Morningstar Advisor - Summer 2008 - (Page 33)

The crisis in the credit market has brought front and center the challenges of financing a college education. Andrea Feirstein, AKF Consulting That’s because Congress changed the law to tax earnings of more than $1,700 a year— interest, dividends, and capital gains—at the parent’s tax rate until age 24 for college students. For nearly 20 years, the cut-off for what was known as the “kiddie tax” was age 14. The upshot: Some advisors are telling families to cash in the custodial accounts and roll the money into 529 college-savings plans, the proceeds of which are tax-free as long as they’re used for qualified educational expenses. A Building Block tuition payments for the grandkids already in school. Provided the payments go directly to the university, those outlays are not subject to gift tax, and they do shift funds out of their estates. If it’s not the perfect solution, the 529 is still a building block. The plans, which for all practical matters are just 10 years old, offer tax-deferral on investment earnings and tax-free withdrawals if the money is used for qualified higher education expenses. Thirty-four states allow a state income tax deduction or tax credit for in-state plan contributions; a handful of these states, most recently Missouri, also offer their residents tax breaks for contributions to out-of-state plans. Despite these perks, total assets in 529 plans were $129.9 billion at the end of 2007, according to the Investment Company Institute. That may sound impressive at first, but it’s $50 billion less than the assets of American Funds Growth Fund of America, the largest equity mutual fund. So, why isn’t there more money in the plans? Joe Hurley, a 529 expert at Savingforcollege. com, thinks that the complexity of the programs has hindered sales. “It’s a more complex sale for advisors,” he says, “and the tickets tend to be relatively small.” There are direct-sold plans as well, but most sales go through the advisors. 529s Getting Better that investors usually don’t have to live in a particular state to use its 529. In fact, the largest such plan is not California’s or New York’s, as one might expect. The biggest, and biggest by a factor of three, is the Virginia CollegeAmerica plan, with $26 billion in assets and 1.7 million accounts. Why? Its advisorsold program uses the enormously popular American Funds. Hurley says that as the 529 market matures the programs will become more uniform and less costly. More plans are offering index funds and certificates of deposit as investment options, he says, both of which are cheaper than actively managed funds. Also popular are age-based investment options, which are similar to the lifecycle funds found in retirement plans. The asset allocations become less risky as the child gets closer to college age: An eight-year-old gets a more risky portfolio than an 18-year-old. Of course, if the current inflationary economic trends continue, prepaid plans might pick up in popularity, too. Clients make an investment now based on the child’s age, and the state guarantees whatever the tuition is when the student matriculates. The drawback is that the guarantee is only good in a state school in the client’s state, which may not be the student’s first choice. Still, such plans turn the collegesavings game on its head. The obligation to pay becomes the state’s, not the client’s. That will be a comforting thought if higher education costs start rising at 8% or 10% a year. K Jeffrey M. Laderman is a former senior editor with BusinessWeek magazine. Even a 529 plan, which is sort of a 401(k)-type plan, is not a one-decision solution. “Opening up a 529 is no more a college-savings plan than opening an IRA is a retirement plan,” says Taylor, of the College Funding Network. She counts at least 13 other ways to save and pay for college, from the obvious--such as Coverdell Savings Accounts, an IRA-like vehicle, and U.S. savings bonds--to the less obvious-such as the life insurance and annuities ideas. Each has its own profile on key criteria such as tax deductibility, tax-deferral, and whether the proceeds come out tax-free. “You need to use the right combination, and that’s going to be different for each family,” Taylor says. For clans with wealthy and generous grandparents, the best college plan could be estate planning: having them gift funds to 529s for each of their grandchildren. “Advisors should bring this up with affluent grandparents,” says AKF Consulting’s Feirstein. “What better legacy is there than to leave your grandchildren a college education? “ Yet another estate-planning strategy is to make Already, some states that have not attracted significant assets are choosing to fold their plans--Tennessee is the latest--and direct participants to others. One of the benefits—and some would say quirks of the plans--is MorningstarAdvisor.com 33 http://MorningstarAdvisor.com

Table of Contents Feed for the Digital Edition of Morningstar Advisor - Summer 2008

Morningstar Advisor - Summer 2008 Contents Letter from the Editor Contributors Inbox College Planning: Solutions and Concerns ETFs: The Next Chapter Engineering Financial Advice Investment Briefs Flexible vs. Style-Pure Managers: The Evidence Forging a New Commodity Index Work Your Way Through College Planning Sizing Up the Options Best and Worst 529 College-Savings Plans A 529 Travel Guide 10 Tax-Smart Tips for College-Savings Planning Global Dialogue How Sequoia Cranks Out Good Returns Year After Year The Many Layers of David Winters Living on the Edge Stocks to Buy Once a Decade With Munis Feeling the Pain, Some Opportunities Arise Health Care Provides Shelter from Economic Storm Help Your Clients Get More Out of Their Bond Portfolios Mutual Fund Analyst Picks 50 Most Popular Equity ETFs Undervalued Stocks Most Popular Variable Annuities New at Morningstar New on MorningstarAdvisor.com Closer to Fine

Morningstar Advisor - Summer 2008

For optimal viewing of this digital publication, please enable JavaScript and then refresh the page. If you would like to try to load the digital publication without using Flash Player detection, please click here.