Eight Questions about 529 Accounts for Jonah Keegan, the Founder of Freshman Fund

These days, whenever I get some time, I have been thinking and reading about 529 plans and trying to determine if we should have one for our baby. Coincidentally, I was recently contacted by Jonah Keegan about an interview to introduce his site Freshman Fund to the readers of this blog. Since its a good chance for me to get some of my questions answered, I quickly took up the offer! I hope some of these questions and answers will be helpful to you readers as well. If you have more questions, I have added the contact information for Jonah at the bottom of the interview - please feel free to contact him directly.

Jonah Keegan is the founder of Freshman Fund. Freshman Fund helps parents save for college by giving them a free online gift registry for their college fund. When you register your 529 college savings plan at Freshman Fund, gifts from friends and family go directly into the plan.

OK. Here we go...

ISPF: With so many different 529 accounts available, how can one determine which plan is the best for them?

Jonah: Like Smokey and the Miracles say, "You Gotta Shop Around." The best 529 is going to be different for each family depending on their child's age, their investment pattern and other factors. Similar to big-ticket purchases like a computer or television, you will find that there are a large number of plans that fit your basic needs, and from there it's a matter of doing some research or working with your financial advisor to determine the best choice for your family.

The good news is that if you do want to enroll in a 529 directly, there are some great online tools for comparison-shopping.

The number-one industry expert is Joe Hurley, and his site SavingForCollege.com has great features that let you look at the plans available in your state, run comparisons on different plans or plan features, and see what he thinks are the current top-rated plans.

ISPF: How can parents pass word to relatives and friends that they would prefer to receive the gifts in the form of contribution to the 529 accounts?

Freshman Fund makes this easy in two ways.

First, we have a contacts manager that lets you import your webmail or social network address book. This makes it easy to build and manage messages on our site, as well as discover if anyone in your address book is already using Freshman Fund.

Second, we've included a notification message that you can send right from your Freshman Fund account. Login, and you will see a "Notifed" link next to your student. Clicking the link takes you to our notifications page (Tip: Import your contacts first and adding message recipients is as easy as clicking on their names, right from your message page). We provide a default message, but you can customize it however you like before you send.

ISPF: What are the limits on how much can be saved in a 529 account each year? How do contributions from friends and family effect this?

The limit on 529 savings for each student is set by the IRS gift tax exclusion limit, currently $12,000. This is a limit per student and not per donor, so parents who save or receive gifts at or near this amount need to keep an eye on their annual savings. Also, this is not a per plan limit, so if a student has multiple 529s in their name, they will also need to keep track of their account balances.

In part, this is one of the problems we started Freshman Fund to solve. Parents were telling us that between grandparents, godparents and themselves, they had multiple 529s open for their children and no idea how much money was actually being saved each year. Freshman Fund lets parents consolidate 529 savings to a single account to better plan for the future (and avoid a visit from the tax man!).

Oh, and most plans have a maximum contribution limit as well, it varies from plan to plan, but on average it's more than $250,000 per account.

ISPF: How does a 529 account affect a child's federal financial aid?

The impact of a 529 on a student's financial aid depends on who owns the plan (the beneficiary of a 529 is always the student, but the owner could be the parents, grandparents or the student themself).

If the 529 is owned by the parent or another non-beneficiary, it is treated as a parental asset, and assessed at a 5.64% rate when calculating financial aid awards.

If the 529 owner and beneficiary are the same, the rate could be as high as 20% for the 2008-09 school year because the funds are treated as a student asset, but starting with the 2009-10 school year, they will be treated as a parental asset whether or not the parent owns the 529, and will be assessed at the 5.64% rate.

Also, 529 distributions are not counted as income for that year, which helps when next year's financial aid eligibility is calculated.

ISPF: What happens if my child does not want to go to college?

Parents with a child who does not attend college can transfer the account to a sibling, grandchild, step-sibling, cousin, niece, nephew or in-law without incurring any taxes or penalties.

Other transfers would be viewed as "non-qualified withdrawals" by the IRS, and the account would be subject to federal (and possibly state) income tax on any account earnings, as well as a 10% federal penalty tax on earnings.

ISPF: What qualifying expenses can be paid with 529 savings without incurring a penalty?

The easy ones are the following: tuition, room & board, any mandatory college fees, books, and a computer (if required).

From there, it varies from plan to plan and state to state, if you have a question about something that is not on the list above, consult with your plan manager or financial advisor.

ISPF: Does investing in a 529 make sense for families who may possibly return to their home country before the children start college?

Much like the question "What's the best 529 for my family?" there is no one answer to this question, families who foresee this scenario in their future should research all of the available college savings options, including 529s, or talk to their financial advisor before making a choice.

I can tell you that 529 savings may be used to pay for many non-U.S. colleges, you can search a list of eligible institutions at http://www.savingforcollege.com/eligible_institutions/, in the STATE: drop-down list, choose Canada for a Canadian college, or Foreign Country for any other international school.

ISPF: What are some alternatives to 529 accounts?

Here are some of the more popular college savings options. Space, time and the limits of my expertise prevent me from including every feature of these savings options, but here are a few highlights.

MUM (Money Under the Mattress... or in a no-interest savings account)
Very rarely a wise choice for any type of savings, and college savings are no exception. Loses ~3% per year at the current rate of inflation, and if it's earmarked for college then you're in even worse luck, as college costs inflate at about twice that rate, or ~6% per year.

U.S. Education Savings Bonds
Savings bonds can have tax benefits at both the federal and state level, but the exact nature of the benefit varies depending on the exact type of bond purchased. Unlike 529 gifts, savings bonds are not covered by the gift exclusion. Also, to qualify for the tax benefit, savings bonds may only be used for tuition and fees, whereas 529 distributions can be used for the broader array of expenses mentioned above. The annual limit on bond purchases is $5,000 per owner per type of bond, or $90,000 over the 18 years of a typical future freshman's life. In contrast, 529 plans have an average lifetime maximum contribution of more than $250,000.

The Uniform Gift to Minors Act and Uniform Transfer for Minors Act are custodian accounts set up for minors by a donor, usually a parent or guardian. The donor is the custodian of the fund, but the donations are an irrevocable gift and must be used for the benefit of the minor. Further, custodianship terminates when the minor reaches the legal age (18 or 21 depending on the state of residence) and may be spent on whatever the beneficiary desires. As you might expect, UGMA/UTMAs are treated as student assets when making financial aid determinations.

Coverdell Education Savings Accounts (ESA)
An education savings account that is more flexible than an UGMA/UTMA, and unlike 529s, can be used for pre-college education expenses. HOWEVER, the ability to use Coverdell ESAs for pre-college expenses will expire at the end of 2010 unless Congress intervenes to preserve this feature. Two other things to note with Coverdell ESAs is that only $2,000 per year may be saved in a beneficiary's name, regardless of who owns the account or how many accounts exist for the beneficiary, and the government steps that limit down, ultimately to zero, starting with incomes of at least $190,000 per year for couples or $95,000 for single filers.

I would like to thank Jonah for taking the time to answer my questions. If you have any additional questions about Freshman Fund, please feel free to contact Jonah at jonah dot keegan at freshmanfund dot com, or 347-416-6498. Please note that he is not a financial advisor, so while he can provide information, he cannot make recommendations. For specific advice, please consult with a financial advisor or tax professional.

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