The 1-2-3 Money Plan Part 21

Saving for College.

The most important thing to know about saving for kids' college expenses is to realize it's not your top financial priority. You're not a bad parent if you don't save 100 percent of the money needed to send your child to an Ivy League college. Eliminating high-interest debt, creating an emergency fund, and regularly contributing 10 percent or more of your income to a retirement plan come first.

Why retirement savings first? Because you can get grants and low-interest loans for college. No bank is going to lend you money for retirement. And how much are your kids going to appreciate having their college paid for if at age 75 you have to move in with them because you didn't save enough for retirement?

Saving for College, 1-2-3.

1. Open a 529 college savings account online.

2. Select an age-based plan.

3. Contribute automatically.

If you look at projections for college costs, you might start feeling ill. You can find costs and use calculators at the College Board Web site, found at www.collegeboard.com. Others are at Savingforcollege.com, d.i.n.kytown.com, and FinAid.org.

For a newborn, you'd have to save about $180,000 to pay the cost of sending the child to a state university. A private university? About $367,000. But those are the scare-you-to-death numbers that stray from reality.

Relatively few students pay the full "sticker price" for going to college. Besides growing college savings over the years, you'll potentially have scholars.h.i.+ps, loans, grants, and other forms of financial aid. In fact, the average yearly cost of a four-year public school in 200809 was just $6,585, according to the College Board. Over four years, that's about $26,000, or about the cost of a modest new car.

Another problem with those scary numbers? It's probably not even wise to save 100 percent of college costs. What if your child doesn't end up going to college? What if through new government programs the costs for college decline? What if your savings grow faster than expected and you have too much saved?

All that said, college is expensive and the sooner you can start saving, the better.

The biggest problem with saving for college is it can be complicated. There seem to be a million and one details, some of which don't seem to make much sense. That's why I'm going to simplify it for you and give you one, single suggestion.

Go to www.uesp.org and open a 529 college savings plan, called the Utah Educational Savings Plan. You don't have to be a resident of Utah to partic.i.p.ate and your child does not have to go to school in Utah. It's just a cookie jar to stash the money so you get a huge federal tax break when you withdraw the money.

In the Utah plan, choose age-based plan No. 8, called Diversified-B. Contribute at least $50 per month, raising regular contributions when you can. You can always transfer to a different plan later if you have a good reason. It's more important to get started than to pick the absolute best college savings plan. In fact, there are good reasons for choosing other plans. But choice No. 8 in the Utah college savings plan is "good enough" for almost anyone. Just get it started.

Here are the details on college savings.

1. Open a 529 College Savings Account Online.

You have many ways to save money for college, but only one is a clear choice for almost everybody. Just like 401(k) and 403(b) retirement plans, the best college savings vehicle has a weird name, derived from the federal tax code that allows it. It's called a Section 529 college savings account.

The basic deal with a Section 529 account is you put money into investments within the account over the years, in lump sums, monthly installments, or both. The money is usually invested in a mix of investments, such as stocks, mutual funds, and bonds. That way, the money is likely to grow so you can pay more and borrow less when it's time to pay-or help pay-for college. Of course, you could do that in regular mutual funds. The big benefit of investing within a 529 account comes when you take money out to pay for college costs at any accredited school. Growth on that money through the years-the gain-is free of federal tax. That's a huge advantage, likely to amount to literally thousands of dollars that go to paying for your kid's tuition, rather than funding Uncle Sam's kitty.

Another advantage of 529 plans is you can contribute a lot of money. It varies by state, but caps are typically around $300,000. And anybody can contribute, including grandparents and other relatives. The money can be used not only for college tuition, but also for room and board, and books and supplies, including a computer.

If your kid doesn't go to college-or, heaven forbid, dies-you can transfer the account to another relative or use it yourself. The definition of a family relative is generous, extending to such familial relations.h.i.+ps as step-children, nieces, nephews, and first cousins. If you don't use the money for college, you'll have to pay a 10 percent penalty on withdrawals plus income taxes. One exception is if your kid gets a scholars.h.i.+p, you can withdraw money equal to the scholars.h.i.+p amount without paying the 10 percent penalty. But you will have to pay income taxes on the money's growth.

Opening an Account.

How do you start a 529 account? That's both easy and hard. But mostly, it's worth it, to keep Uncle Sam's hands off money earmarked for college.

It's easy because once you choose a 529 plan, you just fill out forms and mail a check (or fund it by electronic transfer from a bank account). Some plans let you do all that online. That's it. You've successfully opened a 529 college savings plan. Make sure to open separate accounts for each child, but register accounts in parents' names. That's so you, as a parent, control the investments, and the student might end up qualifying for more financial aid.

Because opening a 529 account is so easy, there's no reason to go through a stockbroker, insurance salesperson, or financial planner. More important, opening an account by yourself is free. A financial professional is likely to put you in a plan that includes commissions and management fees that will r.e.t.a.r.d growth on your college-savings money. That means you'll probably have a smaller total when it comes time to pay college bills. Professionals don't have access to better plans than you do as an individual.

Choosing a Plan.

Where people get bogged down is trying to choose among all the different plans. Section 529 plans are operated through state governments. So, most states offer their own 529 plans. Here's the confusing part: You can pick from most any state's savings plan, and your child can go to school in any state. That means you're not locked into your own state's plan.

That sounds like good news. But there are so many plans with so many different features, costs, and investment choices, it's almost impossible to compare them all in any intelligent way.

But take heart. You can transfer your 529 plan once a year. So, you're not locked into your first choice. You can always change it later.

That's why, to make things simple, I recommend just one: the Utah Educational Savings Plan, found at www.uesp.org. The Utah plan is on virtually every respected list of top-tier 529 plans. It has low fees and great investment choices.

Is the Utah plan the absolute best choice for everybody? Not necessarily. But it's a darned good choice, and it's "good enough" to get you started so you can get on with your life. Opening and regularly contributing to a decent college savings plan is far more important than which one you choose.

Should You Transfer Your 529 Account?

Already have a 529 plan started? It might not be worth switching. When 529 plans first started, some were real stinkers. Fortunately for parents, many states have improved their plans by cutting fees and offering better investment options.

"529 college-savings plans continue to get better," says respected mutual fund a.n.a.lysis firm Morningstar, which each year reports on the best and worst 529 plans. "Several years ago, many were high-cost messes. Since then, some [lousy choices] have been spruced up and others have been shut down. The important thing is that more people using these vehicles to save for college are getting a good deal." Go to www.Savingforcollege.com, and see how your plan is rated. If it receives a rating of four graduation "caps" or more out of a possible five, you're fine where you are. For example, I started years ago with the 529 plan in Iowa. It's not always at the very top of ratings I see, but it's usually in the top few. The Iowa plan received a four-cap rating from www.Savingforcollege.com. As a general rule of thumb, if the plan manager has the name Vanguard or Upromise/Vanguard, T. Rowe Price, Fidelity, and to a lesser extent TIAA-CREF, it's probably a decent plan.

If you're in a plan with high expenses and live in a state with no tax breaks for 529 plans, you should accelerate your search for a new plan. Your new plan will give you instructions on how to transfer money from the old plan to the new one. If you want to shop around for a more optimal 529 plan-and don't want to take my advice to use the Utah plan-here are the primary considerations: * Fund expenses. The most important fees are those charged by the mutual fund companies and those charged by states to administer the college savings plan. These fees might seem insignificant, 1 percent or lower each, but they add up to a lot of lost money over time. States might also charge flat fees for opening and maintaining an account. Compare costs and other features at www.savingforcollege.com/compare_529_plans/.

* Allocations. Though most 529 plans offer age-based investment options, they spread the money around differently among types of investments. Look for a broad allocation among U.S. and foreign stocks, as well as bonds. And always prefer index funds, rather than actively managed funds.

* State tax breaks. Some states won't tax your gains in a 529 plan, although many require you to use your own state's plan to get that break. Others allow you to take a tax deduction on your income tax form for money you contributed. These goodies from state governments are nice and could be considered as you choose a plan. But they probably won't make up for high expenses and lousy fund choices.

Here, briefly are non-529 options for college savings that I skipped earlier.

* Prepaid tuition plans. With these, also called guaranteed plans, you essentially buy college credits at today's prices. They're good for the same number of credits when your kid goes to school. So, the return on your investment is about equal to the price inflation in college tuition costs. This might be a good choice if you just want to preserve the value of money against tuition increases and you don't care about growing it to pay for more semesters. Or, if you can't stand to see the value of your college nest egg ebb and flow with stock and bond markets, the guaranteed program might be best. Some states require residency to use these plans. And many states only allow you to pay for tuition and fees with prepaid money, not room and board.

Starting in 2004, individual educational inst.i.tutions were allowed to offer their own prepaid tuition plans. The Independent 529 Plan is such an offering by a group of private colleges. More information can be found at www.independent529plan.org, or 1-888-718-7878.

To add to confusion, all these prepaid plans are technically 529 plans too. However, most people call these "prepaid tuition plans" and the investment-style plans "529 plans." One strategy might be to use both an investment-style 529 and a prepaid 529.

* Coverdell Education Savings Account. There's nothing terribly wrong with these accounts, formerly called ESAs. The main drawback is you can only contribute $2,000 a year per child. Otherwise, they're similar to a 529 plan. The big advantage as of this writing is you can use them to pay for private school expenses before college. However, unless Congress acts before 2010, contribution limits revert to the old cap of $500 per year, and you can't use the money for elementary or secondary private school.

* Custodial accounts. These accounts are called Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA). They were the primary way to save for college before creation of 529 plans in 1996. However, they have lost almost all of their appeal as college-savings vehicles, when compared with 529 plans. If you already have an UGMA or UTMA, feel free to liquidate the account and put the money in a 529 college savings plan or prepaid plan, or convert to a 529 plan with the help of your accountant and the 529 plan administrator.

2. Select an Age-Based Plan.

Most 529 plans include an option to invest all of your college savings in a single diversified mutual fund. It's an age-based fund invested aggressively when children are young and more conservatively when children approach college age. Unless you have a specific investing philosophy or don't need the money to grow much, these age-based funds are the way to go.

Age-based funds automatically reallocate money to more conservative investments as your child nears college enrollment. When your children are toddlers, the money would mostly be invested in stocks. When they reach high school, the money s.h.i.+fts to more conservative holdings.

For example, in the recommended Utah No. 8 plan, Diversified-B, a toddler would have money invested this way: 56 percent U.S. stocks, 24 percent foreign stocks, and 20 percent bonds. As the child ages, money s.h.i.+fts from stocks to bonds. The other age-based options in the Utah plan are fine too. I like Diversified-B, mostly because it includes a decent portion of foreign stocks. It also provides finer diversification among stocks from companies of all sizes.

Does this automatic investing sound familiar? These are similar to target-date retirement funds, only college is the target date, rather than retirement. They are the no-brainer, set-it-and-forget-it option that is more than "good enough."

QUICK TIP.

If you have a huge lump sum to deposit into an account, rather than trying to grow monthly contributions, you should probably choose a more conservative allocation.

Just like you can switch 529 plans once every 12 months, you can also switch investment strategies within a 529 plan once within a year's time. So, you're only stuck with your allocation for one year, if you decide you don't like it.

3. Contribute Automatically.

We've talked about the importance of making savings automatic. It's the same for college savings. Contribute with regular deposits in your 529 account by setting up automatic monthly withdrawals from your checking account.

Formulate a plan to raise the contributions annually, when you get a raise or at a predetermined time, such as the child's birthday. And consider funding the account with portions of such windfalls as a federal tax refund, annual salary bonus, or cash gift. As you finish paying off debt, you can funnel more money into college savings. For example, if paying off an automobile is your last nonmortgage debt, redirect at least part of that payment to college savings. Again, that's a.s.suming your other priorities, such as paying off high-interest debt, funding retirement, and building an emergency fund, are all under way.

QUICK TIP.

Boosts to your college savings plans can come via rewards programs, where your everyday spending via credit cards or online shopping portals contributes small amounts to college savings. Find details at Upromise.com, BabyMint.com, and Littlegrad.com.

Community College Route.

Saving for four-year college expenses is a swell idea. But if you really want to chop down the price tag, consider sending your child to a community college for the first two years. They would then transfer to a name-brand university to get a four-year degree diploma. It's what I call the two-year, two-year plan.

The cost of tuition and fees at community colleges is typically half of public four-year schools and about one-tenth the cost of private colleges. Studies show students taking the community college route are just as prepared as those who go to four-year schools, and earn just as much money after they graduate.

They might even get a better education in those introductory cla.s.ses. Courses at community colleges are taught by teachers who often have real-world experience working in their fields. Introductory cla.s.ses at four-year schools are often taught by teaching a.s.sistants or professors more interested in research than education.

Choosing a Financial Adviser.

Americans today are forced to make a dizzying array of financial decisions, including many we've talked about in this book: how to build a retirement nest egg, save for kids' college expenses, and deal with debt and insurance.

For help, you might consider hiring a personal financial adviser. That can be a great idea or a bad one. The main advice: Buyer beware.