Personal Finance Advice

With tuition rates rising faster than inflation, saving for your child’s tuition can seem like a daunting prospect. The 529 plan was instituted in 1996 by the federal government to help families with this task. The 529 plan is an educational savings plan named after section 529 of the Internal Revenue Code. Changes to federal tax laws in 2001 and made permanent in 2006 have made the 529 Plan an increasingly popular tool for parents wishing to save for their child’s college education.

The popularity of the plan comes from the favorable tax benefits associated with it. All earnings within the plan are exempt from federal and state taxes. Qualified distributions made to the beneficiary of the plan are also tax exempt. Prior to 2001 these distributions were taxed at the beneficiary’s federal income tax rate.

Contributions of up to $300,000 can be made over the life of the plan per beneficiary with annual contributions subject to federal gift and estate tax laws. Individuals can contribute up to $12,000 annually per beneficiary or as much as $60,000 if a 5 year exclusionary period is taken without being subject to the gift tax. For couples who file a joint tax return these numbers rise to $24,000 and $120,000 respectively. If the 5 year exclusion is taken and the contributor dies within this period a pro-rated amount will revert back to them and be subject to federal estate tax laws.

There are two basic types of plans, either prepaid or savings. A prepaid plan is where you are able to purchase tuition credits based on today’s rates, where the number of semester or years purchased are guaranteed despite what happens to tuition rates in the future. A prepaid plan can either be administered by a state or educational institution. Obviously it’s difficult to determine where your child will enroll in the future so the value of the plan will be determined by the future tuition rates of the institution running the plan if the beneficiary goes to another school.

The other type of plan is a savings plan where value is determined by the underlying investments of the plan. A savings plan can only be administered by state institutions. This type of fund is usually professionally run by a financial institution like a mutual fund or investment firm. They tend to invest aggressively in the earlier phase of the plan but will shift to safer investment like fixed income securities as the beneficiary approaches their college years.

It can be difficult to choose which type of plan to take. Also each state offers their own distinct plan and it is important to note that you are not restricted to choosing the plan from your state of residency although there may be additional tax benefits for doing so. Be sure to sit down with your financial advisor to determine which course of action is best for your specific situation because the sooner you start planning for your child’s future the better off you will be.

In a speech yesterday to the New York Economic Club, Federal Reserve Chairman Ben S. Bernanke explains some of the underlying reasons for the nation’s current credit crunch.  While maintaining that he believes the overall banking system is quite healthy, the weakness in the home lending market has triggered investor concerns over risk for Mortgage Backed Securities.

He comments on how rising foreclosure rates especially in the sub prime market, although it is a relatively small segment of the overall financial market, has shaken investor confidence in Asset Backed Securities as a whole.  Banks and Mortgage institutions issue these securities that are backed by the cash flows by the monthly payments of the loans in order to raise funds to gain liquidity and originate more loans. 

With the financial markets tightening, there becomes less money in the system to loan out.  Last month the Federal Reserve took the aggressive move of cutting the federal funds rate by 50 basis points in order to increase liquidity in short term money markets even though other sectors of the economy remain strong.

He states that the lack of liquidity has intensified the current housing correction.  Since there are a glut of new homes on the market and people are not able to receive loans to purchase them, don’t expect demand to rise in the near future.

This has also had an effect on general economic growth as investment in new construction has slowed recently.  He warns that while conditions have improved somewhat, that investors will need time to gather more information and reevaluate risk before they are willing to reenter the market for these Asset Backed Securities.

The stock market is up, unemployment is down, so the economy is doing great right?  Well not quite. The housing market is still depressed which lead many analysts to believe that the Federal Reserve will once again lower interest rates after this weekend’s meetings even though they already lowered rates earlier this month. 

While this might lead you to believe that it’s a buyer’s market many experts are still predicting doom and think that housing prices will continue to fall for the foreseeable future.  Signs that point to this are the increasing supply of new homes from new home builders, as well as an upward surge in distressed properties on the market, as foreclosure rates have soared recently.  They argue that it will be cheaper to rent than to own for some time to come and that you’re better off investing those savings in the stock market.   They also predict banks will tighten their lending standards in the wake of these increased foreclosures.

So does this leave you discouraged at ever getting into that new home?  Well don’t be, despite all these facts, it still is the best opportunity people have had in years to realize their dream of owning property.    There are many tax credits available to first time home buyers and with the increased supply of homes on the market there are many good deals out there if you do careful research. 

If the rest of the economy continues to heat up don’t expect interest rates to continue to fall.  This golden opportunity won’t last forever.  If you have a steady income and a good credit rating don’t be afraid to jump into the housing market because as long as you’re not looking to make a fast buck, the real estate market remains a great long term investment.