Parent May Find College Savings Plan Is Better Choice Than Education IRA

Q I read with interest your article on college savings plans, which allow parents and others to contribute money that grows tax-deferred for their children’s educations. Am I allowed to contribute to this as well as an education IRA? My kids are 11 and 13, and I have been contributing to an education IRA for the last two years.

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A No, you can’t contribute to both in the same year, and yes, a college savings plan would probably be a better option.

Education IRAs have significant disadvantages. First, you aren’t allowed to contribute more than $500 a year for each child, a sum that will barely cover Junior’s pizza and beer expenses at Wossamotta U. By contrast, contribution limits for state-run college savings plans tend to be quite high--depending on the plan, you could conceivably contribute more than $100,000 in a single year.

Second, in any year you take a withdrawal from an education IRA, you aren’t allowed to take a Hope or Lifetime Learning tax credit. These are valuable credits for middle-income families who will need every break they can get once they start facing college tuition bills.

College savings plans do have some disadvantages compared with education IRAs. Withdrawals from the plans for qualified education expenses are taxable at the student’s rate, whereas education IRA withdrawals for college are tax-free. Also, you, the contributor, control the investments in an education IRA, while college savings plans offer less choice.

There are other ways to save for college as well, such as custodial accounts or simply investing in taxable accounts on your own. Which is best for you depends on many factors, from your family’s income level to your desire for control. It might be worth chatting with a tax preparer who is knowledgeable about your situation, and about college savings plans, to see which option fits your particular bill.

Challenging Notion of Paying Debts

Q I strongly disagree with your advice in your July 23 column given to the single parent with overwhelming debt. You had recommended trying to pay off her bills rather than filing for bankruptcy protection. Bottom line, although a bankruptcy stays on your credit report for 10 years, one’s credit is usually only seriously ostracized for three to four years. In your scenario, the single parent would still have to pay off $30,000 in bills (a nightmare, even with no interest).

Much more financially prudent is to take advantage of bankruptcy protection laws, which are in place to protect individuals in over their heads with credit. She could then teach her daughter the value of prudent problem-solving as opposed to perpetuating years of middle-class poverty just to be able to boast “responsibility” and “self-reliance.” I sincerely hope you are not deeming anyone who files for bankruptcy protection de facto irresponsible.

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A Not anyone, just someone who would use the bankruptcy protection laws to dodge bills she could otherwise pay--or someone who would advise others to do so.

I’m going to guess this argument is wasted on someone who would put quote marks around the virtues of responsibility and self-reliance, but here it goes anyway: Money, possessions and debt are all fleeting. Our only real possession is our integrity. Preserving that should be worth some hardship.

Sometimes bankruptcy is the best of bad options, and it’s entirely possible this woman will find she has little choice but to file. But bankruptcy shouldn’t be used as a first resort or as just another tool to maintain a certain standard of living. That’s why I suggested she contact the nonprofit Consumer Credit Counseling Service in her area to see if it’s possible to set up a repayment plan that could work for her. Although such a debt repayment plan could negatively affect her credit, the impact would not be as bad or as lasting as a bankruptcy.

If you think I’m being too harsh, check out the following response from another reader.

Bankruptcy’s Burden on Public

Q I just finished reading your July 23 column and was very happy to read that you discouraged the single mother from filing bankruptcy. But I believe you did so for the wrong reasons. She may pay a higher rate on her next car, not get a certain job, have to prolong retirement and have a mark on her record for 10 years if she declares bankruptcy, but these pale in comparison to the burden that she (and thousands of others) puts on all consumers because of her irresponsibility. This woman’s debt is directly related to decisions and actions that have been made in her life, and she should be penalized.

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APerhaps we should reinstate debtors prisons . . . or maybe public stockades?

Yes, we all pay some price for bankruptcy but perhaps less than you think. Lenders are getting better at pricing credit so that those at higher risk of default pay more than the rest of us.

Many bankruptcies are preceded by catastrophic events, such as a job loss. This woman’s finances were sent over the edge by a custody battle. True, many bankruptcies could be avoided if people maintained emergency funds, but bankruptcy courts are still a needed relief valve so that people aren’t saddled for a lifetime with unpayable debts.

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E-mail Liz Pulliam Weston at [email protected] or mail her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012.