TCS Daily

Tech Investing for College

By James Freeman - April 19, 2001 12:00 AM

How can you finance a college education for your rugrats? Doing the math for just one child can be fairly intimidating. And for those of you raising a whole tribe of young'uns, it gets downright scary. Tuition and fees at America's 4,000 colleges and universities continue to increase faster than inflation.

The good news is that plenty of investment options exist, including ventures into tech stocks. The bad news for ambitious families is that prices at expensive private colleges are growing even faster than the average, even as college endowments climb into the stratosphere.

Last year, Williams College received public kudos for announcing that there would be no tuition increase this year. That might sound like a step in the right direction, but when you find out that tuition, fees, room and board for a year at Williams already add up to $31,520, you're a little less impressed by the gesture. At Harvard the annual tab is almost $35,000. That's right -- $140,000 to provide a college education for one child.

Why Harvard still charges tuition at all when it's sitting on an endowment of roughly $14 billion is a question for another day. Today the question is how to afford college education for your children.

The latest rage in college saving is to invest in a state-sponsored 529 plan, labeled for the section in the U.S. Code that allows for tax-deferred college savings. (Learn about your state's plan at You open a 529 account in your child's name and then parents, grandparents and anyone else who wants to help are each allowed to contribute up to $10,000 per year without triggering gift taxes. Many of these plans have limits on the total amount to be contributed, but the limits are generally fairly high -- $100,000, for example. Many states also offer tax deductions for some of these contributions.

Once the money is deposited, it can grow tax-free until it's withdrawn to pay for college or grad school, at which time it will be taxed at your child's low rate. Your kid controls the money, but can only use it for legitimate higher education expenses. And the 529 plans are not like the pre-paid tuition plans you may have seen. Your kid doesn't have to go to a school in-state - the money can pay for any accredited institution. In fact, you don't even have to invest in your own state's 529 plan, although you'll probably sacrifice some of the tax benefits if you go elsewhere.

Look before you leap into a 529. You have to invest the money in mutual funds selected by the state government. And in many states, that means you have to invest most or all of the money in bond funds. If your child is still in diapers, this is a terrible idea. Tax avoidance is great, but you're still fortunate to earn 8% per year investing in bonds vs. a typical 12% annual return with stock investments. Committing to bonds is not worth the tax advantage, especially if you're a buy-and-hold investor who naturally defers many of the capital gains taxes anyway.

If you have 10 years or more until college begins, you're better off investing in stocks in your own account and paying taxes as you go. Want to minimize the tax bill on income and capital gains? Invest in great tech companies, which tend to pay little or no dividends, and then hold them until your kid is ready to enroll.

Contributing to a 529 also means that you can't take advantage of the best deal in college savings -- an Education IRA for each of your children. With an E-IRA, you can only invest $500 per year in each account, but both the annual earnings and the withdrawals for higher education expenses are tax-free. Your child can't receive money in both 529 and E-IRA accounts in the same year, so you have to choose one or the other. Especially if you're saving for a less expensive state school, the E-IRA is a valuable tool. (There are income limits for E-IRA donors, so check with your broker to be sure you qualify.)

California's 529 plan now offers an all-equity fund that's worth considering, but again, if you don't live in California you won't enjoy all the tax benefits. Another way to go, if you trust your child, is to set up a custodial account in her name under the Uniform Gifts (or Transfers) to Minors Act (UGMA/UTMA), to which people can contribute up to $10,000 each year without gift taxes. The risk is that when she turns 18 or 21, depending on the state, she can blow the money on a winter in Vail. But with a portfolio heavily invested in stocks, taxed at her low rate, the college money can grow impressively.

James Freeman writes on personal finance and technology investing.


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