College savings made simple

When it comes to financial planning for college, simple solutions often seem the best.

Start early, save regularly and use tax-advantaged college savings plans to minimize the tax consequences. That seems to be the basic advice from most quarters.

But that general advice still leaves plenty of room for pitfalls. Jeff Johnston, president of Premier Investments of Iowa, recalls one of them.

Before the tech bubble burst in 1999, many parents drawn to the strong stock market returns of the day chose the most aggressive college savings plan investment option. Those hard-charging options relied heavily on stocks, which plunged in value after the tech bubble burst.

Parents whose children were only a year or two from college were dealt a severe blow, Johnston said.

“Some of them were just devastated,” recalled Johnston, a chartered financial consultant.

Iowa's own tax-advantaged college savings plan subsequently tweaked its investment options to include four age-adjusting investment tracks.

The “set-it-and-forget-it” tracks automatically and gradually shift savings from highly volatile investments such as stocks to safer investments, such as bond funds, as the student gets closer to entering college, explained Karen Austin, deputy state treasurer.

Getting a late start on saving for college is a common mistake, Austin said, and probably contribute to the willingness of many parents to take investment risks.

Parents often don't think seriously about saving for college until that child enters kindergarten, Austin said. By the time they begin investing, they already are behind in reaching savings goals that might be based on a comfortable savings pattern.

While estimates of the typical college costs abound, they vary widely. The College Board says four-year public colleges and universities in 2011 to 2012 averaged $8,244 in tuition and fees for in-state students.

Private not-for-profit four-year colleges charge an average of $28,500 per year in tuition and fees, while public two-year colleges charge an average of $2,963 in tuition and fees.

Savings track A, the most aggressive age-based track, remains the most popular in the College Savings Iowa plan overseen by the state treasurer's office. The most aggressive non-age based track is also the most popular of the 13 tracks.

The tax advantaged college saving plans are called 529 plans, for the section of the Internal Revenue Code that allows them. They provide an income tax exemption for returns on the invested principle if they are used for qualified expenses.

Some state plans also provide a state tax deduction for contributing to the plans.

Here are some of the details:

• In Iowa, account holders can contribute up to $2,865 per account for 2011 and deduct it from their gross taxable income for state taxes. Both parents can create a separate account in their own name for the same child, so the actual limit could be $5,730 for 2011.
• The maximum total that can be contributed to an account is $320,000.
• The average current account size is $13,600 for all College Savings Iowa accounts, and the average age of a beneficiary is 11, Austin said.

Austin has a fairly good idea from questions people ask what's holding them back from creating a College Savings Iowa account.

Some state 529 college savings plans are structured so that they pay for discounted tuition on a per-credit basis if they are used at an accredited institution in the state that sponsors the plan, Austin said. But the Iowa program allows for use with out-of-state schools.

Another concern some parents express is that saving up for college will reduce their child's prospects of obtaining financial aid if they will need it.

There's somewhat more truth to that.

“Unfortunately, saving for college, while it's beneficial, does count against them in their ability to qualify for grants,” said Bethany Rinderknecht, director of financial aid at Mount Mercy University in Cedar Rapids.

Parental assets are assessed at 5.64 percent in calculating the expected family contribution on the standard federal financial aid form, Free Application for Federal Student Aid.

If a grandparent takes out a 529 savings plan for their grandchild, it is not counted as part of the FAFSA formula.

Many parents, of course, might view not having to worry about financial aid for their child as a huge advantage. That's especially true as parents don't lose all, or even most, of the 529 plan funds if they are not used for college by their children.

Plan holders who make non-qualified withdrawals are subject to a federal income tax on the plan earnings, a 10 percent federal penalty tax and any state and local income tax, Austin said.

The penalty issue points to another potential hurdle for 529 plan college savers. Johnston of Premier Investments strongly advised parents to document and keep records of the qualified expenditures they made from their 529 plans.

Those records could save them from penalties if they are audited by the IRS, he said.

One of the advantages of College Savings Iowa is its low expense ratio of 0.34 percent, which means the plan doesn't charge account holders much for investing their money.

One of the disadvantages, according to Brock Renner, vice president of Premier Investments of Iowa, is that the plan offers a relatively limited array of investment options from the Van Guard fund family. Some of the other state 529 plans offer a greater variety of investment options than the 13 offered by College Savings Iowa and multiple fund families, he added.

Iowans who want to go back to college at mid-career may set up their own 529 plan, but most do not. Rinderknecht pointed out that most of the mid-career students at Mount Mercy University who are paying as they go benefit from employer-sponsored education benefits.

“There are a lot of local employers that have very good tuition-reimbursement plans,” Rinderknecht said. “Some of them pay $5,250, and some pay $7,500.”

Setting aside money in a 529 college savings plan takes more discipline than many parents can muster, given all the other financial demands they face. Renner and Johnston say the absolute best method is to have the contribution automatically drafted from their checking or savings account on a monthly basis.

That way, the decision is never overlooked or postponed.