SAVING FOR college? Want a tax break? States are now offering two different types of tuition plans that accumulate money tax-deferred. If you don't like the plan in your own state, look for a better one somewhere else.
The newest plans -- called savings plans -- invest your college money in stocks, bonds or mutual funds. They're best for families willing to gamble on long-term gains in stocks.
The older plans -- called prepaid tuition plans -- guarantee enough money to cover future tuition at your state's public colleges or universities. They're for families that seek certainty. Tuition always will be paid, no matter what happens to stocks.
When you use your plan to pay for college, the federal government taxes the gains as ordinary income. But they're taxed in your child's bracket, which is probably only 15 percent.
Most states don't tax the gain at all, as long as you're a resident. Some states also let you tax-deduct the money you put in. (You lose the state tax break, however, if you move to another state or invest in an out-of-state plan.)
So far, nearly 847,800 children are enrolled. Here's how the two college plans work:
Savings plans. You put a lump sum into the plan, or sign up to pay in installments as small as $25 or $50 a month.
You're betting that the investment results will exceed the college inflation rate, which is currently running at around 4 percent for state colleges and universities and 5 percent for private schools.
You can apply the money to any higher-education expense -- tuition, fees, books, room, board -- at a school in any state. The account can be switched to another child, if the first one isn't interested.
Savings plans are currently offered by 15 states. Seven more will start in 1999, with a eighth scheduled for 2000.
Some state plans accept you only if the student or parent is a resident. Anyone can join, however, in the following states: Connecticut, Delaware, Indiana, Iowa, New Hampshire, New York and Rhode Island; also California, when its plan opens for business this summer.
With savings plans, what matters most is the state's investment strategy. Be sure to ask how the funds are divided between stocks and bonds.
Two states, Louisiana and Kentucky, buy mostly bonds, so their returns are relatively low. Some states offer balanced funds -- say, 60 percent in stocks, 40 percent in bonds.
A few states invest aggressively when your child is young and conservatively by the time college starts.
For example, take New Hampshire (603-271-2621) and Delaware (800-292-7935), two of the states whose tuition plans are open to all. The money is run by the big Fidelity organization of Boston and invested in its mutual funds. For newborns, 88 percent of the money goes into stocks. By the time college starts, however, your money is mostly in bonds and money market funds.
New York is more conservative, starting newborns with 55 percent stock (up to 75 percent next year). Its plan, also open to all, is run by the giant teachers' pension fund, TIAA-CREF, and charges lower fees than Fidelity does (call toll-free 877-697-2837).
You must use plan money for higher education. If used for other purposes, it's taxed in your bracket, not your child's.
You also face varying withdrawal fees and penalties (often, 10 percent to 20 percent of the gain).
Prepaid tuition plans. Here, the money you pay into the plan is guaranteed to cover a fixed portion of the tuition, generally at a state-run school, when your child matriculates. Florida also lets you prepay room and board.
You're not tied to state schools. A similar amount can generally be transferred to a private college or an out-of-state school. (For nonparticipating schools, Massachusetts refunds what you put in, plus the consumer inflation rate.)
To join most of the prepaid plans, offered by 18 states, including Maryland, the donor or child has to be a state resident.
The effective rate of return on your money equals the future rise in tuition costs. For example, if tuition rises by 5 percent, you'll have a 5 percent return. There are varying fees and penalties, if you withdraw the money for other purposes.
For details on each state's prepaid or savings plan, check www.collegesavings.org or call toll-free 877-277-6496.
One warning: The savings reduce your eligibility for student aid, says financial planner Raymond Loewe, president of College Money in Marlton, N.J.
But most of the aid would have to come in the form of loans. You're better off saving in advance.
Washington Post Writers Group
States with functioning savings plans in 1998: Arizona, Connecticut, Delaware, Indiana, Iowa, Kentucky, Louisiana, Montana, New Hampshire, New Jersey, New York, North Carolina, Rhode Island, Utah, Wisconsin.
States with savings plans due in 1999: California, Minnesota, Missouri, New Mexico, Oklahoma, Vermont. Savings plan due in 2000: Oregon.
States with functioning prepaid tuition plans in 1998: Alabama, Alaska, Colorado, Florida, Illinois, Maryland, Massachusetts, Michigan, Mississippi, Nevada, Ohio, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, Washington, West Virginia, District of Columbia.
A prepaid tuition plan plus savings plan due in February: Maine
Pub Date: 1/18/99