QSTPs -- The right course for college?

The prospect of paying for a college education is daunting enough; learning about the various savings options and picking the right one adds yet another degree of difficulty to the challenge.

Recently, many parents and grandparents have put qualified state tuition programs (QSTPs) near the head of the class.

Called "529 Plans" because they receive special tax status under Section 529 of the Internal Revenue Code, QSTPs offer income tax-deferred earnings that are ultimately taxed at the student's rate, usually 15 percent, so long as they are used for "quafified higher education expenses," which includes the cost of tuition, room, board, books and certain other expenses at most accredited two- or four-year colleges.

There are two versions of QSTPs

-- A prepaid tuition plan that effectively allows savers to lock in future tuition of selected state colleges at today's rates through the purchase of tuition credits or tuition certificates.

-- A college savings plan that is not pegged to future tuition costs, but rather invested according to asset allocation strategies determined by the individual states. This newer type of plan is likely to produce a better return for the long-term investor than prepaid tuition plans, because college costs have only been rising at about 4 percent annually in recent years.

About half of the more than 40 states that offer QSTPs have no residency requirements for contributors or beneficiaries. Some states even offer their residents some state tax advantages.

Both types of 529 plans have no income limits for participation, unlike IRAs, and certain states allow contributions of up to $100,000 or more per child either in a lump sum or periodic deductions. Moreover, QSTPs have an advantage over custodial accounts set up under the Uniform Gifts to Minors (UGMA) or Uniform Transfers to Minors (UTMA) acts, because they are not considered the child's assets. Most colleges weight the child's assets more heavily in determining financial aid.

Anyone can set up a QSTP for a prospective student. That can be especially useful for grandparents looking to trim the size of their estate. A contribution is a completed gift for federal gift tax purposes, but a contribution of between $10,000 and $50,000 can be treated as having been made over a five-year period.

That means a grandparent can utilize as much as $50,000 in gift tax exclusions to shelter a single larger contribution while giving the account the opportunity to grow more quickly than if contributions of $10,000 were made for each of the five years. If so utilized, the grandparent's annual gift tax exclusion would be exhausted for the current year and the next four years.

Moreover, unlike the case of a gift to a UTMA account, grandparents (or any other account owner) could reclaim control of the money by way of a refund, although penalties would generally apply.

Naturally, QSTPs come with restrictions, perhaps the biggest of which is that all the money in the account must be applied toward college in order to receive favorable tax treatment. Thus, taxes on earnings can't be paid from the account without incurring penalties and additional taxes. Also, no contributions can be made to an education IRA on behalf of a child in the same tax year any amount is contributed to a QSTP on behalf of the same child.

Section 529 college savings plans may not be for you if you're accustomed to managing your own portfolio. If you choose a savings plan, make sure that you are comfortable with its investment philosophy, because current laws make it extremely difficult to switch from one state to another.

It also might be wise to keep an eye on Congress. Laws may be significantly different by the time your student is ready to enroll. For example, a proposal is afoot that may exempt state plan funds from all taxes. Another reform may be aimed at making it easier for individuals to shift their accounts from one state plan to another.

Sharon Stanley is a representative of Prudential Insurance Co. in Cape Girardeau (334-2603)