College Investment Plans - Advantages & Disadvantages

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White wings echoing the greek phoenix myth of Rebirth Near Freedom tower in new york city

College Savings Plans have several advantages you should be aware of:

No Federal Taxes
After a new law called the Tax Relief Act of 2001 was enacted, you no longer have to pay federal taxes on the earnings on a College Savings Plan as long as you use it for qualified higher education expenses. This tax exemption will be in place from 2002 to 2010 when Congress will decided whether to extend the provision. In addition, in many states, you won’t have to pay state taxes if the withdrawals are for qualified expenses. This may not mean that much to you but we are sure your parents will appreciate its significance.

In some cases, coverage of your college costs are guaranteed. This is the case with prepaid plans which we discussed in another section.

No Income Limitations
Individuals at any income level can contribute to the plan. This means that if your parents make a lot of money, they can still open a College Savings Plan account for you.

Professional Money Management
You have professional money managers such as TIAA-CREF, Fidelity and others investing your money for you.

Low Minimum Investments
The minimum investment requirements are low—as low as $5 and you (or your parents) can invest as much as a few hundred thousand dollars in total. 


There are a few catches to these plans that investors should be aware of:

States Run Their Own Plans
Because the states run their own plans, they can set their own rules about the withdrawal of the money, they can change where they invest your money, they can change the fees they charge associated with participation in the plan, they can determine whether contributions to the plan are deductible from state taxes, or any other conditions that they wish to impose on the accounts. Each plan has its own participation terms and these terms can vary considerably from state to state.

Some plans are expensive because they charge you a sales fee, a yearly maintenance fee and a fee that goes to the investment managers (such as TIAA-CREF). For this reason, we strongly recommend that before selecting a particular plan, you make sure you know the fees that are associated with the plan. Watch out for sales load and annual expense ratios.

Investment Choices are Limited
In the plans with guaranteed returns, you can’t decide exactly how your money will be invested. In the age-based plans, you have slightly more flexibility in investment choices but you are still bound by pre-established investment guidelines.

Some Plans Have Terrible Track Records
Unfortunately, the track record of some College Savings Plans is terrible. True, many of these plans have been around for only four or five years so they haven't had a chance to recover from market downturns that caused the S&P 500 Index to yield returns of -23.4% in 2002 and -13.0% in 2001. The overall market downturns, however, don't make the poor returns easy to swallow.

You Can’t Move Your Money Around As Often As You Might Like
You can only move your money to a different plan once a year. So if you happen to invest in a dog of a plan, you are stuck for a whole year even while the value of your college savings are going down.

State Tax Exemption Not Assured
If you are investing in an out-of-state plan, you may not be exempt from state taxes (which some states offer on the earnings of the plan). Get all the facts before you invest in another state's College Savings Plan. Find out what disadvantage you may have as an out-of-state investor.