College savings accounts popular, despite drop in returns

LANSING, Mich. -- Sandra Wade has watched the stock market gyrate wildly over the past six months, but she isn't worried about her son's college savings account.

Wade, of East Lansing, invested last year in Michigan's state-run college savings plan and chose an option that guarantees her a return of at least 3 percent a year on money deducted from her pay check every two weeks. By the time 10-year-old Jeremiah heads off to college, she hopes to have enough set aside to cover his bills.

As college costs continue to rise and other investments lose their shine in the uncertain economy, state-run investment options known as 529 plans are attracting hordes of new investors.

"A lot of them are saying, 'This is a long-term account. My kid is young. There's time to recover and grow,"' said Joseph Hurley, a certified public accountant from Pittsford, N.Y.

College savings plans allow parents and grandparents to invest in mutual funds that grow tax-free until the money is withdrawn, when it is taxed at the student's rate. Some states let investors deduct all or part of the contributions from state taxes.

Most states offer an age-related option that moves the money from riskier stocks into more conservative investments as the child grows older. Some also offer fixed-rate investments, or let investors choose from a range of mutual funds.

While there's no guarantee the savings accounts will keep up with tuition increases, the idea is they will match or even exceed that rate. 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.

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.

Gregory Sims of Rockville, Md., invested in the Maryland Prepaid College Trust last December for his 6-year-old daughter, Rachel.

"By the time she reaches the sixth grade, her college tuition will be paid in full," said Sims, 49. He liked the tax write-off and the fact that "no matter what happens in life ... you're guaranteed that your child will be able to go to college."

Nebraska's new college savings plan, which started in January, topped $2 million in investments in just six weeks -- in a state with just 1.6 million people. To date, the fund totals $4.6 million, even though annual investments are capped at $10,000. Contributors qualify for state income tax deductions.

Parents don't have to live in a state offering a college savings or prepaid tuition plan to enroll in one.

Although some states offer only 529 plans to residents or those who work in the state, others -- such as Michigan and Rhode Island -- have opened their plans to investors nationwide.

That has increased the size of the boom in those states. After Rhode Island last November relaunched its college savings program and began marketing it nationally, assets grew from $8.5 million to $272 million by late April. Just $15 million of that was invested by Rhode Island residents, said Rhode Island General Treasurer Paul Tavares.

The plans usually offer tax advantages as well as peace of mind, which is one reason they're recommended so highly by Hurley, who runs a Web site tracking and explaining Section 529 plans nationwide.

He said that nationally, in the college savings programs alone, about $2.5 billion was invested by the end of 2000, an amount he expects to reach $10 billion by the end of the year. He expects the same fourfold increase in the number of accounts, which he says could reach 1.6 billion by the end of 2001.

"The interest keeps accelerating as new programs go online and they get the word out there about them," he said, adding that even the dip in many college savings' plans returns haven't discouraged investors.

The Utah college savings plan's all-stock option -- which earned 28 percent in the first three months of 1999, when it first began -- saw a 21 percent drop in value in the last quarter. But money is still flooding in, said Dale Hatch, the plan's deputy administrator.

"We're getting people coming in and thinking that now's maybe the good time to buy, thinking that it will go up," Hatch said.

Although most college savings plans don't promise to cover the cost of tuition, as the prepaid tuition plans do, New Jersey has tried to make the savings plan less risky by promising the investments will not be lost, even if the stock market crashes. Its program has seen a 183 percent increase in participants since last summer.

Marguerite Beardsley, deputy executive director of the Higher Education Student Assistance Authority in New Jersey, said the state's college savings program may actually be doing better now because of the stock market downturn.

"We feel people will be looking for something with a bit more security, but something offering growth when the stock market turns around," she said.

With so many states offering 529 plans, many are revamping their offerings to allow investors the option to invest in a wider variety of mutual funds. Wisconsin lawmakers recently voted to expand the offerings in their EdVest program.

For David and Nuala Doty, who live in Madison, Wis., investing in a more aggressive account will give them a chance to more quickly build up the college funds they plan to start for daughter Tara, 7, and son David, 11.

"Though it's a little riskier, you have the potential of making a little bit more money for your kids," Nuala Doty said.

Other states are adding tax incentives, or even offering to match some of the contributions parents and grandparents make.

Michigan gives a $1 match for every $3 invested the first year to families earning $80,000 or less a year who open accounts for children younger than 7 years old. The match is capped at $200.

Michigan also makes annual contributions to the accounts deductible from state income taxes.

That's the same as getting a 4.2 percent return even if the investment doesn't earn a dime in the stock market, said U.S. Rep. Mike Rogers, who as a state senator sponsored Michigan's college savings plan. The Brighton Republican now is working to get federal tax breaks for the plans.

Wade was the first state employee in Michigan to sign up when the state offered payroll deduction for those opening a college savings account. Although she and her husband have opened only one account so far, they plan to open others this year for daughter LaShunda, 16, and son Nehemiah, 12.

"It's a combination of being able to do the payroll deduction, plus it also saves on our taxes," she said. "It's a good program for me."

On the Net:

Michigan Education Savings Program, http://www.misaves.com/

Michigan Education Trust, http://www.treas.state.mi.us/met/metindex.htm

Joseph Hurley's Web site, http://www.savingforcollege.com