The Motley Fool: Use 529 for college funding
To maximize savings for their children’s education while minimizing taxes, many folks are using Coverdell ESAs and custodial accounts. Here’s another good option: the 529 plan.
A 529 plan allows you to either prepay tuition for qualified colleges or save funds in a tax-free account to be used to pay higher education costs. You can do this for any child in your life — your kid, your grandkid, or the kid next door who mows your lawn. (If you’re going back to school, you can even set up a 529 plan for yourself!) You don’t necessarily have to live in the state of the plan that you choose, either.
529 plans allow you to sock away huge sums of money — more than $200,000 in some states — versus the maximum annual Coverdell ESA contribution of $2,000. Most 529 plans have no age or income limitations, so higher-bracket taxpayers can participate. Another big advantage is that the person who establishes the account decides when distributions may be taken.
There are no taxes on earnings in a 529 plan, so you can build a big war chest much faster than if you had to pay taxes on the investment gains and income every year. Though your contributions are not tax-deductible, when withdrawals (including earnings) are used to pay for qualified college expenses, they’re free of federal taxes.
There are some drawbacks to 529 plans. If the student doesn’t go to college, there may be a 10 percent penalty on the earnings, depending on the circumstances (though you can also change the beneficiary if that happens). Additionally, the funds in the 529 plan account are handled by plan administrators, not by you — which is actually a plus for some folks. Finally, once the money is in the plan, it must stay there or in another 529 plan.
Still, 529 plans are many people’s best bets. Some are much better than others, though. Learn more about them and other college financing topics at www.savingforcollege.com, www.collegeboard.com and www.fool.com/college.
Ask the Fool
Q: What does it mean when a company is said to be “stuffing the channel”? — J.E., Elizabeth City, N.C.
A: When a company stuffs the channel, it ships inventory ahead of schedule, filling its distribution channels with more products than are needed. Since companies often record sales as soon as they ship products, channel-stuffing can make it appear that business is booming. But if the products are not sold, they may end up being returned to the manufacturer. So sales already claimed may never occur.
To sniff out channel-stuffing, see if a company’s accounts receivable growth is outpacing sales growth. If so, that’s a red flag. Alternatively, calculate its “days sales outstanding” (DSO). First, divide the last four quarters’ revenues by 365. Then divide accounts receivable by the number you got. This reveals how many days’ worth of sales is represented by the current accounts receivable. Between 30 and 45 days is typical. You can also follow the same process for the last quarter, dividing last quarter’s revenues by 91.25 (days in a quarter, on average).
My dumbest investment
By sheer coincidence, I received a spam e-mail with a stock tip just one day after I signed up for a legitimate stock recommendation service. I didn’t pay as much attention as I should have and assumed the spam e-mail was legitimate. I sunk more than $17,000 into a penny stock at an average cost of $0.166 per share. It’s at less than half a penny per share as I write this, effectively turning my fat nest egg at age 21 into a paltry $500. But you learn from these things, I guess. I’ve been trying to learn more about investing ever since, and I hope to eventually make my money back and more! — Dave Selinger, Oklahoma City, Okla.
The Fool Responds: You’re smart to keep at it, though this was a painful lesson. Always avoid penny stocks — those trading for less than $5 per share — and do some digging into any company you’re considering.