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College Planning Q&A: Determining the Best Savings Vehicle

529 plans are often the best choice. Plus, kiddie tax alert: New law extends reach of tax.

Susan T. Bart, 07/27/2007

College-savings expert Susan Bart answers advisors' questions on 529 plans and other education-planning matters. E-mail your questions to advisorquest@morningstar.com.

Q. I am a 50-year-young man living in California. I have a 5-year-young son for whom I would like to plan for his college education.

I am able to make an initial lump-sum investment of $5,000. I would like this investment to be deferred for 12 years. I would like to be able to add to the initial investment during the 12-year period. The purpose of this investment is for my son's college education. I would like the investment to pay for six years of his college education.

What are the best investment vehicles for me to consider?

Susan: If the purpose of the investment is to pay for your son's college education and you would like the income taxes on the investment to be deferred or eliminated, a 529 savings account would work well. (A Coverdell education savings account could also work, but only if your modified adjusted gross income is less than $110,000, and $220,000 for a married taxpayer, and you only wanted to contribute $2,000 per year.)

With a 529 college savings account, you could contribute up to $12,000 per year without any gift tax consequences, assuming that you are not making any other gifts to your son. (In fact, you could contribute up to $60,000 in one year and make an election on your gift tax return to treat it as if you made the gift pro rata over five years.)

To determine how much you should save over the next 12 years, as suggested in my January 2007 column, you would want first to make your best guess as to whether your son would attend public or private school and, to the extent you can make a reasonable guess, what school your child might attend. California has some wonderful public universities, so let's assume that it is likely that your son will attend a public university in California. Tuition and fees for the 2006-2007 academic year at California public universities average $4,560. If we assume that tuition and fees will increase by 7% per year, a national average for public universities, the projected cost of tuition and fees for six years of college would be about $73,500. If we assume that your investment return will be 8% and that your initial investment in the 529 savings account will be $5,000, you would need to contribute an additional $2,970 each year to fund the projected tuition and fees. Of course, this estimate assumes that your son will not be receiving any financial aid.

The above estimate does not include any contribution for room and board. Room and board at colleges and universities in the Western region of the United States for the academic year 2006-2007 averaged about $8,750. If you also wish to save enough to pay for room and board, the total projected cost would be $214,500 and you would need to make an annual contribution of $9,850 to meet your savings goal.

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