Tarhill Photos Inc./Corbis
|
The Grand Plan
By Karen Hube, May-June 2004
Can they give their grandkids a college boost without sacrificing their own security?
|
More On the Money Columns
Nancy and Gerry Swanson, 66 and 71, of Tempe, Arizona, received a
big windfall: an inheritance of $100,000 from Nancy's
brother. They've been getting by okay, so they've decided
to do a noble thing with that money: they'd like to use it to
ensure that their grandchildren—ages one, three, and
six—will be able to afford college. But this decision
wasn't easy. While the Swansons live comfortably, they're
not wealthy, and it's likely they still have years of
retirement ahead. So they struggled with the question, What if we
end up needing the money?
Strengths
The Swansons own their home. From their IRA, a small pension from
Gerry's career as a paper salesman, and Social Security, the
couple has an income of about $39,000 a year.
Weaknesses
If their retirement lasts longer than planned (until Nancy's
mid-80s), or if any large expenditures hit them, they may run out
of funds.
The Plan
The couple should consider 529 college savings plans, which would
allow them to save money for beneficiaries while still
maintaining control of their assets. "If they need the money
later, it's theirs to withdraw," says John Heywood,
manager of the education-markets group at The Vanguard Group. The
529 cash grows tax free, as long as it's used for college
(any accredited school, whether it's a state university,
private college, or trade school in or out of their state).
Minimum investments run as little as $250, or $25 with ongoing
contributions. (A less flexible variety of "prepaid"
529 plans, which let you buy credits now for future in-state
college tuition, isn't right for the Swansons. See www.finaid.org for more info.)
Nancy and Gerry should open three 529 college savings plans,
investing $33,000 for each kid. By age 18, assuming a realistic 6
percent annual return, the six-year-old will receive about
$67,000; the three-year-old, $80,00; and the one-year-old,
$90,000. Unfair? No, because college costs rise at about 5.8
percent per year, says Bruce Harrington, director of 529 plans at
MFS Investment Management in Boston.
A few drawbacks: First, other investments may yield higher
returns. In addition, some 529 plans charge exorbitant fees and
provide sketchy information about how they invest—issues
the Securities and Exchange Commission is currently
investigating.
To avoid these pitfalls, advises Christopher Cordaro, a certified
financial planner in Chatham, New Jersey, opt for a 529 that (1)
lets you invest directly (not through brokers who take a
commission); (2) charges 1 percent or less in annual fees; and
(3) won't charge fees if you roll your cash into another 529
plan (make sure the state doesn't tax the gains, either). If
your state plan offers a tax deduction for contributions and
passes these three tests, consider it.
The Swansons can compare plan features at www.savingforcollege.com
and www.morningstar.com.
After settling on a plan, they should name their grown children
as successors. If Nancy and Gerry pass away before the kids head
to school, the parents will control the money. If one kid
doesn't go to college, the 529 can be transferred to another
child—or be withdrawn for noncollege use, which will incur
a 10 percent penalty and make all gains taxable.
If Nancy and Gerry ever need cash, they can tap the plans and pay
the penalty and taxes. "If they've held the account for
about 10 years, they'll still come out ahead of having the
money in a taxable account, even with the penalty," notes
Harrington, "because they will have had years of
tax-deferred growth."
Karen Hube, our new money columnist, has written for The
Wall Street Journal.
Submit Your
Question to the On the Money column.
|
