NEWS
BYTES
August 2007
http://www.sec.gov/
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.
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.
What
are the differences between pre-paid tuition plans and college
savings plans?
Pre-paid tuition plans generally allow college savers to purchase
units or credits at participating colleges and universities
for future tuition and, in some cases, room and board. Most
prepaid tuition plans are sponsored by state governments and
have residency requirements. Many state governments guarantee
investments in pre-paid tuition plans that they sponsor.
College
savings plans generally permit a college saver (also called
the “account holder”) to establish an account for
a student (the “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.
The
following chart outlines some of the major differences between
pre-paid tuition plans and college savings plans.1
Prepaid
Tuition Plan College Savings Plan
Locks in tuition prices at eligible public and private colleges
and universities. No lock on college costs.
All plans cover tuition and mandatory fees only. Some plans
allow you to purchase a room & board option or use excess
tuition credits for other qualified expenses. Covers all "qualified
higher education expenses," including:
Tuition
Room & board
Mandatory fees
Books, computers (if required)
Most plans set lump sum and installment payments prior to purchase
based on age of beneficiary and number of years of college tuition
purchased. Many plans have contribution limits in excess of
$200,000.
Many state plans guaranteed or backed by state. No state guarantee.
Most investment options are subject to market risk. Your investment
may make no profit or even decline in value.
Most plans have age/grade limit for beneficiary. No age limits.
Open to adults and children.
Most state plans require either owner or beneficiary of plan
to be a state resident. No residency requirement. However, nonresidents
may only be able to purchase some plans through financial advisers
or brokers.
Most plans have limited enrollment period. Enrollment open all
year.
1
Source: Smart Saving for College, FINRA®
How
does investing in a 529 plan affect federal and state income
taxes?
Investing in a 529 plan may offer college savers special tax
benefits. Earnings in 529 plans are not subject to federal tax,
and in most cases, state tax, so long as you use withdrawals
for eligible college expenses, such as tuition and room and
board.
However,
if you withdraw money from a 529 plan and do not use it on an
eligible college expense, you generally will be subject to income
tax and an additional 10% federal tax penalty on earnings. Many
states offer state income tax or other benefits, such as matching
grants, for investing in a 529 plan. But you may only be eligible
for these benefits if you participate in a 529 plan sponsored
by your state of residence. Just a few states allow residents
to deduct contributions to any 529 plan from state income tax
returns.
If
you receive state tax benefits for investing in a 529 plan,
make sure you review your plan’s offering circular before
you complete a transaction, such as rolling money out of your
home state’s plan into another state’s plan. Some
transactions may have state tax consequences for residents of
certain states.
What
fees and expenses will I pay if I invest in a 529 plan?
It is important to understand the fees and expenses associated
with 529 plans because they lower your returns. Fees and expenses
will vary based on the type of plan. Prepaid tuition plans typically
charge enrollment and administrative fees. In addition to “loads”
for broker-sold plans, college savings plans may charge enrollment
fees, annual maintenance fees, and asset management fees. Some
of these fees are collected by the state sponsor of the plan,
and some are collected by the financial services firms that
the state sponsor typically hires to manage its 529 program.
Some college savings plans will waive or reduce some of these
fees if you maintain a large account balance or participate
in an automatic contribution plan, or if you are a resident
of the state sponsoring the 529 plan. Your asset management
fees will depend on the investment option you select. Each investment
option will typically bear a portfolio-weighted average of the
fees and expenses of the mutual funds and other investments
in which it invests. You should carefully review the fees of
the underlying investments because they are likely to be different
for each investment option.
Investors
that purchase a college savings plan from a broker are typically
subject to additional fees. If you invest in a broker-sold plan,
you may pay a “load.” Broadly speaking, the load is
paid to your broker as a commission for selling the college
savings plan to you. Broker-sold plans also charge an annual
distribution fee (similar to the “12b 1 fee” charged
by some mutual funds) of between 0.25% and 1.00% of your investment.
Your broker typically receives all or most of these annual distribution
fees for selling your 529 plan to you.
Many
broker-sold 529 plans offer more than one class of shares, which
impose different fees and expenses. Here are some key characteristics
of the most common 529 plan share classes sold by brokers to
their customers:
Class A shares typically impose a front-end sales load. Front-end
sales loads reduce the amount of your investment. For example,
let’s say you have $1,000 and want to invest in a college
savings plan with a 5% front-end load. The $50 sales load you
must pay is deducted from your $1,000, and the remaining $950
is invested in the college savings plan. Class A shares usually
have a lower annual distribution fee and lower overall annual
expenses than other 529 share classes. In addition, your front-end
load may be reduced if you invest above certain threshold amounts
– this is known as a breakpoint discount. These discounts
do not apply to investments in Class B or Class C shares.
Class B shares typically do not have a front-end sales load.
Instead, they may charge a fee when you withdraw money from
an investment option, known as a deferred sales charge or “back-end
load.” A common back-end load is the “contingent deferred
sales charge” or “contingent deferred sales load”
(also known as a “CDSC” or “CDSL”). The
amount of this load will depend on how long you hold your investment
and typically decreases to zero if you hold your investment
long enough. Class B shares typically impose a higher annual
distribution fee and higher overall annual expenses than Class
A shares. Class B shares usually convert automatically to Class
A shares if you hold your shares long enough.
Be careful when investing in Class B shares. If the beneficiary
uses the money within a few years after purchasing Class B shares,
you will almost always pay a contingent deferred sales charge
or load in addition to higher annual fees and expenses.
Class C shares might have an annual distribution fee, other
annual expenses, and either a front- or back-end sales load.
But the front- or back-end load for Class C shares tends to
be lower than for Class A or Class B shares, respectively. Class
C shares typically impose a higher annual distribution fee and
higher overall annual expenses than Class A shares, but, unlike
Class B shares, generally do not convert to another class over
time. If you are a long-term investor, Class C shares may be
more expensive than investing in Class A or Class B shares.
Is
there any way to purchase a 529 plan but avoid some of the extra
fees?
Direct-Sold College Savings Plans. States offer college savings
plans through which residents and, in many cases, non-residents
can invest without paying a "load," or sales fee.
This type of plan, which you can buy directly from the plan's
sponsor or program manager without the assistance of a broker,
is generally less expensive because it waives or does not charge
sales fees that may apply to broker-sold plans. You can generally
find information on a direct-sold plan by contacting the plan’s
sponsor or program manager or visiting the plan’s website.
Websites such as the one maintained by the College Savings Plan
Network, as well as a number of commercial websites, provide
links to most 529 plan websites.
Broker-Sold
College Savings Plans. If you prefer to purchase a broker-sold
plan, you may be able to reduce the front-end load for purchasing
Class A shares if you invest or plan to invest above certain
threshold amounts. Ask your broker how to qualify for these
“breakpoint discounts.”
What
restrictions apply to an investment in a 529 plan?
Withdrawal restrictions apply to both college savings plans
and pre-paid tuition plans. With limited exceptions, you can
only withdraw money that you invest in a 529 plan for eligible
college expenses without incurring taxes and penalties. In addition,
participants in college savings plans have limited investment
options and are not permitted to switch freely among available
investment options. Under current tax law, an account holder
is only permitted to change his or her investment option one
time per year. Additional limitations will likely apply to any
529 plan you may be considering. Before you invest in a 529
plan, you should read the plan’s offering circular to make
sure that you understand and are comfortable with any plan limitations.
Does
investing in a 529 plan impact financial aid eligibility?
While each educational institution may treat assets held in
a 529 plan differently, investing in a 529 plan will generally
reduce a student’s eligibility to participate in need-based
financial aid. Beginning July 1, 2006, assets held in pre-paid
tuition plans and college savings plans will be treated similarly
for federal financial aid purposes. Both will be treated as
parental assets in the calculation of the expected family contribution
toward college costs. Previously, benefits from pre-paid tuition
plans were not treated as parental assets and typically reduced
need-based financial aid on a dollar for dollar basis, while
assets held in college savings plans received more favorable
financial aid treatment.
Is
investing in a 529 plan right for me?
Before you start saving specifically for college, you should
consider your overall financial situation. Instead of saving
for college, you may want to focus on other financial goals
like buying a home, saving for retirement, or paying off high
interest credit card bills. Remember that you may face penalties
or lose benefits if you do not use the money in a 529 account
for higher education expenses. If you decide that saving specifically
for college is right for you, then the next step is to determine
whether investing in a 529 plan is your best college saving
option. Investing in a 529 plan is only one of several ways
to save for college. Other tax-advantaged ways to save for college
include Coverdell education savings accounts, Uniform Gifts
to Minors Act (“UGMA”) accounts, Uniform Transfers
to Minors Act (“UTMA”) accounts, tax-exempt municipal
securities, and savings bonds. Saving for college in a taxable
account is another option.
Each
college saving option has advantages and disadvantages, and
may have a different impact on your eligibility for financial
aid, so you should evaluate each option carefully. If you need
help determining which options work best for your circumstances,
you should consult with your financial professional or tax advisor
before you start saving.
What
questions should I ask before I invest in a 529 plan?
Knowing the answers to these questions may help you decide which
529 plan is best for you. Is the plan available directly from
the state or plan sponsor?
What fees are charged by the plan? How much of my investment
goes to compensating my broker? Under what circumstances does
the plan waive or reduce certain fees?
What are the plan’s withdrawal restrictions? What types
of college expenses are covered by the plan? Which colleges
and universities participate in the plan?
What types of investment options are offered by the plan? How
long are contributions held before being invested?
Does the plan offer special benefits for state residents? Would
I be better off investing in my state’s plan or another
plan? Does my state’s plan offer tax advantages or other
benefits for investment in the plan it sponsors? If my state’s
plan charges higher fees than another state’s plan, do
the tax advantages or other benefits offered by my state outweigh
the benefit of investing in another state’s less expensive
plan?
What limitations apply to the plan? When can an account holder
change investment options, switch beneficiaries, or transfer
ownership of the account to another account holder?
Who is the program manager? When does the program manager’s
current management contract expire? How has the plan performed
in the past?
Where can I find more information?
Offering Circulars for 529 Plans. You can find out more about
a particular 529 plan by reading its offering circular. Often
called a “disclosure statement,” “disclosure
document,” or “program description,” the offering
circular will have detailed information about investment options,
tax benefits and consequences, fees and expenses, financial
aid, limitations, risks, and other specific information relating
to the 529 plan. Most 529 plans post their offering circulars
on publicly available websites. The National Association of
State Treasurers created the College Savings Plan Network which
provides links to most 529 plan websites.
Additional
Information About Underlying Mutual Funds. You may want to find
more about a mutual fund included in a college savings plan
investment option. Additional information about a mutual fund
is available in its prospectus, statement of additional information,
and semiannual and annual report. Offering circulars for college
savings plans often indicate how you can obtain these documents
from the plan manager for no charge. You can also review these
documents on the SEC’s EDGAR database.
Investment
Adviser Public Disclosure Website. Many college savings plans’
program managers are registered investment advisers. You can
find more about investment advisers through the Investment Adviser
Public Disclosure website. On the website, you can search for
an investment adviser and view the Form ADV of the adviser.
Form ADV contains information about an investment adviser and
its business operations as well as disclosure about certain
disciplinary events involving the adviser and its key personnel.
Broker-Dealer
Public Disclosure Website. You can find more about a broker
through FINRA’s BrokerCheck website. On the website, you
can search for any disciplinary sanctions against your broker,
as well as information about his or her professional background
and registration and licensing status.
Other
Online Resources. You can learn more about 529 plans and other
college saving options on FINRA’s Smart Saving for College
website. The website contains links to other helpful sites,
including the College Savings Plan Network and the Internal
Revenue Service’s Publication 970 (Tax Benefits for Higher
Education). FINRA’s investor alert on 529 plans also provides
valuable information for investors.
http://www.sec.gov/investor/pubs/intro529.htm
