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Higher Education Planning

Most people are aware that many tax breaks exist regarding saving for and paying for higher education. These include the Lifetime Learning and Hope tax credits, an above the line tuition deduction; Coverdell education savings accounts; and, of course, qualified tuition programs often referred to as Section 529 plans. With the exception of the 529 plans, each of the above items is subject to a complex set of income limitations that make most of them unavailable to many taxpayers.

The 529 plan works as follows

Contributions to 529 programs aren't deductible for Federal purposes. Effective for 2006, Pennsylvania residents may deduct up to $12,000 in contributions to any qualified Section 529 plans (from any states) annually from their Pennsylvania state taxable income ($24,000 if married filing jointly, provided that each spouse has taxable income of $12,000). Other states also offer similar tax incentives.

The earnings on the contributions accumulate tax-free to the extent the funds are used to pay qualified higher education expenses. Distributions of earnings that aren't used for qualified higher education expenses will be subject to income tax plus a 10% penalty tax. Typically mutual fund companies, on behalf of a sponsoring state, administer the funds. The owner of the account must choose an investment strategy that is age appropriate for the beneficiary (student). For younger children who are at least five years or so away from needing the funds, an aggressive investment approach in the stock funds might be appropriate.

Eventually, when the student is within five years of needing the funds, it is often recommended that the investment vehicle should be more conservative. In a low interest environment, rates of return on conservative investments have lagged behind the inflation of college tuition since the early 1980's.

As an example, college tuition at Penn State's main campus increased by 7.04% for the fall 2006 semester for first year in-state resident students.

If your child or grandchild is several years away from, or already attending college, how do you keep from falling behind inflation or risking your college fund? If you or the beneficiary (student) is a resident of Pennsylvania, there is an option. It is called the TAP 529 Guaranteed Savings Program (GSP).

As it's name implies, the TAP 529 GSP is a Section 529 plan. For tax purposes it is treated the same as any other 529 plan. The difference is how the money accumulates in the plan. In the GSP you pay for tuition at today's cost. You essentially bet that the inflation rate for college (think of it as a rate of return) will be higher than the return on a conservative investment.

In the GSP, you purchase credits in the specific state college or type of college (in or out of state) that you select at today's tuition cost. Twelve TAP credits equal one semester. To pay for fours years of college through the program you would need to purchase 96 credits. Although you must select from among several savings options (which can be changed once a year) such as a specific Pennsylvania state university (Penn State, Temple, etc.), the average for out of State private schools, or even the average for Ivy League schools, you are not locked into that choice.

No penalty for attending the college of your choice

Tap 529 does not require that the student attend a Pennsylvania college or penalize a student for going out of state. If a student selects a college that differs from the option selected, the state will calculate the dollar value of the account based on the amount of credits times the current value of that credit (there is an exception for switching from one Pennsylvania University to another). For example, if you had purchased one year at Penn State for $7,232 in July of 2002 and your daughter decided to attend college at George Washington in 2005 the state would have written a check to G.W. for the tuition rate at Penn State in 2005. That check would have been for $11,308 and you would not have paid any tax on the increase. If you put that same money in a CD at 4% you would have had $8,135 before paying taxes.

Availability of funds

One requirement is that the money must remain in the account for approximately one year. Contributions made between January 1 and August 31 of one calendar year will be available beginning with the summer semester of the following calendar year. Contributions made between September 1 and December 31 of one calendar year will be available for the spring semester two calendar years later.

Tuition updated annually on August 31

Also, the state updates the price of tuition August 31 of each year, which is after the date that most colleges announce their tuition rates for the coming year. Therefore, you can wait until August to invest so that you will know the first year's rate of return.

PA Direct Investment Plan

Pennsylvania also sponsors the Direct Investment Plan, which, is a more traditional investment type of 529 plan. Effective November 20, 2006, Upromise Investments, Inc., became program manager for the Pennsylvania College Savings Program - 529 Direct Investment Plan. Vanguard is the new investment manager. Delaware Investments formerly managed this program.

Read the prospectus carefully

Before choosing any of these investments (just as any others), you should read the prospectus carefully. The prospectus will tell you, among other things, that the state does not supplement the program or guarantee that it will remain solvent. To learn more about either plan, visit the Pennsylvania College Savings Program Web site or call 800-440-4000.

Posted: January 2007

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