University of Wisconsin - Extension

MADISON, Wis.-Now more than ever there are several good options for someone to consider when deciding among savings plans for college, says Michael Gutter, University of Wisconsin-Extension family financial management specialist.

Some families may elect to utilize Series EE Savings Bonds for college, which are considered a risk-free investment since treasuries have no real chance of default. However, Gutter says, EE bonds offer a lower return, which may not keep pace with the rate of inflation, or more importantly, the rate of increase for college tuition. There are several other choices for families in Wisconsin: a 529 plan such as the EdVest Program and Coverdell Education Savings Accounts.

One recently improved college savings tool for Wisconsin residents is EdVest. This plan is a set 529 plan that also provides for a state income tax deduction for parents and grandparents of up to $3,000 for your contribution. This means that if your state marginal tax rate is 6.75 percent, your contribution would reduce your state income tax bill by $202.50, thus your $3000 contribution would only "cost" you $2797.50, a modest brake. There is no federal deduction for the contribution, however, as with all 529 plans, withdrawals used for higher education expenses will not be taxed at the federal level and possibly not at the state level either. Another benefit of this plan is the ease of starting with low minimum commitments ($250 or $25 per month). You can sign up online at www.EdVest.com .

"After recent events," says Gutter, "this plan may be even more attractive since the investment options have been increased." The program was recently expanded to include new portfolio choices: Legg Mason Aggressive portfolio, Vanguard Stock Index portfolio, Vanguard balanced portfolio, and Baird bond portfolio. One reason for this expansion was to restore confidence in the program, which had come under fire in the current investigation of Strong. Prior to this, Strong and its funds were the only choice in the EdVest program. In addition, the fees on some of these options have been reduced which begins to address that previous criticism of the plan.

"These new funds bring increased diversity of management and portfolio choices," Gutter says. There are two choices one can make regarding the allocation of investment capital to actual funds: age-based allocation and fixed allocation. The age-based allocation is managed by Strong, which begins with a more aggressive portfolio appropriate for a child with over 10 years until college and then gradually becomes more focused on stability and income production. While this management is sound in theory, it costs more than a fixed allocation portfolio.

Contrast this with a different type of plan, a Coverdell Education Savings Account (ESA), formerly known as an Education IRA. There are numerous ESA providers in and outside of Wisconsin and around the country. Many large firms such as Vanguard provide ESA accounts. These plans also allow one to withdraw savings with tax benefits for elementary, middle, or high school tuition as well. The investment options tend to be more flexible with many providers to consider.

"In deciding which one to use, it is important to know their similarities and differences," Gutter says. "Let's begin with similarities. Both provide tax-deferred growth on investments and allow you to avoid taxes on withdrawals that are used toward higher education expenses. Neither prohibits you from using the Hope and Lifetime Learning Credits, although there are rules governing this."

Gutter offers these key differences between 529 plans and Coverdells:

-- First, the contribution limit is much higher for a 529 plan such as EdVest than a Coverdell. A Coverdell has a maximum contribution of $2000, but a 529 plan's limits are based on gifting limits. Thus, one can contribute up to $11,000 per year or $55,000 as long as it is averaged over 5 years.

-- Coverdell plans are not part of the EdVest program, so the state income tax deduction is only for the EdVest 529 plan; note that other 529 plans in Wisconsin do not provide this benefit either. However, keep in mind that the deduction is not so substantial that it should preclude other considerations.

-- Investment options with EdVest and all 529 plans are much more limited than Coverdell ESAs, which like an IRA can be invested in numerous investment vehicles.

-- The tax benefit for distributions also applies to primary and secondary schools as well for the Coverdell; the 529 plans only have these benefits for college expenses.

Gutter also recommends that you ask yourself these questions before deciding what type of plan to use.

-- Do you plan to contribute more than $2000 per year? This eliminates the Coverdell.

-- Are you happy with the investment options that each provides? EdVest is but one plan with some good options to consider. If not, then consider a different 529 plan or a Coverdell. If you would prefer to maintain the ability to modify these investments as needed rather than limited to perhaps once per year, this would suggest considering a Coverdell.

-- Are you saving for college only or possibly for Primary/secondary School? If you want this option, you might consider using a Coverdell.

-- Consider the financial aid equation; 529 plans generally are owed by parents thus only 5.6 percent of the balance counts against financial aid versus 35 percent for assets in the student's name, which is typically the case for Coverdell Accounts.

A final word: Gutter urges anyone who is unsure of which to use to consult a professional such as a financial planner who can guide you through this decision.