You've probably heard of the 529 College Savings Plan. It's a program, usually sponsored by a state, that allows you to open an account and save on a tax advantaged basis for college expenses. There are dozens of 529 Plans to choose from, and no two plans are alike. A parent, grandparent, aunt or uncle trying to walk through the thicket of 529 plans could easily become confused and feel lost. They might naturally look for help.
Many 529 plans are sold by stock brokers. It may seem easier to ask a financial professional which of the confusing array of 529 plans is best. That certainly takes less time than wading through the details of even a couple of 529 plans. But stock brokers don't work for free. They work for commissions, and if they persuade you to open an account with a particular 529 Plan, you can be pretty certain they get a commission from it. If fact, they may have disclosed that commission to you. (If they didn't, ask.)
But there's a cloud on the horizon. The SEC (U.S. Securities and Exchange Commission), which regulates stock brokers, posted a "compliance alert" on its website on June 14, 2007: (http://www.sec.gov/about/offices/ocie/complialert.htm). The alert says that the SEC staff has uncovered problems with the way that brokerage firms supervise the sale of 529 plans. (You have to scroll about two-thirds of the way through the alert to get to the part about 529 plans.)
Brokerage firms have a legal duty to supervise their sales people (i.e., their brokers). The SEC staff has learned that many brokerage firms lack adequate processes and procedures to supervise the sale of 529 plans. That's not good, because 529 plans are hot ticket items these days, with the cost of college educations rising faster than the rate of inflation.
The SEC reported that one problem was a lack of evidence that brokerage firms were reviewing 529 sales to see that they were suitable for the customers. Brokers are supposed to recommend only investments and financial products that are "suitable" for their customers. Suitability is one of the crucial protections you, as an investor, have. Brokers should focus on your individual needs and wants. For example, if you and your spouse are in your 20's and have a one-year old child, the type of investments you'd use for college savings would probably be more heavily weighted towards stocks and their potential for long term growth, because the child has 17 years to go before college and the stock market may offer good returns over a long period of time like that. But if you and your spouse are north of the big 5-0 and the baby of the family is entering college in two years, you'd want to ratchet down the risk levels of your college savings so that you'd have less chance of losing entire tuition payments in the stock market because a big hedge fund has a tummy ache. If the brokerage firms aren't adequately supervising for suitability, there's a greater risk you might end up with a 529 plan that isn't right for you.
The SEC's compliance alert also revealed that, at many brokerage firms, 529 plan transactions were not entered into the firm's computer records. Why does recordkeeping matter? Because it is one of the keys to effective supervision. If a supervisor can't learn about a sale to a customer, how can the supervisors supervise? A supervisor could be responsible for numerous brokers and can't watch all of them every minute. So the supervisor has to rely on records much of the time. Without good recordkeeping, there may not be effective supervision and that heightens the risk of unsuitable sales of 529 plans.
The SEC also expressed concern that many brokerage firms didn't train supervisors or brokers adequately about the suitability of 529 plans the firms were recommending. This makes us furrow our brows more deeply.
Does the compliance alert mean that a 529 plan account that you opened through a stock broker is wrong for you? Not necessarily. Does it mean that your stock broker cheated you? Not necessarily. But it means that circumstances may have made it easier for a naughty stock broker to deal unfairly with you. Review your plan closely and see if it really suits your needs and wants. Think about whether you're comfortable with the risk levels of the investments in the plan. Look at the fees and expenses of the plan. Are they 2% or 3% a year? If so, that's pretty steep. Less expensive 529 plans are readily available. The plans with high fees and expenses may also be the ones that pay brokers generous commissions. If you have an expensive plan, you'd have to consider whether the broker might have put you in that plan in order to get a juicy commission.
If you're going to talk to a broker about 529 plans, be careful. Do your homework first. Learn as much as you can about these plans before you talk to the broker. Sure, the broker is supposed to be the expert. But the broker is also a salesperson. Would you rely on a salesperson at a car dealership to choose the best vehicle for you? No. You'd study up on cars first and have an idea of what you really want. Buying a 529 plan, which can involve a lot of money, deserves your time and attention, before you meet with the salesperson.
For more information about saving for college, please go to Uncle Leo's Den at http://www.uncleleosden.com/Step17FundingCollege.html, and our earlier blog at http://blogger.uncleleosden.com/2007/05/downsides-of-saving-for-college.html.
Celebrity News: Guess who was once a cheerleader (it's weirder than you'd think): http://www.nbc4.com/slideshow/entertainment/13010870/detail.html.
Showing posts with label 529 Plan. Show all posts
Showing posts with label 529 Plan. Show all posts
Friday, June 15, 2007
Monday, May 14, 2007
The Downsides of Saving for College Expenses
Just as a parent will wake up at 3:00 am to feed a hungry new born, a parent will save for the child's college expenses. Many commentators recommend that you first fund your retirement, and use any remaining money for college savings. The idea is that you don't want to be a burden on your kid(s) when you're old. Given the amount of money it takes to retire comfortably, most people would have little left for college expenses if they actually took care of retirement first. But the parental instinct to provide for the child--be it with food or with an education--extends beyond financial rationality. People will save for the educational expenses of their children, even at the cost of adequately funding their own retirements.
That being the case, they should be aware of some of the pitfalls and downsides of saving for college expenses. The 529 Plan and the Coverdell account are heavily promoted today, especially the 529 Plan. Both a 529 account and a Coverdell account offer tax advantages--the money you put into them isn't tax deductible, but the earnings are not taxed if they are used to pay college expenses. Coverdell accounts can also be used to pay primary school expenses. Some states offer deductions from state income taxes to their residents who open an account in a 529 Plan offered by that state.
However, there are the downsides, which you not hear much about. Each 529 Plan has only a limited number of investment options. The plan itself, and the investment options, may impose high costs and fees on your account (as much as 3% per year in some cases). That's a hefty burden. Even with the tax shelter offered by the 529 Plan, fees at that level seriously reduce your long term returns. If you compare an expensive 529 Plan against an inexpensive taxable account (one where you pay taxes on realized investment gains each year), the inexpensive taxable account can produce greater wealth. To see the details of this comparison, visit Uncle Leo's Den at http://www.uncleleosden.com/Step17FundingCollege.html.
Another problem with 529 Plans is that if the money in your 529 account isn't used for college expenses, you can retrieve it only after paying state and federal income taxes, and a 10% penalty on the earnings. So you have an exit strategy problem if Junior doesn't go to college; or does go, but doesn't graduate. Something like 1/3 to 1/2 of all college freshman do not graduate. If you save for college expenses in an inexpensive taxable account, you have no exit strategy problem and may even come out ahead.
A 529 Plan is a good idea if you can find one with low costs. You can search for low cost 529 Plans at www.savingforcollege.com. Among the plans that appear to have low costs are the Utah Educational Savings Plan Trust, the Virginia Education Savings Trust, the South Carolina Future Scholar 529 College Savings Plan (Direct-sold), and the New York 529 College Savings Program--Direct Plan. Note that you don't need to be a resident of a state to participate in its 529 plans. Also, you have to contact each of these states directly to open an account--these plans are not sold by brokers (which probably accounts for much of their low costs, since no one gets a commission for selling you one).
Finding Coverdell accounts with low costs tends to be easier than it is for 529 Plans, since you can open a Coverdell with a wide array of financial institutions. One downside of the Coverdell account is that you can only contribute $2,000 a year (the 529 Plan's limit is $12,000--or $24,000 for a married couple--a year). Also, the Coverdell can only be used by people subject to certain income limits. See www.uncleleosden.com/Step17FundingCollege.html for more details. The Coverdell has a severe exit strategy problem: if the account assets aren't used for educational purposes by the time the child who is the beneficiary of the account is 30, the child gets the remaining assets (subject to payment of state and federal income taxes and a 10% penalty on the earnings). You don't get any of the money back for your retirement or any other purpose.
Persons having incomes below $78,100 if they're single, or $124,700 if they're married filing jointly, may be able to avoid paying some or all of the taxes due on the interest income of U.S. Savings Bonds that is used for college expenses. So U.S. Savings Bonds actually provide a tax shelter for college savings for persons meeting the income requirements. Since Savings Bonds can also be used to fund your retirement, they don't have an exit strategy problem. They're also simpler than 529 Plans and Coverdell accounts.
The tax sheltered plans--529 and Coverdell--also require extra work at tax time, especially when your taking money out to pay for educational expenses. If you're concerned about the downsides of 529 Plans and Coverdells, just save for college expenses in low cost taxable investments like well-diversified mutual funds or U.S. Savings Bonds.
Seafood Lovers: Fishy things are happening at restaurants. Order the cheapest fish on the menu, because that's what you might be getting anyway. Here's why: http://abcnews.go.com/GMA/Consumer/story?id=3171346&page=1&CMP=OTC-RSSFeeds0312.
That being the case, they should be aware of some of the pitfalls and downsides of saving for college expenses. The 529 Plan and the Coverdell account are heavily promoted today, especially the 529 Plan. Both a 529 account and a Coverdell account offer tax advantages--the money you put into them isn't tax deductible, but the earnings are not taxed if they are used to pay college expenses. Coverdell accounts can also be used to pay primary school expenses. Some states offer deductions from state income taxes to their residents who open an account in a 529 Plan offered by that state.
However, there are the downsides, which you not hear much about. Each 529 Plan has only a limited number of investment options. The plan itself, and the investment options, may impose high costs and fees on your account (as much as 3% per year in some cases). That's a hefty burden. Even with the tax shelter offered by the 529 Plan, fees at that level seriously reduce your long term returns. If you compare an expensive 529 Plan against an inexpensive taxable account (one where you pay taxes on realized investment gains each year), the inexpensive taxable account can produce greater wealth. To see the details of this comparison, visit Uncle Leo's Den at http://www.uncleleosden.com/Step17FundingCollege.html.
Another problem with 529 Plans is that if the money in your 529 account isn't used for college expenses, you can retrieve it only after paying state and federal income taxes, and a 10% penalty on the earnings. So you have an exit strategy problem if Junior doesn't go to college; or does go, but doesn't graduate. Something like 1/3 to 1/2 of all college freshman do not graduate. If you save for college expenses in an inexpensive taxable account, you have no exit strategy problem and may even come out ahead.
A 529 Plan is a good idea if you can find one with low costs. You can search for low cost 529 Plans at www.savingforcollege.com. Among the plans that appear to have low costs are the Utah Educational Savings Plan Trust, the Virginia Education Savings Trust, the South Carolina Future Scholar 529 College Savings Plan (Direct-sold), and the New York 529 College Savings Program--Direct Plan. Note that you don't need to be a resident of a state to participate in its 529 plans. Also, you have to contact each of these states directly to open an account--these plans are not sold by brokers (which probably accounts for much of their low costs, since no one gets a commission for selling you one).
Finding Coverdell accounts with low costs tends to be easier than it is for 529 Plans, since you can open a Coverdell with a wide array of financial institutions. One downside of the Coverdell account is that you can only contribute $2,000 a year (the 529 Plan's limit is $12,000--or $24,000 for a married couple--a year). Also, the Coverdell can only be used by people subject to certain income limits. See www.uncleleosden.com/Step17FundingCollege.html for more details. The Coverdell has a severe exit strategy problem: if the account assets aren't used for educational purposes by the time the child who is the beneficiary of the account is 30, the child gets the remaining assets (subject to payment of state and federal income taxes and a 10% penalty on the earnings). You don't get any of the money back for your retirement or any other purpose.
Persons having incomes below $78,100 if they're single, or $124,700 if they're married filing jointly, may be able to avoid paying some or all of the taxes due on the interest income of U.S. Savings Bonds that is used for college expenses. So U.S. Savings Bonds actually provide a tax shelter for college savings for persons meeting the income requirements. Since Savings Bonds can also be used to fund your retirement, they don't have an exit strategy problem. They're also simpler than 529 Plans and Coverdell accounts.
The tax sheltered plans--529 and Coverdell--also require extra work at tax time, especially when your taking money out to pay for educational expenses. If you're concerned about the downsides of 529 Plans and Coverdells, just save for college expenses in low cost taxable investments like well-diversified mutual funds or U.S. Savings Bonds.
Seafood Lovers: Fishy things are happening at restaurants. Order the cheapest fish on the menu, because that's what you might be getting anyway. Here's why: http://abcnews.go.com/GMA/Consumer/story?id=3171346&page=1&CMP=OTC-RSSFeeds0312.
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