College savings plans take off

Tax-deferred state programs can cover tuition cost

By Thomas A. Fogarty, USA TODAY

Prepaid most popular Table of plans

College savings plans run by the states are exploding.

Forty state plans now manage $7.1 billion in college savings, up 40% since June, according to Kentucky-based College Saving Plan Network. Nearly 1.2 million people use the plans to save for college.

“These plans are a tremendous breakthrough,” says Marshall Bennett, Mississippi’s state treasurer and chairman of the national network.

The plans offer professional money management, and state and federal taxes on earnings are deferred until withdrawn. Many plans offer additional state tax incentives.

State tuition plans are either prepaid or savings plans.

Prepaid plans let an investor -- typically a parent or grandparent -- lock in public university tuition rates by paying now for a future education.

Savings plans are state-sponsored, tax-deferred investments. If the money isn’t spent for education, the investor loses the tax benefits and incurs a penalty.

Most recent growth has been in savings plans. Among the reasons for their popularity:

More plans. Arizona, California, Colorado, Maine, Missouri and Virginia -- have launched savings plans just since August. Fourteen more are set to launch soon.

“States have embraced these plans mainly because they’re so cheap to run when they contract (with an investment company), and because they’re great publicity for the governor, the state treasurer and everybody else,” says Joseph Hurley, author of The Best Way to Save for College.

Competition. Many states accept investments nationwide, and some offer enhancements beyond tax concessions. North Carolina makes education loans to parents who have depleted their account.

Aggressive marketing. State officials pitch the programs to residents in TV ads. And investment companies who manage state funds put their marketing muscle behind the plans. Merrill Lynch, for example, markets Maine’s program to investors nationally.

Michigan was first with a tuition plan in 1988. It was the subject of a five-year court fight with the Internal Revenue Service, which argued it didn’t serve a state government purpose. A federal court ruled for Michigan in 1994, and the state stampede began after Congress, in 1996 and 1997, adopted favorable tax rules.

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