529 College Education Saving Plans – a case study in making a great idea unreasonably complicated!
By Richard P. Halverson

America favors education.  Most would agree our future depends upon a well-educated population.  One way the government can encourage higher education is by establishing tax incentives to encourage people to save for college.  To do this Congress established 529 Education Plans.  529 plans have some wonderful features that corrected many of the limitations and shortcomings of the Cloverdell Education Accounts.

·         529 Plan accounts are tax-advantaged accounts, similar in concept to a Roth IRA.  Earnings on the invested money are not taxed by the federal or most state governments.

·         There are no means tests for donors.

·         Amounts that may be contributed are substantial.  The regulations related to amounts are complex and vary by state.  A rough guide relates to the federal gifts tax exclusion of $11,000 per recipient.  Generally, it is possible to contribute up to five times that amount in one year out of five.

·         Funds withdrawn are not taxable if used for education expenses.  This provision expires in 2010 unless extended by Congress.

·         The definition of education expense is broad.

·         The donor can change the beneficiary at anytime, thus retaining substantial control over the assets.

·         Accounts may be rolled over to a new sponsor and investment manager once a year.

These are wonderful provisions designed to encourage families to save for the education of their children and grandchildren and even themselves. 

(NOTE: I am in favor of saving.  I am in favor of saving for specific purposes like college.  I am particularly in favor of saving when the savings offer tax advantages.  In the end I am going to recommend you take advantage of the 529s and I’m going to make suggestions how to get going.  However, 529s are unreasonably complicated.  The next few sections of this article are devoted to ranting and raving about how the federal and state governments have messed this up so badly.  If you are the kind of person who regularly skips over warning labels and want to get to the closing hymn feel free to skip down to the section entitled “You Really Should Do It Anyway.”)

Choosing the Correct 529 Plan is Very Complicated

Regrettably, along the way Congress could not resist making 529 plans so complicated it is difficult for ordinary families to figure out what to do.  Along with the good ideas above Congress also did the following:

·         Made the individual states the sponsors of 529 plans.  Each state’s approach is different.  Most states offer both a prepaid tuition and a straight savings plan.  Within these two categories there are frequently several options.

·         Most states retain large investment firms to manage the assets and administer and even sell the plans.  Each investment firm has strengths and weaknesses and differing performance histories.

·         The investment companies hire brokers and agents to sell 529 plans.

·         Investors are not restricted to investing in their own state.  They can invest in plans from any state.  In general residency is not required.

·         Choices are usually good, but too many choices can be bad.  I have made no attempt to do the math, but the permutations and combinations of fifty states and the District of Colombia each offering multiple plans means the possible choices for a 529 plan run into the hundreds.  Each offers advantages and disadvantages depending upon a lengthy list of personal variables.  I will tell you right now there is no simple way for you or any web site or any financial planner to determine which is the best 529 plan for you.

·         Additionally, the many layers of involved entities, i.e., the IRS, the states, the investment managers, the brokers and even the universities not only create complexity − they add cost.  In some cases I fear it is possible to more than eat up the tax savings with layers of fees.

The whole issue of 529 plans is a textbook illustration of how to mess up a good thing.  It is my experience that people do not use complex investment vehicles.

529 Plans Not Being Used By the Right People

With all this, 529 plans are being used − just not to the degree that they should be or by the people who need them the most.

As a generalization, the people who need the most assistance in meeting college education expenses are people from middle income families.  Wealthy families can cover the costs.  Poor families have numerous financial assistance programs available.  Many of these programs are means tested.  The income tests in these programs frequently eliminate middle income families.  These middle income families are the ones that most need a college savings plan with tax incentives.

Anyone establishing a 529 plan, including these middle income families, could use a little help wading through the maze of options and mountains of bafflegab associated with 529s.  Unfortunately, paying a qualified financial planner to help is expensive.  Please note the financial planner is a professional and deserves to be paid like one.  That compensation will either be paid as an identifiable fee or as part of a product commission.  When the compensation is buried in the product’s commission it may look like the service is free − but it is not.  If the dollars to be invested are modest, which is the case with most middle income families, the expense associated with a qualified financial planner is almost certainly more than the tax savings.  It is like paying an accountant $200 to find $100 in tax deductions for you.

To some extent you can get an idea of what is happening in the field by following the articles financial planners write for themselves. These articles do not talk about techniques for helping people who make $50,000 a year. The articles concentrate on techniques for using 529 plans as estate tax shelter mechanisms for the wealthy.  529 plans are supposed to be college saving plans, not estate tax shelters.  But that is how they are often used because they are terrific for this purpose.  A wealthy person can move potentially hundreds of thousands of dollars out of his estate, shift, reduce or eliminate taxes, and retain substantial control of the assets.  Few estate tax shelters offer such wonderful advantages.  The only problem is these are wonderful advantages for folks with estates in the millions who can gift hundreds of thousands of dollars.  That doesn’t describe most people who are worrying about college expenses.

You Really Should Do It Anyway

Here are several strategies you can use to select a 529 plan.  They range from simple too exhaustive.

General Determinations

1)       Determine what you can contribute toward the future college education of your children, grandchildren or yourself.  Something is better nothing and the power of compounding works miracles if college is still 18 years away for your new baby.

      a)       Do not worry about whether your child will be interested in college 18 years from now.  You can change the beneficiary in the future.  Surely, someone will appreciate the gift.

      b)       In the case you wind up with no one you want to help you can take the money back.  You will have to pay taxes on the earnings and a 10% penalty.

2)       Determine whether you prefer a tuition guarantee program or a savings program.

     a)       In general tuition guarantee allows you to prepay tuition.

     b)       Savings programs allow you to accumulate money to spend on any college education expense.

     c)       Key to the decision is whether you believe tuition costs will rise faster or slower over the years than the rate of return on investments.

The State Approach

The easiest way to open a plan:

1)       Begin with your own state.

     a)       The federal tax benefits apply to all state plans.

     b)       Your state’s plan should have maximum state tax benefits.

     c)       You must accept the investment manager selected by your state.  They have all selected competent firms.

2)       The best way to find your state’s plan is to go to [http://www.savingforcollege.com/].  This is easier than trying to find the state’s web site on your own.  In the left column find the section on “State Plans.”  Select your state.

3)       You will find important information about the plans offered by your state.  The information will include web sites to visit and phone numbers for additional information and/or enrollment.

4)       Most states sponsor multiple programs.

5)       Select the one that appeals to you the most.

6)       If your state does not offer the program you like, try another state.  Some experts feel Alaska has the best program.

The Investment Manager Approach

The largest investment managers have been hired by the states to run their programs.  If you particularly like one investment manager you can find a plan that he runs.  Please note this does not mean you will be able to use your favorite mutual fund run by the company.  Generally, the state has selected the investment options available and have funds run specifically for their plan.

1)       Go to your investment company’s web-site or do a search for <your company 529 plan>.  For example, a search for <Fidelity 529 plan> quickly identifies Fidelity’s web page dealing with the plans Fidelity runs.

2)       Compare the plans sponsored by the various states.  Generally, you do not need to be a resident of the state.

3)       In most cases you will be able to enroll online.

The Thorough Analysis Approach

I am the kind of person who likes to answer all the questions and find the very best fit for my needs.  This is true whether I am buying shoelaces or a flashlight.  The Internet has both simplified and complicated my life.  If you are this way you can find everything you need to know about 529 plans online.

1)       If you do an online search for 529 plans, you will find thousands of hits.  Here are three web sites I think are good.

     a)      http://www.savingforcollege.com/

     b)       http://money.howstuffworks.com/529.htm

     c)       http://www.fool.com/college/college.htm

2)       Make a list of personal considerations as you read through the material.

3)       Compare the numerous plans for fit with your personal circumstances.

4)       Note the ratings offered by www.Savingforcollege.com. They are a useful starting point from which you can either add or subtract your own points.

5)       Follow the links to the state and plan of your choice for enrollment information.

Hire a Financial Planner

If you are the type that likes to hire professional to handle things for you, retain a good financial planner.  He/she can to do the groundwork and help you make the best choice.  I recommend a fee-based planner.  He can be more objective in recommending products for your needs than a commission-based planner, who only gets paid for selling a specific product.

You Can Always Change Your Mind

Regardless of your approach, it is easier to make a decision if you remember one of the very good features of a 529 plan − its flexibility.  You are not locked into this decision forever.  You can roll your 529 plan into another 529 yearly if you want.  You can change beneficiaries.  You can increase or decrease your contribution.  You can even withdraw the money, subject to taxes and penalties.

Of course, there is one more alternative.  You can let your kids work to pay for their own education.  There is a good chance that’s what your parents let you do.  I like the idea of people saving for their kids’ education.  But there is also something to be said for letting them work for it.  We all take better care of what we own versus that which is simply given to us.