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Save money while saving for your child's education

Thanks to the 2001 changes in the tax code, parents have more options than ever for tax-advantaged college savings programs.

Parents can now make tax-free withdrawals from a prepaid tuition program or state-sponsored savings plan.

"It was good before, and now it's outstanding," says Joe Hurley, a Pittsford, N.Y., accountant who runs Savingforcollege.com, an Internet guide to 529 college savings plans.

State-sponsored 529 plans are named after the section of the federal tax code that allows them. All 50 states and the District of Columbia now have 529 plans available.

A state-by-state listing of programs is available on the Web site of the College Savings Plans Network, and on Savingforcollege.com.

Earnings in 529 plans had been allowed to grow federally tax-deferred until the child enters college and a withdrawal is made. At that point, earnings would be taxed at the child's tax rate, typically 15 percent, rather than the parents'.

With the tax code change in 2001, parents can make withdrawals without paying a penny of federal taxes.

529: A plan for the future
Let's look at this example provided by T. Rowe Price Associates.

Let's say a family made a $5,000 annual investment into a 529 plan that earned 10 percent annually over 18 years.

Under the old federal tax rules, and assuming a 5-percent state tax, a family's after-tax savings would total $249,600. Under the new rules, total after-tax savings jumps to $278,000.

Thanks to the new tax rules, this particular family would have an extra $28,400 to devote to college expenses.

"That's pretty significant when you're trying to save money to go to college," says Chris Hunter, program manager at the National Association of State Treasurers.

There are two basic types of plans: prepaid tuition plans and savings plans.

A prepaid tuition plan lets you purchase units of tuition for any state college or university at today's prices. A semester's worth of prepaid tuition purchased at 2004 prices would pay for a semester's worth of tuition at any future date.

"The advantage is you're being locked in to this year's tuition rate," says Jack Joyce, director of guidance services at the College Board.

"It certainly saves money down the road."

Four years of tuition purchased in 2004 would pay for four years of tuition at any in-state university starting in, say, 2013. An industrious parent could pay for four years of college while their son or daughter is still in elementary school.

The nuts and bolts of 529s
To participate in a state's prepaid tuition program, the contributor, typically a parent or grandparent, or the beneficiary, the future college student, must be a resident of the state.

A family clearly gets the most bang for their prepaid buck when the beneficiary chooses to attend a public instate college or university. That's because a year's worth of prepaid tuition is guaranteed to pay for a year's worth of classes any time in the future.

A student could choose to apply tuition purchased in a prepaid program to a private or out-of-state college, but the family may have to scramble to pay additional tuition costs. For example, two year's worth of tuition at a state university purchased in 2004 might only pay a single semester of tuition at a private college in 2011.


Next: " ... kind of an autopilot college savings program."
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