State college savings plans offer tax breaks - Personal Finance - qualified state tuition programs

Healthcare Financial Management, Nov, 1999 by William G. Kistner

Asset Allocation

Participants have no control over a plan's investment decisions. Therefore, they should investigate the plan's management and asset allocation strategy before signing up.

Plans vary widely in their asset mix. New Hampshire's Fidelity plan, for example, invests aggressively. An account established now for a newborn will allocate 88 percent of the money to equities. The equity portion declines to 85 percent at age four, 73 percent at age seven, 63 percent at age 10, 50 percent at age 13, 25 percent at age 16, and 20 percent when the child begins attending college. All or most of the rest of the money is put into bonds until the child reaches 16, when 25 percent of it migrates into short-term bond funds and money-market funds.

The New York State program is much more conservative. The maximum equity exposure ranges from 45 percent for a newborn to 10 percent for a child born before 1984.

Few people put all their college savings into equities, especially for a child in high school. Instead, they can make more aggressive investments outside a state plan and then use the plan for the more conservative portion of a college portfolio.

Participants with more than one child can maximize equity allocations in a QSTP by setting up accounts strategically. Assume a couple has three children, aged 13, nine, and two and currently can afford to fully fund only one QSTP If they set up an account for the 13-year-old under the New Hampshire plan, only 50 percent of their money could be invested in stocks. Instead, the couple could establish an account for the two-year-old and invest 88 percent of the money in stocks. Later, at an appropriate time, they could switch the account from the youngest child to the oldest. Then they could create a new account for the youngest child. The account must be switched in time to cover any shortfall if the equities' value drops just before they need to withdraw the money.

Conclusion

Although QSTPs make sense for many people, they are not for everyone. Certainly, the appeal of a state tax break should not lure people into a plan that will not meet their investment needs since state tax deductions normally are not large. Since all state income taxes are deductible from Federal income tax anyway (subject to the 3 percent of adjusted gross income phaseout), a person really gets only 72 percent of the deduction if he or she is in the 28 percent tax bracket. But, under the right circumstances, that still might be a great deal.

Information on state plans is available from the College Savings Plans Network, (606) 244-8175, or on its Web site, www.collegesavings.org.

William G. Kistner, MM, CPA, is a tax partner, Ernst & Young LLP, Chicago, Illinois, and a member of HFMA's First Illinois Chapter. Readers' comments should be addressed to him at Ernst & Young LLP, 233 South Wacker Drive, Chicago, Illinois 60606-6301.