New tax laws get high marks in college savings

Associated Press

WASHINGTON — Children whose families are taking advantage of education savings accounts will get an extra tax savings when they go to college under new tax laws.

College savings plans allow parents and grandparents to invest up to $250,000 in mutual funds that grow tax-free until the money is withdrawn, much like the popular 401(k) retirement plans.

Interest on money taken out before Jan. 1, when the new law kicks in, would be taxed at the student’s normal rate, but the law President Bush signed Thursday includes a provision that will exempt the earnings from federal taxes.

"It’s a wonderful bonus," said Suzanne Elms-Barclay of Lansing, Mich., who opened accounts last year for her two grandchildren. "You can do something for your grandchildren, and you won’t have to stick your kids or grandkids with a big federal tax bill."

Education savings accounts are growing in popularity as several states have passed them into law in recent years. Elms-Barclay immediately invested $10,000 when they became available in Michigan in November, then another $10,000 this year — the maximum annual amount that Michigan families can exempt from state income taxes.

Her grandchildren, who live in New Hampshire, can use the money to attend any college nationwide or get vocational training.

All 50 states and the District of Columbia have a tuition program or are in the process of developing one. More than 1.5 million children across the country have been enrolled, representing more than $9.5 billion in investments, according to the College Savings Plans Network.

Although some states offer only the plans, called 529 plans from the Internal Revenue Code item that defines them, to residents or those who work in the state. Others — such as Michigan and Rhode Island — have opened their plans to investors nationwide.

Some states let investors deduct all or part of the contributions from state taxes, but the donations remain subject to federal taxes.

Besides tuition, the money can be used for room and board and other college costs. The money also can be used at any school in the country or for vocational training in some states.

"People don’t realize, this is for all income levels," said Rep. Mike Rogers, R-Mich., who created the accounts in his home state when he was in the Legislature. "You don’t have to be middle class or better."

Bush did not include the 529 exemption in his original tax cut plan, but it was added during negotiations in the Senate.

"Millions of Americans work hard to set a few dollars aside each month to send their children to college," said Sen. Mitch McConnell, R-Ky., who fought for inclusion. "Education is a top national priority, and it’s time we stopped penalizing these families who are saving responsibly for college."

While the savings plans are relatively new and are pulling in investors very quickly, prepaid plans have been around since Michigan offered the first one in 1988.

Prepaid tuition plans allow investors to buy one or more years of future college tuition at this year’s prices. Most plans cover tuition and mandatory fees at public colleges, universities or community colleges in the state, and will pay a portion of those costs at a private school or out-of-state institution.