Oct 282006

I have 4 children under 18 that I am looking at the best way to put money away for college. I figure I may as well write what I find as I come across it and start putting my thoughts together.

My first question was – What is available? It seems the the Uniform Gift to Minors Act (UGMA) has been superseded by the newer Coverdell Educational Savings Account (ESA) and the 529 plans. I found this great comparison of these three plans on SavingForCollege.com

Rules for 2006 529 Plan Coverdell ESA UGMA/UTMA
Federal Income Tax Non-deductible contributions; withdrawn earnings excluded from income to extent of qualified higher education expenses Same as 529 plan except earnings withdrawn for qualified K-12 expenses also excluded Earnings and gains taxed to minor; first $850 of unearned income is tax exempt; unearned income over $1,700 for minors below age 14 on 12-31 taxed at parents rate
Federal Gift Tax Treatment Contributions treated as completed gifts; apply $12,000 annual exclusion, or up to $60,000 with 5-year election Same as 529 plan but 5-year election only available under special circumstances Transfers treated as completed gift; apply $12,000 annual gift exclusion | No gift involved; direct payments of tuition not considered gifts
Federal Estate Tax Treatment Value removed from donor’s gross estate; partial inclusion for death during a 5-year election period Value removed from donor’s gross estate Value removed from donor’s gross estate unless donor remains as custodian
Maximum Investment Established by the program; many in excess of $250,000 per beneficiary $2,000 per beneficiary per year combined from all sources No limit
Qualified Expenses Tuition, fees, books, supplies, equipment, and special needs; room and board for minimum half-time students Same as 529 plan plus additional categories of K-12 expenses No restrictions
Able to Change Beneficiary Yes, to another member of the beneficiary’s family Yes, to another member of the beneficiary’s family No; represents an irrevocable gift to the child
Time/Age Restrictions None unless imposed by the program Contributions before beneficiary reaches age 18; use of account by age 30 Custodianship terminates when minor reaches age established under state law (generally 18 or 21)
Income Restrictions None Ability to contribute phases out for incomes between $190,000 and $220,000 (joint filers) None
Federal Financial Aid Counted as asset of parent or other account owner; not counted as a student asset Counted as asset of parent or other account owner; not counted as a student asset Counted as student’s asset
Investments Menu of investment strategies as developed by the program Broad range of securities and certain other investments As permitted under state laws
Use for Non-Qualifying Expenses Withdrawn earnings subject to federal tax and 10% penalty Withdrawn earnings subject to federal tax and 10% penalty Funds must be used for benefit of the minor

From what I can see, there is no reason to use the UGMA to set aside money. The earnings are taxed and the donor does not retain control of the funds. The only advantage to the Coverdell is that the money can be used for K-12 educational expenses. Since I won’t even be able to save enough for the kid’s college expenses, I see no reason to consider withdrawing the money prior school graduation. Therefore it seems the 529 plans are the only real option.

Notice I said plans…. Next I will look at what plans are available and try to compare them.

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