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Tis the season for college savings plans and 529s
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When it comes to saving for college, the 529 Plan is at the forefront of tax-efficient saving. In Maryland, a taxpayer may deduct up to $2,500 annually by contributing to either of the two 529 Plans available. Maryland offers the Prepaid College Trust and College Investment Plan. Both do the same thing when it comes to saving for college, however they do it very differently and with different risks. Both allow tax free earnings if withdrawals are used to pay for qualified education expenses and the added incentive of a Maryland State tax deduction.
The enrollment period for buying a contract in the Prepaid Plan started on December 1, 2008 and continues until April 6, 2009 for the current contract year. This is important because contract prices increase each year based on the average tuition at a Maryland college. You can make contributions to the Investment Plan at anytime. Maryland's plan is making it easier than ever to contribute online. Whichever you decide to use, only contributions made in the calendar year can be deducted on that year's tax return, up to a maximum of $2,500. If you contribute more than $2,500 in any one calendar year you may carryover the unused deduction to future years. So if you want the tax deduction for this year, get your money in before December 31, 2008!
The Prepaid College Trust has gained popularity this year because the stock market is in the tank. Essentially, the Prepaid plan is an insurance contract that you purchase with today's dollars and insure the cost of a future college education. It's good because you lock in the future cost, which is every rising - - historically at an average clip of 8% a year - - using today's dollars. If tuition at the University of MD increases by 15% a year, it doesn't matter to those in the Prepaid plan because they have locked in their cost. The downside is that the plan has assets and liabilities. The assets are your contributions that the plan invests and the liabilities are the future payments to colleges that the plan will have to make. If the future liabilities exceed the current and expected assets, there's a problem. Either benefits could be cut or more assets will be required to keep the same benefits. Maryland's plan has a legislative guarantee that is supposed to kick in when liabilities exceed assets and put the difference in the State budget. I'm not so sure in tough budgetary times, when it is likely to occur, it will be a good idea to pump money into a deficient plan. You get the biggest bang for your buck by attending a Maryland College or University but your contract can be used for out of state schools, just prorated.
The College Investment Plan is a traditional investment vehicle much like your IRA, 401k or brokerage account. You make contributions to the plan and invest the plan as you see fit. Morningstar has named the Maryland College Savings plan one of the best in the country and recently ranked it second among all plans. When you make investment decisions in the Investment Plan you can decide among target date funds based on when the student will need the money for college. These are great because they automatically adjust and get more conservative as the student nears the time they need the money ensuring more of the investments are in fixed income investments. Additionally, you can invest in more concentrated portfolios of stocks, bonds or a balanced portfolio. The balanced portfolio has done very well versus all portfolios available. The annual return since inception is 4.29%. Not bad given the performance of the stock market this year. The risks here are obvious in that some if not all of the portfolios are invested in stocks that may gain or lose value. Check out the performance of all the portfolios on the Maryland College Savings website. The money you save and earn in the Investment Plan can be used for any College or University across the country, as long as it is properly accredited.
So which one is right for you? I think a good approach is to either put all your contributions into a target date portfolio in the College Investment Plan or hedge yourself by purchasing a two-year plan in the Prepaid College Trust and saving enough for the final two years in the Investment Plan. This is clearly a personal decision based on your comfort level, time horizon and risk tolerance and a financial planner can help you with the decision that is right for you.
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Tom Taylor, CPA is a fee-only Financial Planner and Certified Public Accountant and can be contacted at Thoma Capital Management in Towson, MD. He is a member of NAPFA and the MACPA.
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