College Savings Plans More Flexible Than You May Think

New figures show that a growing number of adults age 30 and older are seeking higher education. The National Center of Education Statistics reports a sixteen percent rise in enrollment between 2007 and 2009. Meanwhile, the cost of a four year degree has shot up by 72 percent in the past decade. In tough economic times, many would-be students are looking for ways to afford a tertiary education. A 529 Savings Plan is one option. In this week's "Money Coach" conversation, host Michel Martin discusses the flexibility of a 529 Savings Plan with freelance reporter for the Wall Street Journal, Jaime Levy Pessin.

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MICHEL MARTIN, host:

I'm Michel Martin and this is TELL ME MORE from NPR News.

Coming up, a look into the pages of The Washington Post magazine. Education was the focus this week. We'll hear about how a Catholic school that was losing enrollment found new life as a classics-focused charter school. That conversation is coming up later.

But, first, our weekly talk about personal finance. Today: paying for college. Now, college enrollment has steadily increased over the past decade, especially among adults. But at the same time, tuition costs have soared at a much faster rate. According to the College Board Advocacy and Policy Center, the average tuition at private four-year colleges has increased by 34.5 percent since the year 2000. And tuition at public four-year institutions is a staggering 72 percent higher than it was 10 years ago.

Now, to prepare these higher costs, more people are looking for ways to finance education and one of the most effective options is the 529 savings plan. That's a plan that provides tax incentives to put aside money for college. But what many people may not know is that 529s can also be used for adults. Here to tell us more is Jaime Levy Pessin. She's a freelance financial journalist who recently reported on this for The Wall Street Journal. Jaime, thanks so much for joining us.

Ms. JAIME LEVY PESSIN (Financial Journalist): Thank you for having me.

MARTIN: Now, a lot of people have probably heard the term, you know, a 529. They probably heard that term sort of bandied about. So, just set the table for us, if you would. And just tell us exactly what a 529 is and how this maybe differs from other savings accounts that people might have heard about.

Ms. PESSIN: Sure thing. A 529 plan is basically an account where you can invest money that you've set aside for higher education. You can put that money aside for yourself or for someone you know. It's typically a family member. So the advantage to using one is that you don't pay taxes on the earnings or when you take the money out, assuming it goes to tuition or fees or books for the person who's considered the beneficiary of the account.

MARTIN: Now, do you use pre-tax dollars or post-tax dollars? I mean, is it like something where you - the money that you put into the 529, you don't pay taxes on the money that you put in or is it just that you don't pay taxes on the earnings?

Ms. PESSIN: You don't pay taxes on the earnings. I mean, if you're putting your money away for, you know, 15 years, you could see quite a big increase in what you put in.

MARTIN: Is there any downside to a 529?

Ms. PESSIN: It depends on how you consider the downside. If you take the money out and you don't end up using it for higher education-related expenses, you may be hit with a tax penalty of 10 percent on the earnings, in addition to whatever other taxes you might pay.

But that said, you know, if you have another child or another relative, or even if you want to transfer the money back into your own name so that you can go back to school later in life, you know, you can transfer it around and not have any of those taxes or penalties associated with it.

MARTIN: What kinds of earnings, though, can you get? I mean, I think one question that a lot of people would have is, is my money better off in a 529 plan or is it better off in, say, a mutual fund where I might actually come up with more money for college later on?

Ms. PESSIN: Well, the 529 plans are invested in various funds. It's not a savings account, you know, in the sense of, you know, you're going to earn three percent the whole time. You're putting your money into a variety of funds when you do that.

Like, for example, like a really popular way to invest money in a 529 has to do with pegging it to when your child is expected to start college. I have a two-year-old at home, so he's going to start college hopefully sometime around 2026, but then it'll cost me probably about 300,000 to send him to a four-year school, which is kind of scary.

But one thing I could do is, you know, if I open a 529, I could choose the investment option that would invest really aggressively now for the next, you know, say, 10 years. And then when I'm starting to be about five years away, kind of taper that risk down. The last thing you want to happen is to invest in the stock market two years from when your kid's going to start school and lose all your money.

MARTIN: Well, that was my other question, though. There is still a possibility that you could lose the money. This is not guaranteed in the same way that a savings account up to $100,000 is guaranteeing.

Ms. PESSIN: No, but what's interesting is that some of the states have now added an FDIC option to the 529 plan, so when you get that, say, five years out or whatever, you can transfer your money into, you know, just a much more conservative, essentially, savings account.

MARTIN: And you also reported that one thing that many people may not know is that you can transfer the account to another person, assuming that the money is still used for educational purposes. And I think that's something many people may not know, including another adult, or to yourself, if you want to go back to school.

Ms. PESSIN: That's right. Now, the transfers are limited to a relative of the beneficiary. So, in the most typical situation, you know, you're setting these accounts up for your children or your grandchildren. So that means that you can transfer the money to another grandchild or, you know, your second child or, I believe, a niece, nephew.

MARTIN: And, finally, is there a common mistake that people make when they invest in a 529 plan? Is there something that people should be careful to avoid?

Ms. PESSIN: Well, one of the most common mistakes I learned about when I was reporting this story, it has to do with when you're taking the money out of your 529 account. It's very easy to get tripped up between the academic year and the calendar year. The IRS wants you take out the money from your 529 in the same year that you're writing the tuition check, which means that a lot of people around December want to start taking out that 529 money in order to pay January, you know, second semester tuition. That's a big mistake.

Make sure that if you're taking the money out one year, you're actually writing the check in the same year. You could either take out the money in December, or you could take out the money and, you know, January 1st, and write the check January 1st. But don't take out the money in December 22nd and write the check January 1st.

MARTIN: I see. OK. So you got to make sure that it's very clear that that money is going to pay for educational expenses in the same year in which those expenses are incurred.

Ms. PESSIN: Correct.

MARTIN: OK. Jaime Levy Pessin is a freelance financial journalist and she wrote about 529 plans for The Wall Street Journal and she was kind enough to join us from our studios in New York. Jaime, thanks so much for joining us.

Ms. PESSIN: Thank you.

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