College? Sounds Like a Plan
If you have youngsters and wonder whether you’ll be able to afford to see them through college, you should know about something called “qualified state tuition programs.”
These programs, which aim to help parents cope with the seemingly impossible rise in college costs, have been offered in a handful of states for decades. However, the 1996 and 1997 tax laws granted them a variety of federal tax benefits, which has bolstered the old plans and spurred many states to launch new programs.
Indeed, even though only 25 states currently offer tuition savings plans, they are growing so fast and the interest is so high--nine of the 25 plans have been launched in the past year alone--that some predict it’s only a matter of time before they’re offered everywhere.
“Almost every state in the country has either passed legislation [to start such a plan] or has legislation pending,” says Rick Grafmeyer, national director of tax legislation at the accounting firm Ernst & Young in Washington.
What are these qualified state tuition programs and how might they help you finance your child’s college education?
In a nutshell, they are state-operated programs that allow parents to contribute to an account that can be used to pay for their children’s college education, says Sally Adams, a tax attorney and state tax analyst at CCH Inc., a Riverwoods, Ill.-based publisher of tax information.
Generally speaking, they can be set up in one of two ways: As a prepaid tuition program, under which the parents contribute a set amount, with their child’s college education paid for by the state fund, no matter how high (or low) the future cost; or as a savings plan, where the parent may get certain state tax breaks for their contributions and income tax deferrals on the interest accrued in the account, but with no guarantee that their savings will be sufficient to pay for the full cost of college.
In most cases, payments can be made in a lump sum or on a monthly basis to either type of plan. For instance, parents who are offered a savings plan might contribute $50 or $100 per month from the child’s first birthday until they enroll in college. At that point, their savings will pay for either a set number of semester units, based on a prearranged formula set up by the state, or it might be used like any other dedicated savings account, where the funds pay tuition until the account is depleted.
Those offered a prepaid plan, on the other hand, usually are told precisely how much they must contribute to have their college cost paid-up on a guaranteed basis. They might then be given the option of paying the full amount up front, or paying in monthly installments.
In the 1996 and 1997 tax laws, Congress locked in tax-exempt status for qualified state tuition plans and granted federal tax deferrals to money saved within the plans. In other words, when the money is withdrawn to pay for a child’s education, the interest earnings will be considered taxable income. However, there is no taxable income generated while the account is building. Importantly, too, the 1997 act stipulates that parents can not only save for tuition and fees through these plans, they can also save for their child’s future room-and-board expenditures. These expenses often equal or exceed tuition costs, so that was a significant break, Grafmeyer says.
However, there are also a few drawbacks.
First, plans that are set up as savings programs generally offer relatively modest rates of return that typically equate to either the national inflation rate--which averages just over 3%--or the college-cost inflation rate, which is about twice that. Even after accounting for the tax benefits, parents might be able to earn better returns--and thus make the college fund grow faster--by investing on their own.
Additionally, while each state’s plan is a bit different, most of them are not particularly flexible. In most cases, prepaid tuition plans will pay only the cost of a public education, which means your child must choose a state college or university if they want the entire bill taken care of. If the child opts for a private or out-of-state college, the state tuition plan usually will transfer the money to the college of the student’s choice. But parents and student may be on the hook for a larger portion of the college bills.
That’s because most prepaid tuition programs promise to pay 100% of the cost of higher education at any public school in that state, but will give the student only the average cost of public education if the child withdraws the money to go to a private college.
Other states, such as Michigan, spell out which colleges and universities the tuition plan will cover, Adams says. In Michigan’s case, the state plan will pay for certain private colleges if their tuition and fees do not rise more than the rate of inflation over a set period.
If the child decides not to go to college at all, most tuition plans allow the savings to be transferred to another family member, with minimal or no penalty. However, if the money is withdrawn and not used for higher education, most states impose penalties that can be fairly substantial.
For instance, Wisconsin imposes a penalty of 1% of the total account value, while Florida charges $50 plus any interest earned in the account, according to the Special Report on State College Savings Plans, compiled by the College Savings Plan Network.
To clarify, consider a parent that contributed $10,000 to a savings plan that promised a 4% return. At the end of 10 years the account is worth $14,802. If the child opted not to go to college--or if the parents decided they wanted to use the money for something else--they’d be penalized 1% of the account value--$148--in Wisconsin. But if this family were in Florida, the penalty would amount to $4,852--the $4,802 in interest, plus the $50 fee.
Parents who want more information about state tuition payment plans can visit the College Savings Plan Network’s Web site at https://www.collegesavings.org or call your state treasurer or Department of Education.
*
Kathy M. Kristof welcomes your comments and suggestions. Write to her in care of Personal Finance, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail kathy.kristof@latimes.com
