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Nontraditional Options for College Savings

Qualified State Tuition Plans

There are two types of qualified state tuition plans, both of which are 529 plans. That means they fall under section 529 of the tax code, which permits investing for college in a tax-deferred vehicle. One type of qualified state plan is known as a Prepaid Tuition Plan or Tuition Assistance Plan. The other is simply called a 529 Plan.

The 529 Plan was revised in 1997 and again in 2001. This plan is the newest way to save for a child's college education. Basically, it's an account that's set aside for a child's education, and is tax deferred until it's used. The money, however, can't be accessed by the child. If Rob buys that motorcycle and takes off for Europe, he can't grab the money from the account on the way out.

Adding It Up

Tax-deferred income is earned, but not taxed until the income is used. Tax-free income is never taxed.

A 529 Plan is even more appealing under the most recent Tax Act, which in 2002 made all earnings within a 529 Plan tax free, not just tax deferred. And, up to $50,000 can be contributed to a 529 Plan each year by an individual, or up to $100,000 by a couple. Contributions to these plans are considered gifts. The person setting up the account and depositing money is called a contributor, and remains in control of the money. If the child for whom the money is intended does not go to college, the money can be passed along to another beneficiary (within the large family unit—nieces and nephews rather than just brothers and sisters like an education IRA), or retained by the contributor.

At that point, if the contributor retained the money, it would become taxable, and there would be a 10 percent penalty. The penalty is meant to be a deterrent to people using a 529 Plan as a convenient way to stash away tax-free money, never intending to use it to pay for college.

The Prepaid Tuition Plan is intended to fund tuition expenses only. Money in these plans can't be used to prepay room, board, books, fees, and so forth. It's strictly for tuition. That means you'll probably need to have another college investment vehicle, as well.

The governments of various states normally set up these Prepaid Tuition Plans, which are guaranteed against losses in the stock market. You probably will need to be a resident of the state in which you set up a plan.

A Prepaid Tuition Plan guarantees that your tuition credits will pay for your child's tuition. No matter what happens to tuition costs, your purchase “locks in” the cost of future tuition. The plan can be used for tuition at any accredited, public or private college or technical school in the United States.

This plan may keep you eligible for financial aid, since it only covers the cost of tuition. You'll still need to come up with the money for room and board.

The funds you contribute to a Prepaid Tuition Plan are used to buy tuition credits that equal credit hours paid at different types of institutions. You'll need more credits for a four-year college or university, for instance, than you would for an area community college. You'll need to purchase more credits if your child is interested in a university, while you'll need to purchase less if your child is interested in a community college.

If your child doesn't use all the tuition credits you've purchased, you may be able to get a refund.



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Excerpted from The Complete Idiot's Guide to Personal Finance in Your 40s and 50s © 2002 by Sarah Young Fisher and Susan Shelly. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.

To order this book visit the Idiot's Guide web site or call 1-800-253-6476.


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