Popularity of state-sponsored college savings plans rising
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By JEAN ORTIZ / Lincoln Journal Star
They call him the 529 guru.
Once your average certified public accountant, Joe Hurley has swapped his days of preparing tax returns for a solid schedule of educating parents and students, millions of them, about how to pay for college.
And as the 529 guru -- a nickname he doesn’t hear much around the house -- he’s devoted a significant share of his career to 529 plans. A decade ago he stepped into the still-fledgling world of state-sponsored, tax-friendly college savings plans believing they were among the most dynamic college savings tools yet offered.
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529 plan: A type of investment, named for the applicable part of the federal tax code, that allows people to save money with tax advantages, achieve investment gains and use the money tax-free for higher education purposes.
Direct sold: One type of 529 plan that allows investors to directly choose their investment options and avoid additional costs that come in a broker-sold plan.
Broker/adviser sold: One type of 529 plan that has a broker setting the investment strategy. It’s designed for investors who want professional advice, but they also have to pay a fee to compensate the broker. Like the direct-sold plan, funds can be used at eligible schools nationwide and are not tied to a particular state.
Prepaid tuition plan: This type of plan essentially locks in future tuition costs at today’s prices. A prepaid tuition plan is exempt from federal income tax, and is often exempt from state and local income taxes. The value of a prepaid plan can be transferred to private and out-of-state schools, although you may not get full value.
Age-based portfolio: Contributions are invested according to the age of the beneficiary. Investments create growth potential while a beneficiary is still young and become more conservative as the college years approach.
Target portfolio: Diversified portfolios that provide a targeted or “static” asset allocation of stock and bond investments.
Individual fund portfolio: Each portfolio is invested in a single mutual fund. The portfolios range from lower risk/lower return potential to higher risk/higher return potential alternatives.
Source: College Savings Plan of Nebraska; FinAid; Savingforcollege.com
Coming next week:
The search for financial aid to cover costs of higher education is not without its share of rackets and scams. Find out what to look out for.
Today, as the savings plans continue to thrive across the nation, attracting more investors and billions of dollars all earmarked for future college educations, Hurley -- now an author, researcher and speaker on the topic -- said he hasn’t changed his mind.
“My opinion is that 529 plans are probably the primary vehicle for families that are looking to save significant dollars for college,” Hurley said.
The plans, which got their start with the signing of the 1997 Taxpayer Relief Act, get their numerical name from the 529 section of the Internal Revenue Code. The idea was simple: Give taxpayers a program with built-in tax advantages to save for college.
Today there are more than 100 plans nationwide, including prepaid tuition plans and the more popular offerings: savings plans sold directly to investors and savings plans sold by brokers. There are a myriad of options.
Account holders name a single beneficiary, who can be a child, grandchild, spouse, or other family member. Anyone can contribute to the fund, but only the account holder can claim tax deductions for doing so.
Contributions can go toward a variety of investment options. The College Savings Plan of Nebraska, for example, offers age-based portfolios, target portfolios and several individual fund portfolios. The Internal Revenue Service also allows account holders to roll the funds over into a different 529 plan, though keeping the same beneficiary, once every calendar year without penalty.
Taxes are deferred as the investments grow, and the money can be withdrawn free of federal taxes at any time for qualified college costs -- which can range from tuition and fees to books and computers.
Contribution caps vary by state, in Nebraska’s case it’s $300,000, though contributions greater than $12,000 a year will be subject to federal gift taxes. In some cases, there are no set minimum contributions.
Account holders, who retain complete control over the account, also can change the beneficiary to another family member, which comes in handy if college plans fall through. They also can withdraw the funds for non-qualifying expenses, but will have to pay taxes and a 10 percent federal tax penalty on the earnings. The penalty tax is waived in the event of the beneficiary’s death or disability.
In addition to getting federal tax breaks, Nebraska state income tax filers can deduct up to $1,000 annually per state return for contributions to a plan. A legislative bill introduced this year seeks to increase the maximum annual deduction to $5,000.
The plans will have some impact on federal financial aid eligibility, but it’s minimal, Hurley said.
Funds are factored into financial aid at a rate no higher than as if they were a parental asset. That means no more than 5.6 percent of the savings in the plan will be treated as available to cover college costs. That’s much better than being calculated as a student asset, which currently treats 35 percent of funds as available.
The state treasurer serves as trustee of the plans offered in Nebraska, which are organized under the Nebraska Educational Savings Plan Trust. Union Bank & Trust serves as program manager overseeing plans offered by the College Savings Plan of Nebraska, TD Ameritrade, AIM Investments and State Farm Insurance.
Why the different offerings? Nebraska State Treasurer Shane Osborn said it’s important to have a mix of viable options to make the plans accessible to more people.
Though the focus is on making it reasonable for Nebraska residents to participate, out-of-state investors are important too, he said.
More participants mean lower fees and more ability to negotiate come contract negotiation time, Osborn said.
“The bigger you get, the more power you have in the marketplace,” he said.
Nebraska plans have earned varied marks on investment rating lists, including mixed reviews from investment research company Morningstar. The firm lists the College Savings Plan of Nebraska among the best values, while the AIM Investments plan received criticism for what it called above-average expenses and unproven investment options.
Since the ratings were issued, AIM has made changes, including eliminating some fees and providing more investment options, making the plan more favorable, Osborn said.
With contracts for all plans expiring in the next four years, Osborn said he will demand exceptional performance from all the state’s partners.
“I don't want Nebraska's name associated with anything but the best,” he said.
About 8 percent of state residents under 18 have a direct or broker-sold account set up in their name, according to the trust’s 2005 audit, which includes account information through September 2006.
The most popular plan in the state, the College Savings Plan of Nebraska, today holds more than $1.1 billion in investments, up from about $7.5 million invested six months after its launch in 2001, said Jay Steinacher, college savings group manager with Union Bank & Trust.
Nebraska residents hold about 34,200 of the current accounts, with out-of-state residents holding a near equal number, he said.
The average account holder typically starts saving when a beneficiary is 8 or 9 years old, Steinacher said. The contribution of those saving via automatic deduction averages about $120 a month.
Those contributing to the plan are across all income levels, with monthly contributions ranging from $10 a month to thousands of dollars, Steinacher said.
To cover the costs at a public four-year in-state college, assuming a 5 percent college cost inflation rate and 7 percent earnings on investments, a family would have to save $320 a month if they began saving when the child was born.
If they wait to start saving until the child is 8 years old, the monthly savings needed jump to $470 a month.
“Time is really on your side, as well as the power of compound interest,” Steinacher said.
Considering a private 4-year school? Stash away $649 a month, if savings start when the child is born, or $955 if savings start when the child is 8.
Nationally, some seven million 529 plan accounts are in existence, holding about $100 billion in investments, Hurley said.
The average balance hovers around $10,000 to $15,000 and investments have shown steady growth since the plans’ inception, he said.
“It shows that there is a lot of money in 529 plans and there’s more coming in all the time,” he said.
The plans, which are in many cases supplementing other funds to pay for college, have become increasingly attractive in large part because of changes along the way -- permanent tax exemptions, greater flexibility and more favorable financial rules.
“There’s a lot of positive things that have happened to make 529 plans more appealing than ever,” he said.
Though appealing, 529 plans still may be out of reach for the groups that need the most help -- the middle and middle-to-low income groups, said Carna Pfeil, associate director of Nebraska’s Coordinating Commission for Postsecondary Education.
“I think it's a struggle to get parents who are not in the upper middle income to designate funds for that kind of purpose,” she said.
It’s not just the lack of discretionary funds that keeps people out of 529 plan participation, Hurley said.
From understanding the tax incentives, to the web of rules guiding financial aid, it’s a very complicated area, he said. But that shouldn’t stop people from studying it to see whether it makes sense for their finances.
“Just educate yourself as much as you can -- that is probably the most important thing you can do for yourself,” he said.
Reach Jean Ortiz at 473-7107 or jortiz@journalstar.com
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