Tax-free savings plans: What's up with that?
The prospect of paying for college can be daunting--regardless of whether your child is a freshman in high school or just entering pre-school. With college costs rising at an astronomical rate, it's not unreasonable to think it will take $100,000-plus to get each kid through college. And that's before she announces plans to continue on to graduate school.
To take the edge off, Congress created Section 529 college savings plans. The plans (like the better-known 401(k) plans, they are not-so-creatively named after the section of the federal tax code that created them) come in two varieties--a pre-paid tuition plan that guarantees it will pay for college when the kids are ready and a tax-deferred investment plan with a value that will rise and fall along with the stock and bond markets.
College Illinois, the pre-paid tuition plan, is open to new investors until March 31. The program, akin to buying an insurance policy guaranteeing college tuition and fees will be paid when the time come, offers a variety of payment options and results. At the high end, parents can choose to pay a lump sum of $25,432 now to guarantee eight semesters' tuition at a public state university, or they can invest as little as $24 a month for the next five years to guarantee payment of one semester at a community college.
Savvy investors who believe they can outsmart the stock market can choose to invest college savings in state-sponsored 529 plans managed by professional money managers. In Illinois, the Bright Start College Savings Plan is managed by Salomon Smith Barney. Tax code changes allow the earnings on 529 accounts to grow exempt from federal income tax at least through 2010. That means withdrawals are tax-free so long as the money is used for college expenses, including tuition, room and board and textbooks. For Illinois participants, however, there's a hitch. Gov. George Ryan signed a bill in July that requires Illinois residents to pay 3 percent state income tax on withdrawals made from out-of-state 529 accounts. In addition, rollover contributions to Illinois' Bright Start plan from an out-of-state plan no longer will be tax-deductible.
On a brighter note, contributions to Illinois' Bright Start plan are fully deductible against state income. Also, money invested in the state plan will not be considered when determining whether a student is eligible for an Illinois-funded student aid program.
Should junior decide to hit the road rather than hitting the books, either plan allows the parents (the official owners of the accounts) to roll the money over to another child or simply take back the cash, after reimbursing Uncle Sam for the tax breaks.
More information on Illinois plans is available at www.collegeillinois.com and www.brightstart savings.com, while www.savingforcollege.com offers an overview of all state plans, including a calculator for comparing returns.
-- Cindy Richards and Mary Ellen Podmolik