New College Savings Programs

Individual states are finally jumping on the bandwagon of what experts describe as one of the best kept secrets in the tax code: tax-deferred investment plans for college. Until very recently, few states provided such investment programs. In October, California launched their college savings program, called the Golden State Scholar-Share Trust, and in so doing, joined 15 other states which already offer similar programs. As many as a dozen other states are planning to join those ranks.

So, what's the big deal? These programs, approved for tax-deferred investment status by Congress in 1996, allow families to a better way to save for their children's college education, instead of relying on debt to pay for college, and to do so in much the same manner as they save for their retirements. Money placed in the program has already been taxed, but the earnings are not taxed until they are used, and then it is taxed at the student's rate, which is usually considerably lower than the contributor's rate. Congress has tried twice to pass legislation that would allow money from the account used for college expenses not to be taxed at all. The legislation failed to pass both times for other political reasons. However, it seems clear that Congress does intend to pass such legislation soon.

These new programs also offer significant advantages over other education investments such as the Educational IRA, which has a maximum contribution limit of $500, a mere pittance compared to the skyrocketing costs of a college education, or the HOPE Scholarship Credit and the Lifetime Learning Credit, which both limit eligibility based on income level.

Depending on the age of your child, her college funds can be significantly increased just by investing in this tax deferred vehicle instead of traditional, taxable mutual funds. Investing just $2,500 per year for 12 years will result in an after-inflation booty of $44,204, presuming a return of 7% on equities, 31/2% on bonds and 2% on money market funds and 3 percent annual inflation.

The downside? It depends on the program. Some programs have less than stellar returns. Many states do not yet offer such programs, though several states have programs with no state residency requirements. There are also programs which only cover tuition. Finally, the flexibility and refund policies of some of the plans are a cause for concern. Overall, however, with the right plan, this may be just the college savings plan you've been waiting for.

Steps to take:

• Get more information on programs in your state, or programs with no state residency requirement by checking out www.collegesavings.org. If your child is old enough, have her do the research and bring you the info.
  
  
• Discuss the new savings vehicle with your child, keeping her age in mind. Children as young as seven can grasp financial concepts such as long term savings, compound interest and the stock market, much better than many adults give them credit for. At the very least, they need to understand that the money they have been saving in their long term savings jar is going into their college funds.
  
  
• Determine which, if any, of these state sponsored programs is appropriate for you. Sharing this process with your child is an excellent opportunity for you to teach them how to make important financial decisions.
  
  
• If you decide to invest in such a program, have your child help you open the account and track its progress. The California program, for instance, invests in mutual funds and determines the asset allocation (a fancy term for diversification, i.e., insuring that all of your eggs are not in one basket by spreading your money into different kinds of investments like stocks, bonds or money market funds) based on how close the child is to needing the money to pay for school. While the fund is therefore a hands off investment, it is still a useful exercise to have your child see how her investment is doing.
  
  

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Julie Kletzman is the author of MoneyMentors, a monthly newsletter for parents who want to teach their kids good money management skills, and KidsKash, a monthly newsletter for kids who want to learn good money management skills. Ms. Kletzman is also the author of two booklets for the money conscious: "101 Ways to Improve Your Bottom Line" and "80 Ways for Kids to Improve Their Bottom Lines".

E-mail her at webmaster@moneymentors.net.

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