feature
Selecting an
Education Savings Plan
I
n addition to retirement, one of the most prevalent long-term financial goals is
or her college expenses, it’s essential to begin investing as early as possible. With
education costs rising every year, you want to be sure your assets have the maximum
amount of time to achieve their potential growth,” says Greg Rego, CFP®, a financial
planner with T. Rowe Price.
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I L L U S T R AT I O N B Y G R E G PA P R O C K I
saving for a child’s education. “If you’re interested in helping your child meet his
Two popular investment choices for education
savings—529 plans and Education Savings Accounts
(ESAs)—may help boost your investments by providing
tax-free growth potential in addition to other possible
tax advantages. “These are two distinct savings options,
both with unique features, benefits, and a range of
investments designed to help meet education savings
goals,” notes Rego. “Understanding the benefits and
considerations of each is the first step to selecting the
option that’s best for you.”
will be paid in full at the time of registration, and their
monetary values can typically be used at public or
private colleges in or out of state. In general, qualified
withdrawals from a prepaid tuition plan are restricted
to tuition and mandatory fees.
Savings plans allow individuals to set aside assets
(up to $250,000 or more, depending on the plan) in a
professionally managed account where proceeds can be
used at virtually any institution of higher learning in the
U.S. In addition to tuition and any fees, qualified educational expenses for 529 savings plans generally include
room and board, books, equipment, and other supplies
at a college, university, or graduate school.
Any earnings grow tax-deferred, and qualified
withdrawals are federal income tax-free. Earnings
on a distribution not used for qualified education
expenses may be subject to income taxes and a 10%
federal penalty.
529 Plans
Taking their name from the section of the Internal
Revenue Code that created them, 529 plans are taxdeferred accounts usually sponsored by a state and
managed by an investment firm. The plans come in
two varieties—prepaid tuition plans and savings plans.
(Please note that the availability of tax or other benefits
may be conditioned on meeting certain requirements
such as residency, purpose for or timing of distributions,
or other factors, as applicable.)
Prepaid tuition plans allow individuals to pay for
future education at discounted rates set today. These
plans generally provide that some education expenses
529 Advantages:
• Tax-Free Investing: Any growth of investments in a
529 plan is tax-deferred, and contributions and earnings
can be withdrawn federal tax-free as long as the money
is used to pay for qualified higher-education expenses.
Saving a little more each month can make a difference
No matter which college account you choose, it’s a good idea to start investing early to give your contributions
more time to grow. The chart below illustrates the potential tax-deferred growth you could expect over a 15-year
period, given various monthly contribution amounts.
$80,000
70,000
$69,208
$200 Monthly Contribution*
60,000
$100 Monthly Contribution
50,000
$50 Monthly Contribution
40,000
$34,604
30,000
20,000
$17,302
10,000
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
YEARS
The chart above assumes an 8% hypothetical rate of return compounded monthly. This chart is for illustrative purposes only. It does not
represent the return earned by any specific investment option. Investment returns will vary and may be higher or lower than in this example.
*The maximum annual contribution to an Education Savings Account for each beneficiary is $2,000.
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• Potential State Tax Deduction: Depending on your
state of residence, you may be able to deduct instate 529 plan contributions from your state income
taxes. If so, and depending on the other plan features, such as account fees and sales options, your
state’s plan may be your best option. If your state
does not offer a deduction, then consider plans
from other states that offer a wide range of investment options and a low fee structure. Please note
that state tax benefits are generally only available
to residents of that state; however, a few states are
now offering a deduction to residents for any 529
plan contributions, not just for contributions made
to the in-state plan.
• Account Holder Control: As the account holder, you
control how the money is invested, when withdrawals are taken, and for what purpose. The plans also
allow you to reclaim the funds for yourself anytime
you want. Of course, you will have to pay appropriate
taxes and penalties if the plan assets are not used for
qualified educational expenses.
• Beneficiary Flexibility: Most 529 plans will allow
you to change beneficiaries. So, if your child decides
not to attend college, you can transfer the 529 plan
account to a new beneficiary who is a family member
of the beneficiary, such as a sibling, first cousin, or
certain step-relatives.
• No Income Limit: There are no income limitations or
age restrictions on who can contribute to a 529 plan.
Education Savings
Options From
T. Rowe Price
T. Rowe Price currently offers Education Savings
Accounts (ESAs) and manages three 529 plans:
The T. Rowe Price College Savings Plan, the
Maryland College Investment Plan, and the
University of Alaska College Savings Plan. Visit
troweprice.com/college or call 1-800-401-1819 for
additional information.
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529 Considerations:
• College Only: As a tax-advantaged account, if, for
any reason, you decide not to use the funds for
qualified college expenses, taxes and penalties
may apply.
• Investment Choices: 529 investors typically have
a choice between enrollment-based and static
mutual funds or portfolios offered by the plan.
Enrollment-based portfolio allocations are professionally managed and become increasingly more
conservative as the child nears expected college
age. Static portfolios, on the other hand, maintain a
consistent asset allocation in a variety of equity and
fixed-income funds.
• Performance and Fees: Be sure to check performance and fees when you look for a 529 plan. These
factors can affect the amount of money that will ultimately be available for use.
Call 1-800-401-1819 or visit troweprice.com/college
to request a Plan Disclosure Document for any of the
529 plans that T. Rowe Price manages. Each 529 Plan
Disclosure Document includes investment objectives,
risks, fees, expenses, and other information that you
should read and consider carefully before investing.
Please consider, before investing, whether your or your
beneficiary’s home state offers any state tax or other
benefits that are only available for investments in that
state’s plan. T. Rowe Price Investment Services, Inc.,
distributor/underwriter.
Education Savings Accounts
Unlike 529 plans, ESAs can be used to pay for
expenses from kindergarten through grade 12, in
addition to college. However, there are income
restrictions on who can contribute. Additionally, total
contributions on behalf of a single beneficiary are
capped at $2,000 per year.
As with a 529 plan, any money placed into an ESA
is allowed to grow tax-deferred, and contributions
and earnings can be withdrawn free of federal taxes
as long as the money is used for qualified educational
expenses, including tuition, room and board, books,
supplies, tutoring, uniforms, transportation, and certain computer technology or equipment. Assets used
for other purposes will be subject to the same penalties noted for nonqualified 529 plan withdrawals.
SEPTEMBER 2006
Selecting an Education Savings Plan
ESA Advantages:
• Investment Flexibility: An ESA can be easily opened
through many financial institutions. You can then
invest the money as you like—mutual funds, stocks,
bonds, cash, etc.—and you are free to change your
investments at any time.
• Elementary and Secondary Schools: ESAs are a
tax-advantaged choice when saving for elementary or
secondary private school expenses.
• Beneficiary Flexibility: The same rules generally
apply to an ESA as to a 529 plan.
While college expenses continue to rise, it’s important to know that there are investment vehicles available
to help you afford educational costs for your child. The
key is starting early and allocating your assets to maximize any growth and minimize the expenses and taxes
that could lower your returns. “A thorough evaluation
of your education savings needs and careful investment plan selection can bring you closer to achieving
your financial goals,” concludes Rego.
ESA Considerations:
• $2,000 Annual Contribution Limit: For any one student, contributions to all ESAs from all sources, such
as parents and grandparents, cannot exceed $2,000
per year. As a result, many families may still have to
look at additional college savings options in order to
fully fund their goal.
• Income Limitations: To make the full $2,000 contribution to an ESA, your income has to fall within a
certain range. Currently, this range is up to $95,000
for a single filer and $190,000 for married couples
filing jointly. A partial contribution is allowed for
incomes up to $110,000 and $220,000, respectively.
• Account Holder Control: The custodian or authorized person typically maintains account control
until the child reaches the age of majority—18 or
21, depending on the state and rules for that ESA. At
this point, most investment firms allow the parent to
choose whether to relinquish control of the account
to the child.
• Age Restriction: Any assets in an ESA must be distributed within 30 days after the beneficiary reaches
age 30.
Navigating Your Choices
When selecting the most appropriate education savings option, it helps to identify the account features
that are most important to you. For example, if you
want to fund an elementary or secondary education at
a private school, an ESA would be applicable (if your
income permits). If you are saving for college with
more than $2,000 per year to invest, a 529 plan may
be more effective. The Education Savings sidebar to
the right can help you determine whether a 529 plan
or ESA would meet your needs.
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Education Savings
529 Plans
• Contribution limits up to $250,000 or more,
depending on the plan.
• Distributions are free of federal income tax if
used for qualified college expenses.
• Account holder makes all decisions regarding
the plan.
• Beneficiary can be changed to a relative of
the child.
• Penalties apply when not used for qualified
education expenses.
• No income limitations or age restrictions on
who can contribute.
ESAs
• Maximum $2,000 annual contribution per
beneficiary.
• Distributions are free of federal income tax if
used for qualified education expenses.
• Authorized person makes all accounts decisions,
although the beneficiary may gain control of the
account at the age of the majority.
• Beneficiary can be changed to a relative of
the child.
• Penalties apply when not used for qualified
education expenses.
• Your income must fall within a certain range to
contribute to an ESA.
• Account assets must be used by beneficiary’s
30th birthday.
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