INVESTMENTS -  COLLEGE
 
 

Qualified State Tuition Plans

Here’s a great link that provides a wealth of information on Qualified State Tuition Plans, also known as Section 529 Plans:

Investing College Money as Your Child Nears College Age

Saving up to send a student to college is not unlike saving for retirement: The closer you get to the big event, the less risk you should take with the money that is earmarked to pay for it. The reasons for caution are clear. While investments involving risk generally promise greater long-term returns, they are prone to temporary reversals. In other words, you don’t want to have to sell a chunk of a growth-stock mutual fund to pay tuition after the market has taken a nosedive.

The best approach, therefore, is to start off investing in stock funds and long-term bond funds in the child’s early pre-teen years, and once the child becomes a teenager, gradually begin to shift the allocation of college funds to emphasize lower-risk short-term bond funds and cash equivalents.

The following table illustrates how this might be accomplished. When the college-bound youngster is age 13, the portfolio is invested primarily for growth and high current income: 50% in stock funds, 40% in long-term bond funds, and 10% in cash. But over the following years, the college funds are gradually reallocated into what, by the time the child is ready for college, is primarily a low-risk portfolio of mostly short-term bond funds (40% of the college portfolio) and cash equivalents (50% of the college portfolio). Only 10% remains in stock funds.

The Wealth Factor. A conservative investment allocation is particularly important if you have limited resources outside of this college nest egg to draw upon. The situation changes, however, depending on how much outside money you have to draw on.

Parents who can fund most or all of the tuition from other sources, can more readily assume the risk of a more aggressive investment allocation, even during the college years. Parents with some outside resources to fund tuition costs should still reduce college fund risk somewhat, but not by as much as illustrated in the table.

Tax Advantages for the Over-13 Set. Income taxes also play a role in saving money for college in the child’s name. The “kiddie tax,” which taxes investment income over $1,400 (in 1999) earned by children under age 14 at the parents’ income tax rate, can take a large bite out of investment returns.

But as of January 1 of the tax year during which your child turns 14, your income and tax bracket no longer are a consideration. In effect, he or she can enjoy quite a bit of interest, dividend, and capital gain income while nestled comfortably in the 15% income tax bracket. For 1999, a single taxpayer doesn’t reach the 28% tax bracket until his or her taxable income exceeds $25,350.

Does it make sense to make gifts to your child in the form of education-earmarked money? For a child over the age of 13, the tax advantages of shifting investment income from the higher-taxed parent(s) to the lower-taxed child are compelling. But tax issues aside, there are a couple of issues to keep in mind.

First, there is no guarantee your kid will spend the money on education. So unless you are confident your offspring won’t blow it once he or she reaches the age of majority, don’t put a lot of money in the child’s name.

Second, a cache of money in your child’s name could be a liability if you qualify for financial aid from the government. In calculating how much aid a student is eligible for, the expected contribution from investments in a student’s name is much higher (about 35% per year) than the expected contribution had those investments remained in the parents’ name (about 12% per year).