Starting late

My little sister will be a high school senior next year. I want to invest some money for her college years. I don't know whether a 529 is the best option? If so, how do I determine which state's plan would be best? Obviously, I don't want to throw the money away, but I am willing to take some risk for chance of greater return. Of course, knowing who or what has the best track record would be great. Looking for any intelligent and useful guidance!

First, I want to commend you on your desire to help your sister. Don't read anything I write as anything other than trying to help you through some thoughts.

I am not sure a 529 is the right vehicle. With a 529 you are, effectively, paying a slightly higher fee structure with limitations on investment flexibility in order to gain federal and state tax advantages. The tax advantages are of significance the longer the account is open and the higher your tax bracket (as well, of course, as the level of earnings realized within the vehicle). Given the short time frame you are considering, it may not be the most cost- or return-effective approach for your circumstances.

Also, using a 529 (or Coverdell, even) may impact your sister's ability (and/or your parents) to claim other federal tax advantages - including the Hope and/or Lifetime Learning tax credits.

If you then decide to simply save money in a taxable account and provide her with cash or equivalents while she is in school, be aware of the possible impact on her financial aid eligibility. I may be mistaken (so be sure to verify this) but any money that is given to student from somebody other than the parents or spouse is currently considered, by the FAFSA guidelines, to be a resource that will reduce financial aid in the next year on a dollar-for-dollar basis. For example, if your sister qualifies for $10,000 of need-based aid in her freshman year and you give her $2000, then she is required to indicate that $2K on her FAFSA for the next year, which will reduce her need to $8K, everything else being equal. I am sure that people generally ignore this, but you do so at your own peril (or hers, rather), and I wanted to make you aware of this consideration. The workaround is that you provide money only in her last 1-1/2 years, so it won't show up on the FAFSA and affect her.

In other words, you want to be sure that - however you do it - you coordinate with her regarding other payment and financial aid sources.

I hope this is of some help/interest.

TJ

Thank you to the person who responded to my question. For anyone out there, do you know if TJ NC is correct about mmy contributions counting against any financial aid package (other than scholarships) my sister might receive? I know I can give her $10,000 (perhaps an old figure) as a gift, tax free. Does any gift count toward aid package determination? I may not even know how much I will provide in a given year.

Obviously, I want whatever I give her to be a contribution and not a penalty against her. Is there an advisable way to make the contribution? Anyone have other investment suggestions?

Also, can 529 funds be used for graduate study?

Where can I learn further information on the tax credits?

See IRS Publication 970 for information on the tax credits and other federal tax benefits for higher education.

529s can definitely be used for graduate school.

You should be able to find the FAFSA, including instructions, somewhere on this site: www.fafsa.ed.gov.

TJ