley Weiner, president and owner of Heritage Financial Advisors in Montville, N.J., says most of her wealthy corporate clients haven’t opted to deposit upfront. Instead, she advises clients to put some of the cash into life insurance or a trust and “keep some money for yourself.”

Load and Lock

Besides the decisions about what state plans to use and how much and when to contribute to them, parents also need to decide whether to contribute to educational savings plans or to another kind of account: prepaid tuition plans. Unlike the more widespread educational savings plans, which often involve stock market risk, the prepaid plans enable parents to lock in their tuition costs at current rates without having to play in the market.

In Florida’s pre-paid plan, for example, parents can fix what they will pay for tuition (after a fee) by agreeing to pay for up to four years worth of education at a Florida state college in a lump sum or in monthly installments. What’s more, the person opening the account doesn’t have to live in Florida or even be related to the child.

Still, like the 529 educational savings accounts, the pre-paid plans represent something of a crazy quilt in terms of their uses. Offered in some 21 states, the prepaid plans differ on what will happen to the money if the child goes to a non-state school or private college within the state.

Starting in 2004, private schools will be able to offer pre-paid programs that are exempt from federal tax. Currently, some twenty schools, including Vanderbilt, Emory, and Trinity, reportedly belong to national consortium offering a prepaid program. Under the plan, parents can buy certificates guaranteed to pay a fixed percentage of tuition at consortium schools.

Ferrari Factor

Despite their tax advantages and growing flexibility, 529 plans, whether market-based or pre-paid, aren’t for everyone. Parents who want to retain control over how their college savings are invested might be among those who shun them. Each 529 plan, after all, is run by a fund manager and usually consists of only a handful of fund alternatives.

In that light, a major benefit to saving via a Uniform Gift to Minors Account, or UGMA, is that the parent has complete control over how the portfolio is invested. What parents don’t get with the UGMA, however, is control over the asset itself.

For some parents, the ugly side of the UGMA is that assets don’t have to be used for education. That means that when the child turns 18, he or she could use the funds to buy a bright red Ferrari, for instance.

An UGMA also doesn’t have nearly the tax benefit that a 529 does. When a parent donates, say, $11,000 to a child’s UGMA, the first $750 of income accrues tax-free. The second $750, however, is taxed in the child’s tax bracket, and anything over that $1,500 is taxed in the parent’s tax bracket, according to Weiner. (That’s assuming the child is less than 14 years old. Once the child is older, the UGMA is taxed entirely at the child’s tax rate.)

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