Annuity or 529 Plan

Being in the financial industry for about a decade and a half now I have from time to time come across a number of these self proclaimed “gurus” who tout annuities as a vehicle for college tuition saving in lieu of a 529 plan. This concept is marketed to insurance agents as a sales tool to increase business with a flock of new clients and promises commissions beyond their wildest dreams. Now, let’s take a moment to look at this premise and the pros and cons. An annuity basically is a financial contract designed to accept and grow funds from an individual and pay out a series of payments at a later date. There are a variety of different annuity products out there depending on what your particular needs are that can be very accommodating, but in the interest of time we’ll look at the basic concepts and comparison of annuities, 529 plans and Education Savings Accounts.

Annuities grow on a tax deferred basis however there is a surrender charge, which is a ten percent fee if there is a withdrawal made early. Typically the surrender charge decreases each year over a specified number of years. There are “no surrender annuities” which allow you to withdraw your interest earnings or up to 15% per year without a penalty although any withdrawal from an annuity may be subject to taxes. At fifty nine and a half you may take withdrawals with out a ten percent surrender charge and those withdrawals are taxed as ordinary income. If you withdraw prior to fifty nine and a half, one worst case scenario could be over 40% of your earnings going back to the federal government.

A 529 college savings plan could allow for contributions over $300k depending on the plan however contributions are gifts, so the $13k annual gift limit should be observed. Qualified distributions can be taken without federal income tax or penalty for tuition, books, fees, supplies, room and board, etc…Withdrawals used for expenses other than qualified education costs may be subject to federal and state taxes plus a ten percent penalty. Anyone who plans to attend an eligible postsecondary educational institution can be the beneficiary of a 529 plan. Investments into a 529 savings plan enjoy tax deferred compounding and there are no limitations on the age or income of the owner or beneficiary.

Finally, Education Savings Accounts or ESA’s can be used to pay qualified education expenses for a student in an accredited primary, secondary or post secondary vocational school. 529 assets can only be used to cover qualified higher education expenses. You can contribute $2,000.00 per year in all ESA’s for one beneficiary, however ESA’s offer a wider choice of investments than a 529 plan. ESA and 529 assets are treated as the owners therefor these assets have minimal impact on federal financial aid if the parent is the owner. However, if the child is the owner, the assets are included in the federal financial aid calculation.

An annuity is not likely to be a strong choice for most parents however there’s a small percentage of parents out there that may want to give it a second glanse. Parents who will be over the age of fifty nine and a half by the time their child starts college and who also expect to be in a moderately low tax bracket during the college years may want to put some thought into it. Comparing apples to apples, a 529 plan or an ESA is most likely your best bet to prepare for your child’s educational costs rather than an annuity. If you have a child or grandchild who is planning to attend college, I would recommend you sit down with a qualified financial planner to determine which financial choice is best for you.

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