Filling the Gap

1. Filling the Gap 529 Plans 2005 NYSFAAA Guidance Counselor Workshop

2. What is a 529 plan? • A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code – hence the name. • There are two types of 529 plans: pre-paid tuition plans and college savings plans. All fifty states and the District of Columbia sponsor at least one type of 529 plan. In addition, a group of private colleges and universities sponsor a pre-paid tuition plan called the Independent 529 Plan.

3. Pre-paid tuition plans • Pre-paid tuition plans are currently offered in 13 states. New York is not one of them. • These plans generally allow college savers to try and to lock in future costs of colleges by purchasing units of future expenses at participating colleges and universities. • Many state governments guarantee investments in pre-paid tuition plans that they sponsor. • Residency in the state is often required

4. The Pre-paid downside • Prepaid contract programs are the less popular option. • The purchaser has limited options on where their money can be spent. • The purchaser also limits the potential gains their investment might have. • Some states, like Texas, have stopped accepting new enrollments all together. Rising tuition rates have put a burden on the guaranteed nature of the funds. • Expect pre-paid tuition 529 plans to close in the future as they don’t make as much financial sense for family’s in most cases. For the ones that do, they are costing states too much money to continue.

5. College savings plans • College savings plans generally permit a college saver to establish an account for a beneficiary for the purpose of paying the beneficiary’s eligible college expenses. • An account holder may typically choose among several investment options for his or her contributions, which the college savings plan invests on behalf of the account holder. • Investment options often include stock mutual funds, bond mutual funds, and money market funds, as well as, age-based portfolios that automatically shift toward more conservative investments as the beneficiary gets closer to college age. • Withdrawals from college savings plans can generally be used at any college or university. • Investments in college savings plans that invest in mutual funds are not guaranteed by state governments and are not federally insured.

6. More details • Savings programs are offered by every state. • There are usually tax benefits for residents. • Some plans have residency requirements, some don’t. Ones that are limited to residents might do something special like match a certain level of contribution based upon income and dependency age. • Plans can be sold directly to the investor or through a broker. Be aware that brokers sometimes steer clients towards more expensive options since they make a commission on the sale.

7. What does NY State do? • New York Saves Website: www.nysaves.com • In New York State, individuals can deduct up to $5,000 from their state return; $10,000 for joint return. • New York offers fifteen investment options managed by Vanguard. Three are age based and 12 are varied based on investment strategy and risk tolerance of the account holder. • There is a maximum contribution limit of $235,000 for a single beneficiary. • Minimum contributions are $25 or $15 with payroll deduction. • No fees to enroll or maintain an account. Only .58% fee for management. • Easy link to Upromise (www.upromise.com). Upromise is a cash back program that invests a percentage of certain purchases you make directly into your 529 Plan.

8. On the horizon • Sunset clause – all these great tax benefits may expire in 2011. It will be very unpopular politically though, so don’t be surprised to see these changes made permanent. • Potential tax changes were just recommended by President’s Advisory Panel on Federal Tax Reform may impact 529 plans • 529’s would be combined with other tax favored plans and replaced by “Save for Family Accounts”. These all in one accounts would have a $10,000 annual limit and could cover education, medical, home and retirement needs.

9. How does investing in a 529 plan impact financial aid? • Each educational institution may treat assets held in a 529 plan differently. • Generally, investing in a 529 plan will reduce to some degree a student’s eligibility for need based financial aid.

10. More pre-paid downside • Assets held in pre-paid tuition plans are generally treated differently for financial aid purposes than assets held in college savings plans. • Assets held in pre-paid tuition plans typically reduce need-based financial aid on a dollar for dollar basis. • If you expect your beneficiary to receive a significant amount of need-based financial aid, it is probably best not to invest in a pre-paid tuition plan if you have an option.

11. College savings plan advantage • Assets held in college savings plans generally receive more favorable financial aid treatment than pre-paid tuition plans. • Financial aid treatment for college savings plans depends on whether the assets held in the plan are considered to be assets of the parent or the student.

12. Where you save matters • According to Federal Methodology, about 6% of parental assets, in contrast to 35% of student assets, are expected to be contributed toward the student’s college expenses for each academic year. • According to Institutional Methodology, 25% of student assets are expected to be contributed towards a student’s college expenses each year

13. An example • Mary’s parents saved $40,000 for her in an UGMA account through a one time gift from her grandparent’s estate. When she applies for need-based aid, her student contribution from assets is between $10,000 and $14,000 depending on what formula is used. • Bill’s parents also received $40,000 but opened up a 529 savings plan in their name with Bill as the beneficiary. When he applies to college, his student contribution from assets is $0. His parent’s contribution from assets increases by approximately $1,600 to $2,400, depending on which formula is used. • The net difference is at least $8,400 in financial aid for the family.

14. Control of the money • In the previous example, the money from Mary’s UGMA account is considered a student asset because that’s exactly what it is – Mary’s asset. Instead of going to college, Mary could also choose to spend that money on a new BMW and a shot at Hollywood! • Bill however, does not own any assets. He is the beneficiary. If Bill leaves school to join the circus, his parents can designate another sibling to receive the money, or they can choose to take the money for themselves and pay taxes on it. No BMW for junior!

15. Another wrinkle • Since 529 plans are considered to be the property of the account owner, and not the beneficiary, anyone can own one. • This means that grandparents and friends of the family could start accounts for a student who is not their child. • Under current financial aid rules, this information is not collected, and is therefore invisible to a financial aid office when determining the family contribution.