529s are a good way to save for college

Staying Ahead

January 16, 2000|By Jane Bryant Quinn | Jane Bryant Quinn,Washington Post Writers Group

IF YOU HAVEN'T yet heard about state Section 529 savings plans, listen up. They're a great way for parents or grandparents to build a college fund.

These plans drip with income-tax and estate-tax breaks, and offer a potential for gain that older college plans can't touch. Many top plans are open to residents of any state.

Until recently, 529s were marketed by the states themselves or by two no-load mutual fund groups -- Fidelity and TIAA-CREF -- that some states have hired to manage their money.

Brokers and financial planners who work for commissions weren't paid to sell 529s, so they steered your college money somewhere else.

Now, two big brokerage firms are also in the game, selling state 529 plans to a national clientele. Merrill Lynch & Co. hitched up with Maine's NextGen program. Salomon Smith Barney has Colorado's Scholars Choice plan, and will soon offer West Virginia's plan.

This creates an army of brokers prepared to tout this new form of investing to the public. Commercial sales should help get more people talking about 529s.

State 529 plans (the name refers to a section of the IRS Code) were authorized by Congress in 1996. You can invest lump sums or make regular monthly contributions. The plans come in two forms: A prepaid tuition plan. The conservative choice. These plans guarantee that the money you save today will match the growth in tuition inflation at state-run colleges. Currently, that's an effective 3.4 percent return. You can also use the money for tuition at out-of-state schools.

A college-savings plan. Here, you contribute to an investment pool that has the potential of rising faster than the college-inflation rate (although there's no guarantee).

Savings plans are currently offered by 23 states, with nine more starting up this year. If your state doesn't have a savings plan, or has one with unattractive features, you can join one in another state.

A few states keep your money in bonds, but most provide a mix of stocks and bonds. A typical 529 account leans heavily toward stocks when the child is young, then moves automatically toward safer bonds and money-market funds as college draws near.

Some states give you a choice of accounts. Maine, for example, offers four accounts -- one of which is 100 percent invested in stocks.

Under 529 rules, you can't switch your money from one account to another within the plan. To diversify, you'd contribute to more than one account, says Maine's treasurer, Dale McCormick.

Here's the beauty of 529 plans. All the earnings accumulate tax-deferred. When you take out the money for higher education, it's taxed in your child's bracket, not yours.

The value of the plan is not included in your taxable estate. But you still control the money, says certified public accountant and 529 expert Joseph Hurley of Bonadio & Co. in Pittsford, N.Y.

If you spend 529 money on something other than higher education, that withdrawal will be taxed in your bracket. You'll also pay a penalty -- typically 10 percent of earnings.

Surprisingly, 529 savings plans detract little or nothing from your child's potential financial-aid award. The money is treated as belonging to the donor, not the student.

For Hurley's opinion of all the state plans, visitsavingforcollege.com. For extended information on all the state plans, call the National Association of State Treasurers at 877-277-6496 or visit its Web site at www.collegesavings.org.

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