529 plans offer perks for college savings

The cost of sending a kid to college is skyrocketing at a rate that has surpassed the rate of inflation for each of the last five years, according to the College Board. That makes saving for college a high priority for parents or guardians who wish for their children to get an undergraduate education. Many consumers are turning to 529 college savings programs to help pay for higher education.

There are more than a hundred 529 plans to choose from, and every state offers at least one. The good news is that most plans are available to all U.S. residents, regardless of where someone lives. And in many cases investments can be used for institutions located anywhere in the country. That means a person could live in California, contribute to a 529 plan in Ohio, and send a child to college in Florida.

This flexibility gives consumers plenty of options. The downside of having so many choices, however, is that a little extra work is needed to find the right plan.

The two main flavors of 529 plans are prepaid tuition plans and college savings plans. As the name indicates, prepaid plan allow parents to purchase future tuition credits for a specific institution or set of institutions at current prices. The advantage here is that parents could conceivably pay all of a 2020 graduate's tuition at State U in 2008 dollars. But most prepaid plans are restricted to state residents only, as in the case in Michigan and Maryland. Some states, such as Massachusetts, don't have residency restrictions.

In addition, if a student decides to head out of state for college, parents could lose the guaranteed tuition rates, although they will be able to take most of their contributions with them. Finally, prepaid plans often have restrictions on enrollment. The Massachusetts plan, for example, only allows enrollment from May 1 through the end of June.

Given the restrictions on prepaid plans, it's not surprising that savings plans are a more popular 529 option. These plans consist of a managed investment account that grows tax free. Money saved in these plans can be used to pay for eligible college expenses such as tuition, room and board and books. Many plans also allow parents to choose the type of fund in which the money will be invested, such as a target-date fund in which the allocation begins heavier in stocks and then sifts toward less risky investments, such as bonds, as a child nears college age.

Contributions to a 529 savings plan are made with after-tax dollars. However, investment earning is free from federal and state taxes as long as the money is used to pay for qualified education expenses. Some states also provide tax deductions for a certain portion of contributions to in-state plans. Know what perks a state offers can help determine whether someone is better off sticking with the state plan or searching elsewhere.

Tom Rush is a wealth investor with the Yuma Investment Group. He can be reached at 329-1700.