529 Plan a good bet for college

Saving for a college education is a daunting task, especially with many schools already charging more than $20,000 per year. To maximize savings while minimizing taxes, many folks are using Coverdell IRAs (formerly known as Education IRAs) and custodial accounts. There’s also a (relatively) new option you should consider: 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.

A 529 Plan allows you to sock away huge sums of money — more than $200,000 in some states — vs. the maximum annual Coverdell IRA contribution of $2,000. Most 529 Plans have no age or income limitations, so higher-bracket taxpayers can participate. Another advantage is that the person who establishes the account decides when distributions may be taken.

Also, 529 Plan earnings aren’t taxed, 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. When the money is used to pay for qualified college expenses, the earnings are federal tax-free! (This is true through 2010, at least.)

There are some drawbacks to 529 Plans, though. If the student doesn’t go to college, there may be a 10 percent penalty on the earnings, depending on the circumstances. Additionally, the funds in the 529 Plan account are managed 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 at www.savingforcollege.com, www.collegeboard.com, www.fool.com/college and “The Motley Fool’s Guide to Paying for School” (Motley Fool, $12.50) by Robert Brokamp.

Ask the Fool

Q: Can I give single shares of stock as holiday gifts? If so, how? — T.D., Oradell, N.J.

A: This is a wonderful gift idea that could transform your loved ones’ financial futures.

There are several Web sites where you can buy one share of a stock as a gift. Examples include www.registerstock.com, www.oneshare.com and www.frameastock.com. It’s not the smartest way to invest for yourself, though, as you might end up paying $15 or more in fees to buy one $30 share of stock (that would put you down 50 percent from the get-go). But if it’s a gift, then the recipient ends up with a $30 stock that might be worth $60 or more one day. It sure beats giving a sweater that never gets worn.

If you’re buying stock for yourself, take commissions and fees into account. Try to not pay more than 2 percent or 3 percent of an investment’s value in fees. (For a $500 investment, that would be $10 or $15.) Learn more about how to invest very effectively with just a few dollars via direct investment plans or dividend reinvestment plans (DRIPs) at www.dripcentral.com and www.fool.com/School/DRIPs.htm.

Q: What is the Federal Reserve? — C.Y., Martinsville, Ind.

A: Founded by Congress in 1913, it’s the central bank of the United States. In its own words, the Fed’s duty is “conducting the nation’s monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices; promoting the stability of the financial system; providing banking services to depository institutions and to the federal government; and ensuring that consumers receive adequate information and fair treatment in their interactions with the banking system.” Learn more at www.federalreserve.gov.

My dumbest investment

In the early ‘80s, I thought I’d get rich on options. I bought a “call” on Kerr-McGee on the sole recommendation of a golden-tongued snake at a brokerage firm. I should have done the opposite and bought a “put.” The stock hit the floor and I lost my wad. Next, I left my investments with a highly touted stock adviser. Since 2000, my portfolio has been hemorrhaging. It boasts a very impressive list of large-cap stocks, but very few shares of each, with lots of trading done each month. I made the brokerage a lot of money! After losing about 60 grand, I think I can do better with The Motley Fool and some more studying. — Ken, Richmond, Utah

The Fool Responds: As you learned, options can be tricky, and many brokers and advisers are not looking out for your best interests. That’s why we’ve long urged people to learn more and take control of their finances. No one has your best interests at heart more than you do. That said, there are some great advisers out there who can guide you. Learn how to find them at www.fool.com/fa/finadvice.htm and www.sec.gov/investor/brokers.htm.