529

Saving for college is a tough job – on par with saving for retirement, and often in direct conflict with that goal as well. Adding to the difficulty of the task is the fact that there are so many different options out there (in terms of investment vehicles) that really muddy the waters for the individual college saver.

One question that comes up very often is whether it is just as effective to utilize tax-effficient mutual funds instead of 529 plans as we save for college. The idea is that the mutual fund can generate a higher overall return than the 529 plan due to the additional costs associated with the administration of the 529 plan.

It is a fact that most 529 plans charge management fees that have a direct impact on the overall return of the account, and it is also a fact that many tax-efficient mutual funds (such as index funds) can produce higher returns at a lower cost than most other investments. But here are a few reasons why a 529 plan is nearly always the superior choice when it comes to college savings activities:

A. Taxing Matters – with a 529 plan, you pay no tax at all (when the funds are used for Qualified Higher Education Expenses, QHEE), while with any other type of account, you’ll pay some tax. In my book, no tax is always better than some tax, no matter how little.

In addition, while today’s tax rates on capital gains (the tax you’d pay on an indexed mutual fund) are at the lowest they’ve historically ever been, at either 5% or 15%, depending upon your tax bracket – these rates are scheduled to sunset at the end of 2010, increasing the rates to 10% or 20%. So, the question becomes: will your student be finished with college before the rise in rates?

The third taxing matter has to do with the Kiddie Tax. Recently there have been some changes made to this portion of the tax code, with detrimental effects for parents who have counted on a strategy of repositioning funds to the child’s name in order to benefit from a lower tax rate. Beginning next year, the child’s investment income above a minimum of $1,700 can be taxed at the parent’s highest rate all the way up to age 23!

B. Financial Aid Impact – any income that is reported on your form 1040 (which includes capital gains) is considered as a part of the calculation for financial aid for the following year. As you begin drawing monies from the mutual funds, it is possible that you will be increasing your income to the detriment of available need-based financial aid. If, on the other hand, these funds were in a 529 plan and withdrawn for use in paying QHEE, there will be no taxable income reported on your 1040, thereby having no impact on the financial aid calculation.

C. Inherent Costs – with the 529 plans, there are administrative and manager fees, but, as shown with the recent changes to the BrightStart plan in Illinois, these fees are beginning to come down. Plus, most 529 plans (BrightStart and Bright Directions included) have very low-cost investment options available, reducing the expense ratio of the funds themselves. Analysis of 529 plans versus mutual funds has consistently shown that, when considering the tax benefits and the costs of the two options, there are very few instances where a low-cost mutual fund performs better than a 529 plan, and then only when the 529 plan in question is one where the administrative expenses are relatively high and the taxpayer is in the lowest possible tax bracket.

In addition to the internal costs of the various options, mutual funds quite often make certain investment decisions that have tax consequences, such as distributing capital gains and dividends. 529 plans do not have to make this sort of decision, and therefore decisions can be based entirely on investment considerations.

All in all, while non-529 investments may provide additional investment options over those available in the 529 plans, unless for some reason you do not have the option of choosing a 529 plan for specific college savings, the 529 plan is the better choice across the board.

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For those of us with kids nearing their college years (if they’re in diapers, they’re nearer than you think!), the goings-on at the Illinois State Treasurer’s office has had more than just a passing interest for us.

If you haven’t been following the story, just prior to leaving office, Judy Baar-Topinka negotiated a new management deal with Oppenheimer Funds, to manage the Bright Start 529 plan. As one of his first acts in office, Alexi Giannoulias (rightly so) asked for the negotiations to be reviewed, as due diligence. What resulted was a dramatic improvement in the terms of this plan, making BrightStart, in my opinion, superior to the other savings-type plan sponsored in Illinois – the Bright Directions 529 plan.

The primary reason that I consider the BrightStart plan superior to Bright Directions at this point, is that the cost structure of the BrightStart plan is now within the range of the most efficient investing vehicles that Americans have available to them. The new cost structure for the BrightStart plan ranges from 0.20% to 0.63% – you’d be hard-pressed to find ANY investment vehicle with expense ratios that low!

By contrast, the Bright Directions plan’s expense ratios range between 0.12% and 1.24%, with a program management fee of 0.45% tacked on to each account. In addition, unless you’ve chosen to use a Fee-Only financial advisor (like, for example, Blankenship Financial Planning!) to assist you with acquisition of your Bright Directions account, you will have to pay a commission of anywhere from 3.5% up front to a 0.50% annual trailing commission. Effectively, you’re paying around 4% up front (or more) for this plan, plus annual fees of an extra 0.50% for the underlying funds.

Now – if you happen to own the Bright Directions plan, there’s probably a very good reason for it. Up until this recent announcement, the BrightStart plan had fees very comparable to the Bright Directions plan, with fewer choices for your investments, making it far inferior to Bright Directions. Just because at present the BrightStart plan has the edge over Bright Directions doesn’t mean that you should switch plans or make dramatic changes to your strategy. I suspect that there may be improvements in the wings for the Bright Directions plan as well – and even if things don’t change, the Bright Directions plan still offers a very good choice of investments. If you pay attention to how you manage the account, your costs can still be very low compared to the industry. If you’d like to discuss your options, give me a call.

The good news is that the BrightStart plan has “stepped up” and is now providing Illinois residents with a very cost effective 529 plan. If you’re trying to decide what the best savings plan is for your Education Savings Strategy, the choice just got a little easier.

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You may have heard recently that there have been some changes made to the BrightStart 529 College Savings plan in Illinois. Our state Treasurer took a look at the state of things, and decided that it was time for a change.

What has happened is that the Treasurer has made a change to the administrator of the accounts, which is a very positive change for college savers. While the details are yet to come, we are being told that the new administrator, Oppenheimer, will provide the account at one of the lowest costs in the industry!

This plan was, a couple of years ago, the better of the two alternatives (at that time), but it wasn’t stellar by any means. The introduction of the newer Bright Directions plan has been a very positive influence, probably at least part of the reason why this change was made to the BrightStart plan.

I’ll keep an eye on things and let you know if these new developments warrant any changes to our current directions with regard to this type of account – but for now, if you’re already in either the BrightStart or Bright Directions plan, just stay put.

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With the passage of the 2006 Pension Protection Act in August and the President’s signing of the Act, the tax treatment of 529 Plans, originally set to expire in 2010, has been made permanent.

The long-sought-after 529 tax permanency provision removes the uncertainty surrounding the tax treatment of 529 plans after the year 2010 and provides college savers using 529 plans with unique tax benefits going forward. The Pension Protection Act does not help Coverdell Education Savings Accounts (ESAs), which are still facing a 2010 sunset of tax benefits contained in the 2001 EGTRRA.

In addition to the above change, this act also provides the IRS with the authority to develop regulations to prevent taxpayer abuse of 529 plans. This is to address concerns raised by the Treasury Department that 529 plans might be used for non-education funding purposes.

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Parents of college-bound students: If you haven’t heard about the 529 loophole, listen up: Congress passed a law earlier this year, making changes to the way 529 plans and Coverdell ESAs are treated for financial aid purposes.

In the past, these college savings accounts and tuition plans were considered either assets of the account owner (in the case of a savings 529), or an income source (in the case of a pre-paid tuition plan). What this meant was that, if the dependent student was the owner of the 529 plan, the value would be assessed at a rate of 35% (savings), or 100% income source (prepaid tuition). The new law removes these accounts from financial aid consideration altogether.

It’s important to note, the only place that this “loophole” makes a huge difference is if the student owns assets, such as within an UTMA or UGMA, or an existing 529 plan (with the student as the owner). This is probably a small group of families that face this situation, but the impact is significant

If you happen to be in this position, keep this loophole in mind as you file (or re-file) your FAFSA form. In some cases it may make sense to re-file a corrected form to eliminate the account(s).

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Last year, President Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 into law. Some of the very helpful provisions in this law affect college education savings plans such as 529 plans.

The specific provisions that protect college savings from creditors are as follows:
· Full exemption is provided only for funds contributed to college savings plans more than two years prior to filing bankruptcy.
· The protection is limited to $5,000 for funds held for one to two years.
· If the account or contributions have been in place less than one year, there is no shielding from creditors.
· The education savings vehicle beneficiary must be the debtor’s child, grandchild, stepchild or step-grandchild. You cannot establish a 529 plan in your own name and take advantage of the new protections.

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* ATTENTION parents of students of the Class of 2007, 2008, and 2009! Has your student begun the process of choosing a college? Do you or your student even know where to start?
I can help with complete college planning. This includes step-by-step guidance along the way as your student prepares for college, choosing a college, and helping you develop plans to pay for tuition, books, fees, room and board, and the like.
* I also provide assistance for students in their senior year (Class of 2006) as you prepare for filing for financial aid, in order to avoid costly delays.
If you’d like some help with either situation, give me a call. It may be too late and I won’t be able to help you out, but it won’t cost anything to talk it over and see if there is anything I can do to help.
* SPEAKING of college planning, one of the biggest mistakes I see parents making these days is to put saving for college ahead of all of their other financial goals. Understandably, they want to give their children everything, and that includes an education without cost to the student.

Keep this thought in mind: you can always take out a loan for college. You can’t take out a loan to retire.

With the cost of college spiraling upward, many parents come realize that not only do they need to save for education, but out of the same paycheck they need to put money aside for retirement as well.

College preparation, including savings, should be thought of as a family project, so include the children in the activity. It’s not bad parenting to share the cost of college with your children – in fact, many would argue that teaching this kind of fiscal responsibility is very important to a child’s (or young adult’s) financial education. Encourage your kids to:
· get a part time job to help save up for school costs
· discuss the concept of student loans with them, so they will be mentally prepared when the time comes
· Do their best in high school – this will boost their chances for scholarships and grants

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One recent study by UNC-Wilmington accounting professors concluded that federal and state tax subsidies for 529 plan participants were accruing to the mutual fund distributors and brokers rather than benefiting the investor. Another recent article declared that 529 plans have become too complex: “What should be a consumer’s paradise is, instead, a quagmire of investment funds, tax incentives and tangled rules and regulations, enough to confuse the most astute expert.”
What does this mean to you? Quite likely, it will eventually mean greater oversight by the Securities Exchange Commission (SEC). With this oversight, it is possible that the current tax incentives that 529 plans enjoy may be a thing of the past.
We’ll have to keep an eye on this situation and let you know how it turns out. With the “sunset” of 2010 only five years away (how did that happen?), it makes one wonder if the tax incentives will go away at that point.

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