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A red flag raised on college-savings plan

State college-savings plans, known as 529 plans, may benefit families who fall in upper-income brackets much more than middle- and lower-income families, according to a report in the February issue of the Journal of Financial Planning.

The tax-deferred plans have been described as an ideal way to save for a child's tuition. But the article says the tax savings from 529s might not be as high as the amount of financial aid a middle- or lower-income family loses as a result of having the plan. That's because when a need-based student withdraws money saved in a 529, the money is treated as "increased income," driving down the amount of financial aid available.

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Consider two families in the 15-percent income-tax bracket. One puts $2,400 a year in a 529 plan for an 8-year old child; the other saves that amount in a taxable mutual fund. Assuming a 10 percent rate of return over 10 years, the family using a 529 would lose $8,912 in net financial aid from the college, while the one using the mutual fund loses only $2,136. In the 28-percent tax bracket, the family using a 529 loses $6,782 in potential aid, versus $2,008 for the family saving in a taxable mutual fund. Parents in higher income-tax brackets benefit from 529s because they are often ineligible for financial aid. For more information about 529s, now available in 33 states, see www.collegesavings.org.

(c) Copyright 2001. The Christian Science Publishing Society