3/10/08
Contact:
Patricia Swanson, Human Development and Family Studies, (515) 294-2731,
pswanson@iastate.edu
Investing for College
Many parents and grandparents have as an investment goal saving for their children’s or
grandchildren’s college education. “As long as your retirement goals are being taken care
of, this is truly a gift to the next generation,” says Pat Swanson, CFP® and families
specialist with Iowa State University (ISU) Extension’s Invest Wisely Project
(www.extension.iastate.edu/investwisely).
When investing for a child’s education, it is important to consider how long it is until the
money is needed. The farther away college is, the more risk you can take. Parents and
grandparents of newborns and toddlers might consider investing most of their money in
stock and stock mutual funds. “The stock market will decrease in some years, as is
occurring currently, but historically, over time, stocks have earned more than other
investment categories,” Swanson says.
However, Swanson advises that if you have fewer than five years until the first tuition
payment is needed, you will want to move your money from stocks into less risky
investments such as bonds, certificates of deposit, or money market accounts. “And by
the time the child is a college freshman you will probably want to have most, if not all, of
your money in fixed income investments.”
Some parents and grandparents are concerned about the taxes paid on their investment
earnings and withdrawals. With a custodial account – known as Uniform Transfers to
Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) – you invest in the child’s
name. In 2007, the first $850 of a child's investment income was tax free and the next
$850 was taxed at the child’s own rate. But any unearned income in excess of $1,700 in
2007 was taxed at the parents' tax rate.
“It is important to realize when setting up a custodial account that the child assumes
control of the account at legal age and the funds might not be used as you initially
intended. Also, they are counted as a student’s asset when student aid is calculated,”
Swanson cautions.
Another popular way to save for college is the Coverdell Education Savings Account
(ESA) – formerly the Education Individual Retirement Account (IRA). Up to $2,000 can
be contributed each year for each child under age 18. “However, you cannot contribute to
a Coverdell ESA if your adjusted gross income is $110,000 or more in 2007 --$220,000 if
filing a joint return,” Swanson says.
If you qualify to open a Coverdell ESA, you can do it with a bank, brokerage, or mutual
fund company and choose your investments from stocks, bonds, mutual funds, or cash
equivalents. Withdrawals are tax-free if used for qualified education expenses before age
30. Distributions can be used for elementary or secondary school as well as college. The
account can be transferred to a relative if not needed for the educational expenses of the
beneficiary.
Another option is a 529 college savings plan, which is offered by most states. It is a taxadvantaged way to save for the future educational expenses of a designated beneficiary.
Withdrawals are exempt from federal income tax when used for qualified higher
education expenses.
“You
may invest in the 529 plan of any state, but there are tax advantages to investing in
the Iowa plan,” Swanson says. “When investing in Iowa’s 529 plan, called College
Savings Iowa, earnings and withdrawals are exempt from Iowa state income tax when
used for qualified higher education expenses. Iowa taxpayers also can deduct up to
$2,685 in contributions, adjusted annually for inflation, per beneficiary from their state
income tax. There are no income limits for contributing to a 529 savings plan.”
According to Michael Fitzgerald, State Treasurer of Iowa and administrator of the plan,
Money magazine recently recognized Iowa’s plan as one of only five state plans whose
strong management and low fees made them top choices not only for Iowans but for
those living outside the state as well. “With more than $2 billion invested, we’ve
continued to work hard to improve the program to provide individuals with the best way
to save for college.” More information on Iowa’s plan can be found at
http://collegesavingsiowa.com.
Unlike a custodial account, the assets in a 529 college savings plan remain in control of
the person who established the account. “And like with a Coverdell ESA, you can
transfer the 529 plan account to a new beneficiary who is directly related to the original
beneficiary if the state plan you have selected allows this,” Swanson says.
The number of investment options vary from plan to plan. “Typically you can choose
from investment tracks. For example, there may be an age-based portfolio that has a
higher percentage invested in stocks when the child is younger and shifts to bonds as the
child gets older,” Swanson says.
When deciding which state’s 529 plan to enroll in, Swanson advises to consider
enrollment fees, annual fees, tax advantages for residents, and investment options of the
different plans. “You can roll your 529 plan from one state to another once a year.”
The ISU Extension Invest Wisely Project provides a series of newspaper, radio, and web
resources for investors. It is funded by a grant from the Investor Protection Trust (IPT).
The IPT is a nonprofit organization devoted to investor education. Since 1993 the IPT has
worked with the States to provide the independent, objective investor education needed
by all Americans to make informed investment decisions. www.investorprotection.org.
-30-