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If you think higher education is expensive today, just wait. Like everything else it's going up. Will you be ready? Over the last 20 years, the cost of a college education has increased by nearly twice the rate of inflation, as measured by the Consumer Price Index. This trend shows no sign of reversing.

The bad news: Paying for college is harder than ever. College costs roughly $137,000 for four years at a private school and $64,000 for a public school today. At four-year public institutions, costs rose 14.1% for the 2003-04 academic year. (Source: The College Board for the 2003-04 school year.)



As the table shows, costs are soaring. There are tuition, books, fees, room and board, and many other costs to consider. Yet, a quality education can greatly increase a child's chances for success and everyone wants
to help their children or grandchildren realize their dreams – whether it's to become an astronaut, engineer, teacher or technician.

The good news: Saving for college is easier than ever. With the advent of the 529 plan, no matter how much you earn, you can take advantage of a tax-advantaged college savings plan with more flexibility and control than ever before. The Coverdell Education Savings Account, formerly called an Education IRA, can be used for primary schools in addition to college, but has an investment limit of $2,000 per year.

Traditional UGMA/UTMA accounts are still an option, but the minor assumes control of the account at the age of majority, 18 or 21 in most states, which frightens some parents.

What is a 529 Plan?
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as "qualified tuition plans," are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. There are two types of 529 plans: pre-paid tuition plans and college savings plans. All fifty states and the District of Columbia sponsor at least one type of 529 plan. In addition, a group of private colleges and universities sponsor a pre-paid tuition plan.

Pre-paid tuition plans generally allow college savers to purchase units or credits at participating colleges and universities for future tuition and, in some cases, room and board. Most prepaid tuition plans are sponsored by state governments and have residency requirements. Many state governments guarantee investments in pre-paid tuition plans that they sponsor.

College savings plans generally permit a college saver (the "account holder") to establish an account for a student (the "beneficiary") for the purpose of paying the beneficiary's eligible college expenses. An account holder may typically choose among several investment options for his or her contributions, which the college savings plan invests on behalf of the account holder. Investment options often include stock mutual funds, bond mutual funds, and money market funds, as well as, age-based portfolios that automatically shift toward more conservative investments as the beneficiary gets closer to college age.

Withdrawals from college savings plans can generally be used at any accredited college or university. Investments in college savings plans that invest in mutual funds are not guaranteed by state governments and are not federally insured.

What does tax-advantaged mean?
Investing in a 529 plan may offer college savers special tax benefits. Earnings in 529 plans are not subject to federal tax, and in most cases, state tax, so long as you use withdrawals for eligible college expenses, such as tuition and room and board.

However, if you withdraw money from a 529 plan and do not use it on an eligible college expense, you generally will be subject to income tax and an additional 10% federal tax penalty on earnings. Many states offer state income tax or other benefits, such as matching grants, for investing in a 529 plan. But you may only be eligible for these benefits if you participate in a 529 plan sponsored by your state of residence. Just a few states allow residents to deduct contributions to any 529 plan from state income tax returns.

If you receive state tax benefits for investing in a 529 plan, make sure you review your plan's offering circular before you complete a transaction, such as rolling money out of your home state's plan into another state's plan. Some transactions may have state tax consequences for residents of certain states.

What about withdrawals?
Withdrawal restrictions apply to both college savings plans and pre-paid tuition plans. With limited exceptions, you can only withdraw money that you invest in a 529 plan for eligible college expenses without incurring taxes and penalties. In addition, participants in college savings plans have limited investment options and are not permitted to switch freely among available investment options. Under current tax law, an account holder is only permitted to change his or her investment option one time per year. Additional limitations will likely apply to any 529 plan you may be considering. Before you invest in a 529 plan, you should read the plan's offering circular to make sure that you understand and are comfortable with any plan limitations.

Will this hurt chances for financial aid?
While each educational institution may treat assets held in a 529 plan differently, investing in a 529 plan will generally reduce a student's eligibility to participate in need-based financial aid. Beginning July 1, 2006, assets held in pre-paid tuition plans and college savings plans are treated similarly for federal financial aid purposes. Both are treated as parental assets in the calculation of the expected family contribution toward college costs. Previously, benefits from pre-paid tuition plans were not treated as parental assets and typically reduced need-based financial aid on a dollar for dollar basis, while assets held in college savings plans received more favorable financial aid treatment.

Before you start saving specifically for college, you should consider your overall financial situation. Instead of saving for college, you may want to focus on other financial goals like buying a home, saving for retirement, or paying off high interest credit card bills. Remember that you may face penalties or lose benefits if you do not use the money in a 529 account for higher education expenses. If you decide that saving specifically for college is right for you, then the next step is to determine whether investing in a 529 plan is your best college saving option. Investing in a 529 plan is only one of several ways to save for college. Other tax-advantaged ways to save for college include Coverdell education savings accounts, Uniform Gifts to Minors Act ("UGMA") accounts, Uniform Transfers to Minors Act ("UTMA") accounts, tax-exempt municipal securities, and savings bonds. Saving for college in a taxable account is another option.

Each college saving option has advantages and disadvantages, and may have a different impact on your eligibility for financial aid, so you should evaluate each option carefully. If you need help determining which options work best for your circumstances, you should consult with your financial professional or tax advisor before you start saving. Like any major financial goal, funding higher education can be achieved with commitment and careful planning.

It's never too soon – or too late – to start saving.

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