Retirement & Financial Planning Report

When you’re saving for your children’s college education, 529 plans offer some outstanding tax advantages. Investment buildup is tax-free and withdrawals may be tax-free, too. That will be the case each year that you spend at least as much on higher education costs as you withdraw from the 529 plan.


There are drawbacks, though:

* Limited investment options. You must choose from the menu that’s offered. If you’re an active investor, you may prefer to put together your own portfolio to fund education bills.

* Limited access. If you need the money in a 529 account for non-educational purposes, you might owe income tax plus a 10 percent penalty on withdrawn earnings.

* Tax complexity. The definition of "adjusted qualified higher education expenses," and the accompanying explanation, takes up nearly a page in IRS Publication 970.


Therefore, you might want to use 529 plans along with your own investments as part of a diversified strategy for college savings.

Consider these strategies:


* Buy individual stocks. If you hold several stocks, you can decide which stocks to sell, when needed for college bills. That will put you in control of the investments used for your children’s education.

If you sell appreciated stocks held more than a year, you’ll owe tax at a low rate. You may be able to take losses on other stocks, to reduce the tax you’ll owe each year. Thus, managing your own college fund might not be very taxing.

* Use tax-managed mutual funds and exchange-traded funds. These funds usually won’t generate much in the way of taxes, until you need to take gains to pay college bills. Again, you’ll be in control of your family’s education finances and you’ll have access to the money, if you need it for other purposes.

Just as you should hold a diversified investment portfolio, for better long-term results, the same principle can be applied to education funding. You shouldn’t load up on one strategy, whether it’s a 529 plan or a do-it-yourself stock portfolio. Instead, you might want to put some money into 529 plans, some into stocks, and some into tax-efficient funds.