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Table of Contents
Chapter 1
Introduction to 529 plans
Chapter 2
529 fund issues and flaws
Chapter 3 Alternatives to the 529 plan
Chapter 4
What if you already have a 529 fund?
Chapter 5
Research and resource tools
Chapter 6
1
Key questions to ask your financial adviser
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Chapter 1 - Introduction to 529 plansBased upon the statistics from the United States Bureau of Labor
Statistics, it shows that employers show favor to applicants with acollege degree over another candidate with only a high school
diploma. College graduates may even receive a higher salary than
those with job related experience, but who have never been to
college. This can prove to be discouraging for some and stressful for
others. Unfortunately, knowing that college is one path to success is
not productive unless one can actually attend and graduate from one.
Below is a graph showing the increase of college costs over a four
year span. 1
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1Source: Trends in College Pricing 2005 , The College Board ® .
Assumes a 5% increase in college costs each year and a child
entering college at age 18.
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The continuing increase in price for college tuition and related
educational expenses may cause alarm for some who have not taken
the time to financially prepare to send a loved one off to school.
Years of strict budgeting and knowledge of savings plans are usually
needed in times like this, but sometimes the decision to go to school
is not made in enough time to take the proper course of action.
Section 529 plans were devised in 1996 to offer families a tax-
advantaged medium for college expenses. Using this plan can help
aid in a successful journey to college for the beneficiary, but there is
key information to take into consideration when making a decision to
invest in a Section 529 plan.
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Stocks and investment bonds have already been chosen by Section
529 plan sponsors to give contributors an option where to invest their
money. Section 529 plans will mandate that you divide your
investment contribution geared towards an asset allocation based
upon the age of the beneficiary. Basically, the plan will advise for
your investment choice to be more aggressive for younger
beneficiaries and less aggressive for students nearing entrance into
college.
Sponsored by educational facilities, states, and state agencies, there
are two plan types available for section 529. They are pre-paid tuition
plans and college savings plans. The United States and the District of
Columbia supports the minimum of either one of these plans. Also,
there are a number of private universities that sponsor a pre-paid
tuition plan as well.
There are also several marketing techniques that were developed for
the Section 529 plan where an employer can offer a Section 529
Section plan as a payroll deduction or other options to their
employees. They also can offer an affinity rebate program that funds
college savings plan accounts from funds rebated by participating
merchants from where the investor purchases goods or services.
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Pre-paid tuition plans
Generally, pre-paid tuition plans are supported by state agencies and
have a residency requirement for the participant and offer a plan
guarantee backed by the state. This type of plan allows a person to
buy tuition credits, at the current rate, for future use and some can
include housing expenses. Eligible public and private universities and
colleges will lock in their price to avoid tuition inflation. Some policies
are applicable for a two or four year tour of college. It can include a
combination of a two year community college and then transferring
to a four year university. A few plans can go towards graduate school.
They have an age and a grade limit for the participant and carry
limited enrollment periods. Some of these plans also have pre-
determined lump sum goals before purchase based upon age of the
beneficiary and the amount of time the student plans to attend
college. Additional expenses such as housing are not covered, so
another savings plan might have to be considered to cover this cost.
5
The general idea of a pre-paid tuition plan is to hone in on a tuition
rate based upon the current rate. This is supposed to create a way to
save money in a frugal way. Payments are made in installments overa number of years. There are things to consider such as the added
restrictions when choosing a college and strict terms and conditions
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to follow for withdrawals. A list of schools is given so that a student
will know his or her college choices.
If the beneficiary of the pre-paid tuition plan decides they want to
choose another school that is not on the pre-approved list, it can be
transferred to another school, but it may reduce the value of the
policy. For example, if you have a policy that locked on to a
community college’s tuition rate, then those rates might be lower
compared to another school whose tuition might be higher. Therefore,
you still may have to pay out of pocket to make up the difference in
tuition rates.
It is possible to transfer a policy to another sibling, if the beneficiary
decides to forego college altogether, but age restrictions can
complicate matters if there is an older sibling involved. If there is no
one to give the pre-paid plan too, the investor can get his or her
money back, but only what they contributed and there might be a
cancellation fee involved.
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Most of the states guarantee funds contributed to the pre-paid tuition
plan with the assurance that if the Section 529 plan should find itself
in financial distress, the states will give the program what is neededto help them out of distress. Some states will help out financially
while others have no formal guarantee, but will make decisions as
deemed appropriate to the state’s legislature to keep the Section 529
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plans flourishing. A select few offer no guarantee whatsoever and will
do nothing to intervene if the plan starts to fail financially.
Pre-paid tuition plans have residency requirements and mandates
that either the purchaser or the beneficiary reside in the state
offering the tuition savings plan. They do not offer year round
enrollment, so it is necessary to be aware of application deadlines.
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There are no investment options available for pre-paid tuition plans.
The price of the policy is calculated before the purchase and depends
on the following factors: type of contract, the current age of the
beneficiary, current tuition rates, and projected future rates. This
money is pooled together and is used for long term investments so
the return on investments will meet or exceed the cost for tuition as
it increases over time.
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College savings plans
Savings plans that are offered differ from pre-paid tuition plans in
various ways. They do not guarantee a lock on tuition prices but
contributing to a savings plan covers housing, tuition, mandatory fees,
and miscellaneous items such as books. They have contribution limits
in excess of $200,000.
They have no state guarantee and most investment choices are
prone to market risk. This option may not be profitable and can also
decline in value. The plan offers neither age restrictions nor residency
requirements for the contributor or the beneficiary of the plan. Out of
state residents would possibly have to purchase a college savings
plan through a broker or financial adviser, but the plan offers year
round enrollment.
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Unlike the pre-paid tuition plan, a student is not confined to a list of
schools they can attend. Contribution limits vary depending on the
state, but there are no household income limits or annual
contribution limit. Large annual contributions of $12,000 or more may
require a special tax form to be completed called a federal gift taxform. There are state tax deductions a contributor may be eligible for
if they are a resident. Earnings are tax deferred in the Section 529
plans.
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The investment options are plentiful with the college savings plan.
Investors have an assortment of mutual fund portfolios and age-
based mutual fund portfolios. Generally, the portfolio’s funds are
invested in stock funds when the beneficiary is younger and as the
child ages the asset allocation changes to other bond funds.
There are some states that offer investment options that are not age-
based. You can choose different portfolio risk levels. Some states also
have an option to get a certificate of deposit that associates their
interest rates with a file that measures the average tuition rate.
Recently, the IRS has allowed investors to change their options once
each calendar year.
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This graph outlines the difference between plans:
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Prepaid Tuition Plan College Savings Plan
Most plans allow you to prepay
tuition at eligible public and
private colleges and universities
at today's price.
No lock on college costs.
All plans cover tuition and
mandatory fees. A few plansallow you to purchase a room &
board option, use excess tuition
credits for other qualified
expenses or cover all qualified
education expenses.
Covers all "qualified higher
education expenses," including:
• Tuition
• Room & board
• Mandatory fees
• Books, computers (if
required)
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Most plans set lump sum and
installment payments prior to
purchase based on age ofbeneficiary and college tuition
years 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.
Some state plans have
age/grade limits for
beneficiaries.
No age limit. Open to adults and
children.
Most state plans require eitherplan owner or beneficiary to be
a state resident at the
enrollment time.
Most plans do not have a residencyrequirement. 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.
Source: Smart Saving for College , NASD®
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Potentially, you can receive a state tax benefit for contributing to a
college savings plan, but carefully review the plan offers before
participating in one. It is good to know if rolling money over into
another state account is allowable if the participants move out of
state. Some states provide other benefits for investing into a Section
529 plan with a matching grant. Unfortunately, matching grants
benefits are for in state residents. Withdrawals from the Section 529
plan will come with a 10% penalty and income tax on earnings if not
used for college expenses, but there are also numerous fees involved
with the plan, which can reduce your returns overall.
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Chapter2 - 529 fund issues and flaws( flaws, issues, costs, etc)
Section 529 plans can be purchased in two ways:
The first option is to purchase the college savings plan directly from
the state that supports the plan with no broker or third party involved
in the transaction.
The second option is “advisor sold,” where investors purchase a
college savings plan through a brokerage firm or bank. When this
option is utilized then there are hefty fees that need to be taken into
consideration such as a sales load or fee.
Regulation of Section 529 plans
The U.S. Securities and Exchange Commission decided in 1999 that
interests in Section 529 plans are community securities for reasons of
the federal securities laws. With that being said, the Section 529
plans are not mandated to be registered as investment businesses
under the Investment Company Act of 1940. The interests in these
plans are not cataloged under the Securities Act of 1933 or the
Securities Exchange Act of 1934. Even though they are not registered
under these acts, it does not mean they are not subject to the laws
of the states that sell the Section 529 plans, because they are.
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Interests in Section 529 plans are grouped under the regulatory
regime of the Municipal Securities Rulemaking Board, MSRB, because
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they are municipal securities. Security firms that issue Section 529
plans must show general knowledge or pass a qualification exam that
is favored toward Section 529 plans. The MSRB proposed some rules
that would enforce advertising and no cash paid compensations
customs on the issuance of Section 529 plans that are comparable to
mutual fund sale standards under NASD rules.
The NASD, Inc. is an organization that represents individuals and
companies that do business in the securities industry. They regulate
trading practices, license individuals, and also discipline those who
fail to abide by regulatory compliance and written rules that are
sanctioned by the U.S. Securities and Exchange Commission, SEC.
Securities are a combination of debt and equity categories such as
savings bonds, mutual funds, corporate stock options or other stock
options that can be bought or sold.
14
In 2003, NASD, Inc. recorded multiple enforcement actions and
suspended a larger number of individuals in the securities industry
than in prior years. They also monitor trade transactions on the
NASDAQ Stock market and have employees based nationwide. Over
2,000 employees are governed by a Board of Governors, with the
majority being unassociated with the securities industry.
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NASD, Inc. does not govern the state issuers of Section 529 plans.
They do enforce MSRB rules for the securities companies that issue
Section 529 plans. They also apply their own advertising rules to the
promotion of the fundamental investments needed to make the plan
work.
High Fees
There are various fees involved with the Section 529 plans that
diminish the purpose of purchasing a college savings plan in the first
place. It is imperative to understand the fine print associated with the
plan. Administration and enrollment fees can vary by state and the
plan chosen. If you are an out of state resident and purchase a
college savings plan through a broker, you are subject to the broker
fees, as well as the plan fees.
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A broker is a mediator between a buyer and a seller. Generally, incommerce a broker is used to assess suitable solutions in the best
interest of the client. Commerce deals with the supply and demand of
business transactions. If there is something you want to buy, but do
not have the knowledge to obtain it, then a third party represents
you and obtains the information or product for you, for a fee. When
dealing with Section 529 plans, people rely on the knowledge abroker has about college savings plans to help them choose the best
option. No fees are paid up front; the brokers are typically
commission based.
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The term that is used for this hefty fee is called a “load.” Along with
the commission the broker gets for selling a Section 529 plan, there
are also annual distribution fees that range from .25% to 1.00% of
your total investment. A broker usually receives most of these fees. A
lot of plans that a broker might offer have more than one class of
shares. Each class consists of various expenses and fees. Listed
below are definitions of each of these classes:
Class A shares: Requires you to pay a fee up front, called a front-end
sales load, therefore reducing your contribution into the savings plan.
For example, an investor has $2,000 and purchases a plan from a
broker that has a 10% front end load fee, then that amount is taken
from the original investment of $2,000. Subtract $200 from $2,000
and you have $1800. According to the National Association of
Securities Dealers, also known as NASD, Inc. for mutual funds, a
front end load can not be more than 8.5% of your investment.
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Class A shares typically have lower annual fees and expenses
associated with other Section 529 share classes. Also, if you
contribute more than a certain monetary amount, you can possibly
receive a breakdown discount. Some savings plans base breakdown
discounts on the condition that more than one plan is purchased or
discounts could be dependant on the total amount you invested into
the plan. If the plan has a breakdown discount, this can possibly
reduce your front end sales load fee, but not by much. Breakdown
discounts are not applicable to Class B or Class C shares.
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Class B shares: This class does not require you to pay a front end
sales load. A fee may be charged if you take money out from an
investment option. This is known as a back end load fee and is
money you pay when you sell your shares. This fee typically goes to
the broker who sold the Section 529 plan. The amount of the load
depends on the duration of the shareholder’s ownership of his or her
shares and generally reduces to zero if they hold on to it long enough.
An example is if the investor sells their shares within one year of
purchasing, they may have a high back end load fee. If he or she
waits until five years of ownership and then decides to sell they may
not get charged a back end load fee.
Class B shares can have higher annual distribution fees and expenses
than Class A shares. Sometimes Class B shares will convert
automatically to Class A shares if you keep your shares for a lengthy
amount of time.
Class C shares: This class can have a front or back end sales load,
annual distribution fees, and other expenses. This class does not
automatically convert into another class over time, which can become
costly if you hold on to these shares over time.
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Below is a College Plan Share Class Costs Comparison Chart
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How the fees are used
There are various levels of fees that can differ from state to state for
the Section 529 savings plan, but it is the plan’s responsibility toshow how the fees are being used, however a main concern lies with
the varying cost of administrative fees. For example, Some people
feel Tennessee’s plan is lower than average because of low cost
index funds they use and they do not utilize the broker sold option.
They have a cost structure that is easy to follow because it charges a
flat rate of 0.95% regardless of the investment choices selected.
Unfortunately, Tennessee’s administrative costs are ridiculously
expensive. The program’s disclosure documents make no effort to
explain why it costs nearly 50% more than similar plans offered by
Missouri and Michigan. Tennessee charges as much as 0.88% in
administrative fees, without explanation as to why it is so expensive.
Ironically, Utah reported that is has been able to maintain operating
costs with administrative fees as low as 0.25%.
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States should be held accountable for the fees and expenses that
they charge. A proactive way to improve their seemingly deceitful
ways is to justify their administrative fees and to explain where the
monies from these fees are ultimately being used. Currently, thereare few answers for those important questions.
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Questionable broker practices
As previously mentioned, the NASD, Inc. is an organization that helps
enforce regulations and guidelines put in place by the SEC toencourage ethical security business practices. Based on numerous
customer complaints, Section 529 savings plans have been under
investigation. Several consumer complaints have been filed about the
fees associated with purchasing a Section 529 plan and also the lack
of supervision of brokers selling these plans.
Consumers are afraid that brokers do not have adequate knowledge
to provide them with the best savings plan for their financial situation.
There was an investigation involving 20 securities firms and the
majority of those firms sold out of state Section 529 plans, which
benefited the commission earning broker more than the client. But,
even if a plan is purchased directly through the state, important
information could still not be disclosed to the contributor.
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MSRB Rule G-19 mandates that a broker-dealer “have reasonable
grounds” for their recommendations they deem to be in the best
interest of their client. NASD knows that, according to the MSRB’s
perceptions of rule G-19, an out of state college savings plan sale can
be a suitable option based upon the applicant’s situation.
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For example, an underlying investment company can offer an in state
plan that would provide substandard portfolio management or a
limited selection of investment options. The fees and expenses
included with the in state plan could be very expensive. In some
states, the in state plan may not offer a state tax deduction or
benefit. A broker should consider an array of factors in addition to
the possible in state benefits, before offering a suggestion.
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NASD, Inc. chose twelve additional firms to review to include small
broker-dealers, mid-size firms, and bank and insurance affiliated
firms. They also included firms that offered different kinds of Section
529 plans rather than just one to see if it had an impact on sales
procedures and the in-state/out-of-state statistics. Their March 2004
investigation focused on sales of out-of-state applicants of 26
jurisdictions that seem to have the best tax incentives to use in state
plans.
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The findings of the review are listed below:
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The NASD, Inc. investigation is ongoing and will work together with
other regulatory authorities to ensure that interests in Section 529
plans and their investments are advertised and issued in an ethical
manner that protects buyers.
Inadequate disclosure
NASD, Inc. also was concerned that information was not being fully
disclosed to investors about the potential state tax benefits that are
lost if an out of state Section 529 plan was purchased. It is also
cause for worry when other options are not presented to the investor.
Sales brochures were also a part of the investigative process, due to
the fact that suspicious tactics were being used by not disclosing
certain terms and agreements and also not disclosing investment
risks. It has been stated by Congress that states are not bound by
the same regulations, with a few exceptions, as other securitiescompanies. Therefore, some Section 529 plan practices may prove to
be unethical, because they are not forced to include all fee
disclosures on any or all material. It is mandated that the annual
account statements investors receive show earnings, distributions,
and contributions.
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Most Section 529 Savings plans bury important fees and expense
information in the very back of a 100 page long program disclosure
document. This could form an opinion that, because of the lack of
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effort put into making the information more readily accessible, it is a
practice of deceit.
A good way to rectify that problem would be to feature fees andexpense information on their web sites or as a “snapshot” in their
publications. Costs could be highlighted at the base level as well as in
an investor’s summary of all the plan’s expenses. That way, investors
can see what they are paying for in a more convenient style than a
book filled with fine print.
24
In 2003, more than 2,000 sales brochures promoting Section 529
plans were reviewed by NASD, Inc. The staff focused on questions
concerning adequate disclosure of risks as well as the benefits of
contributing to Section 529 plans, disclosures of sales charges and
other fees, as well as an accurate picture of tax penalties for
investing in Section 529 plans.
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Television commercials were also reviewed as part of their ongoing
investigation. One in particular was a commercial that discussed high
private college tuition costs and the focal point of the commercial
included a child holding a college savings plan withdrawal check for
$250,000. The advertisement pointed out that Section 529 plans
have “powerful savings benefits” and suggested that contributing in a
Section 529 plan will provide enough money to pay for the price of
expensive private college tuition.
The NASD, Inc. prohibited the broker-dealer from using the
commercial due to the fact that there are no guarantees when it
comes to investment plans. The opportunity to produce a $250,000
check at the conclusion of a college savings plan is a highly favorable
goal; there is no assurance it can be reached.
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NASD, Inc staff also corrected sales material that did not represent
the tax treatment of investments in Section 529 plans. There was a
print advertisement reviewed that highlighted the headline, “Pay for
college TAX-FREE!” The headline suggested that college tuition costs
would be covered and that there were no tax implications for in or
out of state applicants during the investment process. That is not a
true statement for out of state applicants; therefore NASD, Inc.
mandated the broker firm make changes to their advertising
campaign before using it again. They will continue to review Section
529 plan advertising campaigns to prevent incorrect information
being distributed.
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NASD, Inc. supports standardized disclosure of Section 529 plan fees
and expenses. It would specify the fees associated with contributions
in a Section 529 plan and would assist an investor’s capability to do a
cost comparison affiliated in an investment in Section 529 plans.
They also recommend concise disclosure in regard to the forms of
compensation paid to the dealers who issue the Section 529 plans.
In August of 2004, NASD, Inc. proposed to the MSRB and SEC that
each SEC and NASD, Inc. sales practice standard that applies to the
allocation of mutual funds to retail investors should also apply to the
sale of mutual funds in Section 529 plans. These standards should be
implemented by additional sales requirements to address the
distinctive traits of Section 529 plans. The point behind the
recommendations was that Section 529 plans present similar
disclosure and sales practices as that of mutual funds.
26
NASD, Inc. closely worked with the SEC to develop what they hoped
to be favorable disclosures to investors when they purchase mutual
funds. It would be unfair to Section 529 plan holders to be reduced
to a lower standard of clarity than mutual funds. Also, the same
benefits that Section 529 plans proclaim to have, such as in state tax
deductions and fee reductions offer additional disclosure and sales
practice confusion.
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The different variations associated with the Section 529 plans
complicate the options for investors and the sales procedures for
those issuing the plans. While federal tax advantages are common to
all college savings plans, the state tax treatment of Section 529 plans
can vary between states. Knowing what the state tax treatment is for
the investor's state plan can help in the decision making process.
Investors receive a tax deduction or credit in the District of Columbia
and the 25 states that sponsor the Section 529 plans.
The difference in plan fees can also cause confusion to investors. All
Section 529 plans charge fees and expenses and contributors to the
plan have to look to compare the plans. Not only do these costs vary
between Section 529 plans, they also can differ within one solitary
plan.
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Section 529 plans are a cause for more alarm than basic mutual
funds and other savings bond options because they are not governed
closely by the SEC. They do not have the authority over the State
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Governments who are administrating the Section 529 plans. In an
ordinary mutual fund plan, a broker is paid a fee and then the
investor pays fees to the fund manager.
With Section 529 plans you are placed in a position to possibly pay
enrollment fees, form fees, account maintenance fees, administrative
fees, asset based fees, and program management fees. That is while
you are actively participating in the plan, which does not include
penalties for withdrawal.
These fees are being taken out of your savings plan and are greatly
reducing the money in your account. It could prove to be beneficial
to invest in another kind of savings plan where you are not paying
layers of fees associated with having middle men administrating the
Section 529 savings plan.
28
Based upon the family's financial situation, having s Section 529could prove to do more harm than good. The excess money that
covers fees to the college savings account adds up and can be used
for another family obligation such as saving for a down payment on a
house or car.
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Investors’ resources
Section 529 savings plans can cause confusion for both brokers and
investors. Broker-dealers need more education so they can explain topotential customers the complexities of these plans. Customers also
need to be proactive in educating themselves about what Section 529
plans offer and what other investment options are available.
The NASD, Inc. web site gives guidance for both investors and
brokers who deal with Section 529 plans. See http://www.nasd.com/ .
NASD, Inc. has two resources online to help investors compare plans.
Their booklet, Smart Saving for College, features detailed information
on Section 529 plans and also other avenues for college savings.
They also have created a tool to aid investors to compare how fees
can affect returns. It also guides investors where to find Section 529
disclosure information.
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On the next page is a picture of the resource tool. Just plug in the
information as described and it can do a comparison among the plans
for you.
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MSRB
The MSRB is a self regulated organization created by Congress in the
Securities Acts Amendments of 1975 to write rules in regard to
security transactions in municipal securities issued by brokers,
dealers, and municipal securities dealers. A unique factor in the
legislation is specified in section 15B of the Securities Exchange Act
which dictates that the MSRB board shall include members who are
divided equally among non broker members, bank dealers, and
members who are affiliated with securities firms.
Also, a member has to represent an issuer of municipal securities.
The MSRB was designated as a sector specific legislation to regulate
broker-dealer securities transactions sold by state and local
governments.
Meetings are held periodically throughout the year to make policy
decisions, review developments and approve rules in the municipal
securities circuit. A full time staff takes care of the day-to-day
operations of the MSRB. The MSRB are funded by assessments made
on broker-dealers for initial fees, annual fees, fees for underwriting,
and transaction fees.
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More than 2,400 broker-dealers are registered with the MSRB to
participate in municipal securities activities. They range from small
firms to the very large with nationwide coverage. A considerable
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number of these broker-dealers issue Section 529 college savings
plans.
The MSRB was devised to write rules to help govern broker-dealerconduct in the municipal securities market, but the Exchange Act
gives the inspection of broker-dealers for compliance to be carried
out by other agencies. NASD, Inc. and the SEC perform the
enforcement and compliance inspections for securities firms.
The MSRB gave guidance to a Section 529 college savings plan to
offer the A, B, and C share class. Broker-dealers have to consider a
suitable share class for a particular investor. The MSRB also stated
that a customer’s investment goal can be a major factor when
deciding which share class is appropriate for their client. The goal
primarily consists of how long the customer plans to keep the
account and when funds are expected to be withdrawn.
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Broker-dealers are also forbidden from suggesting transactions to
investors that are excessive in size or frequency. If a broker-dealer
knows that an applicant is contributing to a Section 529 college
savings plan hoping to be eligible for a federal tax benefit, it could
violate Rule G-19 if he or she recommends roll-overs from one
Section 529 savings plan to another in such a pace that they lose thefederal tax benefit. Even if the federal tax benefit is not affected, if
there are multiple roll-overs suggested to a customer, depending on
the situation, it could be looked upon as illegal churning.
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Churning is the rapid buying and selling of an investor’s stocks, which
is an illegal practice because generally brokers get commission on
each trade they make for an investor. The best interest of the client
is not performed if the investor is paying fees on top of fees for
investment trading transactions.
Broker-dealers should not engage in transactions designed to
increase commission revenues in a way that is not beneficial to the
customer. Also, suggesting transactions to clients in an amount
created to avoid commission revenues such as sales under
breakpoints where the client would be permitted to lower commission
charges, or withholding benefits of breakpoints may also violate Rule
G-17.
The MSRB, in June 2004, proposed for comment a set of draft
amendments to its gratuities and gifts rule in progression of the
MSRB’s goal of lowering potential conflicts of interest and
empowering the merit-based environment in the municipal securities
market. The proposal would stop broker-dealers from accepting or
making payments of non-cash compensation with an offering of
community securities, with limited exceptions.
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The MSRB and NASD, Inc. are subject to provisions that prohibit eachto abide by rules that “impose any schedule or fix rates of
commissions, allowances, discounts, or other fees to be charged by”
the broker-dealers subject to their jurisdiction.
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The MSRB has proclaimed that the charges permitted by NASD under
its Rule 2830 for mutual fund sales is a factor in deciding what a
broker-dealer selling shares of Section 529 savings plans is charging
for a commission fee and needs to ensure that it’s a fair price.
Charges for a Section 529 savings plan transaction in excess of those
within limits are similar to mutual fund shares under NASD Rule 2830
can not, based upon the situation, meet the reasonable standard
under MSRB Rule G-30(b). Also, a sales charge for a Section 529
savings plan transaction should meet the NASD scale for scale of an
exact mutual fund, which should abide by the MSRB Rule G-30(b).
In respect to state tax treatment of investments in Section 529
savings plans, the MSRB is the forefront of ensuring that broker-
dealers are obligated to educate their clients that it is possible to lose
state tax benefits if he or she chooses to invest in an out-of-state
Section 529 savings plan.
Chapter 3 - Alternatives to the 529 plan
The Coverdell Education Savings Accounts (ESAs).
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This is also known as Education IRAs. The Coverdell Education
Saving Accounts are another option to save for college education.
Their investment choices are almost endless. With the exception of
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life insurance policies, buying and selling can occur at any time. ESAs
can be purchased at most brokerage firms, a mutual fund company,
or any other securities institution.
In 2001, The Federal Tax Act allowed a tax exemption on earnings
on withdrawn funds for qualified education expenses. After the law
came into effect, almost a million-and-a-half United States children
with Section 529 accounts were valued at $9.5 billion. A few years
later, Section 529 plans became the preferred method to save for
college. Although this law was set to expire in 2010, it was extended
by the Pension Protection Act of 2006 and is now permanent.
Another advantage that ESAs provide is that money can be
withdrawn to pay for private elementary schools, high school
expenditures, and post secondary school expenses. You can combine
having an ESA account along with a Section 529 account.
There are two annual contribution limits for investors:
1. There is a limit, up to $2,000 for contributions, for one
beneficiary at any time.
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2. If more than one ESA is purchased for one beneficiary by other
family members, it needs to be verified that they are not
exceeding the $2,000 annual contribution limit as a whole.
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There is a penalty for exceeding these limits and it is a 6% excise
tax on the excess money. This can be forfeited if the excess
amount is withdrawn within six months of the contribution.
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Coverdell ESA Contributions Graph:
To get a better example of how an ESA can work, if a father
invests $2,000 a year with an annual yield of 6% when his child
turns one year of age, then monies accumulated will be
approximately $61,000 that can be available for your eighteen
year old college bound student.
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There are income restrictions associated with an ESA. If a couple
files a joint return on their federal tax return and their modified
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adjusted gross income is less than $190,000 a year, they can
contribute $2,000. If the modified adjusted gross income is above
$220,000, then couples are not able to contribute.
Your modified adjusted gross income is annual adjusted income
without taking IRA deductions, student loan interest, and other
deductions under the Internal Revenue Code.
If you are a single taxpayer, then you will be able to contribute up
to $2,000 if your modified adjusted gross income is less than
$95,000. If your modified adjusted income exceeds $110,000,
then you are not allowed to contribute to an ESA.
Organizations can contribute to ESAs without income limitations.
Below is an equation to figure your modified adjusted gross income:
If your income is between $190,000 and $220,000 (joint filers), or
$95,000 and $110,000 (single filers), you can figure your ESA
contribution limit by using the following equations:
Married Joint Filers
$2,000 - (Modified Adjusted Gross Income - $190,000 * $2,000) =
Contribution Limit
$30,000
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Single Filers
$2,000 - (Modified Adjusted Gross Income - $95,000 * $2,000) =
Contribution Limit$15,000
Fees and other associated charges will vary based upon the
investments that are chosen and the financial institution the ESA is
purchased from. It is still wise to understand that any plans with fees
can become costly over time and make or break the advantages to
any savings plan.
Rollovers
Assets can be rolled over from one Coverdell ESA to another or the
beneficiary can be changed. The beneficiary’s interest can be
transferred to a spouse or former spouse due to a divorce.
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Amounts rolled over from a Coverdell ESA are not taxable if they are
rolled over into another Coverdell for the benefit of the same
beneficiary or a member of the beneficiary’s family who is under the
age of 30. The age limit is not applicable if the beneficiary is a specialneeds student.
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Members of the beneficiary’s family include:
• Child or descendant of a child
• Brother, sister, stepbrother, or stepsister
• Father or mother or ancestor of either
• Stepfather or stepmother
• Son or daughter of a brother or sister
• Brother or sister of a father or mother
• Son-in-law, daughter-in-law, father-in-law, or mother-in-law
• The spouse of any individual listed above
• First cousin
Custodial Accounts
A custodial account is a Uniform Gift of Minor ACT account or
Uniform Transfer to Minors Act account. A student’s guardian,
grandparent, or another adult acts as a custodian for these types ofaccounts. They are in charge of making investment decisions for the
beneficiary. The beneficiary can make investment decisions on the
account when they reach the age of maturity.
The Uniform Gift to Minors Act accounts are limited to cash and
securities. Conversely, the Uniform Transfer Minors Act account does
not have those limits. The Uniform Transfer Minors Act can include
other types of property.
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Custodial Accounts Advantages
The initial $750 in earnings in this account is tax free, for
beneficiaries ages 14 and younger. The subsequent $750 in earningsis taxed at the beneficiary’s federal tax rate. When earnings on the
custodial account reach over $1500, then that is taxed at the
custodian’s federal tax rate.
Beneficiaries aged 14 and older have a similar benefit where the first
$750 in earnings is tax free and any earnings afterward are taxed at
the beneficiary’s tax rate. To read about the tax rules for
beneficiaries, you should read IRS Publication 929: Tax Rules for
Children and Dependents.
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Custodial accounts have a wide array of investment options. There
are no income or contribution limitations. Withdrawals can be made
without penalty. It does not have to be a qualified education expense.
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Disadvantages
Based upon the state in which the beneficiary lives, he or she can
take ownership of the custodial account and use it however they wishwhen they reach a certain age. The ages can vary from 18 to 25
depending on the state in which they reside.
When the adult who purchased the custodial account loses ownership
to the beneficiary, this can cause conflict, if the beneficiary decides
they do not want to go to college and wants to use it for something
else.
In this instance, because the account is deemed as the beneficiary’s
asset, it can not be transferred to another sibling or another family
member who would want to use the money for college.
What Utah is doing
Studies revealed in 2004 that if a student wanted to complete a four
year degree at one of Utah’s universities or colleges, they could
expect to spend $32,000 or more by the time they graduate.
Projections show that the same degree can cost more than $80,000
by the year 2024.
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The State of Utah wanted to create a low cost and basic college
savings program and devised Utah’s Educational Savings Plan. UESP
have been rated by many investment research groups, publications,
and other third parties as one of the top five Section 529 plans in the
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nation. UESP markets solely in Utah, but 80% of the savings plans
participants are out of state residents.
UESP provides matching funds for low income in-state residents.UESP will match incentives of up to $300 per year, for four years, for
the initial 50 children of resident families who apply with incomes up
to 200% of the federal poverty level.
UESP is a member of the College Savings Plan Network and joins in
on the effort to create a voluntary disclosure system between the
various plans. UESP is developing and redefining materials to meet
the standards of the disclosure principles, so that information they
provide will help customers make an informed decision when
comparing savings plans.
Series EE & I Savings Bonds
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U.S. Series EE savings bonds that were issued after 1989 or Series I
savings bonds are another tax advantaged way to save for college.
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Positives
This is backed by the credit of the United States government; the
interest from these bonds is tax free when used for qualified collegeeducation expenses. The interest on Series EE and I Savings bonds is
exempt from state and local taxes.
Negatives
The entire interest exclusion is available to married couples filing
jointly with a modified adjusted gross income of $91,850 and less.The same goes for single filers with a modified adjusted gross income
of less than $61,200 in 2005. The interest exclusion does not apply if
your modified adjusted gross income is between $91,850 and
$121,850 for joint filers and between $61,200 and $76,200 for single
taxpayers.
Income is not a factor if you are married and filing separately
because you can not take advantage of the Series EE & I Savings
Bonds program. Additional information is readily available at the IRS
Publication 970: Tax Benefits for Education .
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To get more information about using savings bonds for educational
purposes, you should visit the Bureau of Public Debt’s website . TheBureau of Public Debt phone number is (800) 487-2663 and you can
inquire about current rates for savings bonds. Another number that
can provide rate information as well is (877) 811-SAVE. You can also
use that number to purchase savings bonds from the federal
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government. Or you can call the Federal Reserve at (866) 388-1776
to get additional information on savings bonds for education.
Scholarships, Fellowships, Grants, and Tuition Reductions
Scholarships represent money given on behalf of an undergraduate
or graduate student, to a college or university, to help pay for classes.
A fellowship is money given, on behalf of a student, to help pay for
research studies.
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Below is a table that gives an overview of tax treatment of money
received as a scholarship or fellowship.
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A tax free fellowship or scholarship is only available if:
• You are a student for a degree at an eligible college or
university or trade school• You use the fellowship or scholarship to pay for educational
expenses
Here is a definition of a student eligible for a degree. You are
considered eligible for a degree if you:
1. Attend a primary or secondary school or are pursuing a degree
at a college or university, or
2. Attend an accredited educational institution that is authorized
to provide:
A. A program that is acceptable for full credit toward a bachelor’s
or higher degree, or
B. A program of training to prepare students for gainful
employment in a recognized occupation.
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Eligible educational institution: An eligible educational institution is
one that maintains a regular faculty and curriculum and normally has
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a regularly enrolled body of students in attendance at the place
where it carries on its educational activities.
Qualified education expenses : For purposes of tax free scholarshipsand fellowships, these are expenses for:
• Tuition and fees required to enroll at or attend an eligible
educational institute, and
• Course related expenses, such as fees, books, supplies, and
equipment that is required for the courses at the eligible
educational institution. These items must be required of all
students in your course of instructions.
For these to be qualified education expenses, the conditions of the
fellowship and scholarship can not be used for other purposes
such as housing. It also should specify that it can not be used for
tuition or course related expenses.
Ineligible expenses : These costs are not considered as qualified
educational expenses:
• Room and board
• Travel
•
Research• Clerical help, or
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• Equipment and other expenses: those that are not required
for enrollment in or attendance at an eligible educational
institution.
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These statements are true even if the fee has to be paid to the
educational institution as a requirement of enrollment orattendance. Fellowship amount or scholarship amounts used to
pay these costs are taxable.
The worksheet below can help figure out the tax free and taxable
parts of your fellowship or scholarship.
Example 1:
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A student receives a scholarship of $3,000. The scholarship was
not given under either of the conditions listed above. As a
requirement to receive the scholarship, the student must work as
a part-time teaching assistant. Of the $3,000 scholarship, $2,000
represents compensation for teaching. The provider of the
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scholarship gives the student a Form W-2 showing $2,000 as
income. The student used the entire amount of the scholarship for
qualified educational expenses. If all of the other conditions listed
above are met, $1,000 of your scholarship is tax free. The $2,000
you received for teaching is taxable.
Example 2:
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A student is a candidate for a degree at a dental school. The
student received a scholarship for dental education and training.
The conditions of the scholarship require the student to perform
potential services. Penalties will apply if the student does not
comply with their terms and conditions. The entire amount of the
scholarship is taxable as payment for services in the year it is
received.
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Qualified Tuition Reduction
If a student is allowed to study without paying tuition or at a
discounted rate of tuition, the student may not have to pay tax onthis benefit. This is what is called a “tuition reduction.” This would
not be a part of a student’s income.
A tuition reduction is only available if you receive it from an
eligible educational facility and use is at an eligible institution. A
student does not have to use the tuition reduction at the
educational facility that gave it.
For example:
If a student is an employee at a eligible community college, but
they arrange for the student to take classes at a four year
university without paying tuition, he or she may not have to
include the full tuition rate in their income.
The rules for knowing if a tuition reduction is qualified, which
would make it tax free, are different if the courses taken are
below the graduate level or are graduate education.
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The student must include in their income any and all tuition
reduction if it was payment for services rendered.
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Other kinds of educational assistance
Fullbright Grants
A Fullbright Grant is treated as a scholarship or a fellowship in
regard to how much of the grant is tax free. The only thing
reported is the taxable amount.
Pell Grants
Pell Grants are need based grants that are treated as scholarships
for reasons of deciding their tax treatment. It is tax free as long as
its used for qualified education expenses during the year the grant
is awarded. The only thing reported is the taxable amount.
Payment to military personnel
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Payment received as a cadet or midshipman at an armed services
academy is pay for personal services and will be reported in box 1
of Form W-2. A student will include this in the year he or she
received it unless it is one of the exceptions.
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Payment for services
A student must include any part of their scholarship, fellowship, or
tuition reduction that represents payment for any teachingreceived or other services. This is mandatory even if the students
who are pursuing a degree perform the services to receive a
degree.
Exceptions to the rule
The student does not have to include in income any part of ascholarship or fellowship that represents payment for teaching,
research, or other services if the money is received under:
• The National Health Services Corps Scholarship Program, or
• The Armed Forces Health Professions Scholarship and
Financial Assistance Program,
And you:
• Are a student pursuing a degree at an eligible educational
institution, and
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• Use that part of the scholarship or fellowship to pay qualified
education expenses.
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Veterans’ Benefits
The Department of Veterans Affairs gives compensation to veterans
for education and training and it is tax free. If a veteran qualifies foreducation benefits, they can contact their local VA office for
assistance.
Hope and Lifetime Learning Credits
The Hope and Lifetime Learning Credits are available to help a
student offset the costs of expensive higher education by reducing
the amount of your income tax.
The Hope credit
A student may be eligible for a Hope credit of up to $1,650 for
qualified education expenses paid for each eligible candidate. A tax
credit reduces the amount you may owe in income tax. This is not
like a deduction which could reduce the amount of income subject to
tax; it is a credit that reduces the tax itself. It can reduce your tax to
zero, but if this happens and the tax is more than your credit, then
the student will not receive a refund.
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A student can only take one education credit per year. If the student
claims the Hope credit on a 2006 return, they can not claim the
Lifetime Learning credit. If the total qualified education expense for a
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student is less than $7,500, it is favorable for the student to claim the
Hope credit.
If there are qualified education expenses for more than one studentin the same year, then a choice can be made to take credits on a
per-student, per-year basis. If a parent has paid for their childrens'
qualified education expense in any given year, they can claim the
Hope credit for one child, and the Lifetime Learning credit for the
other.
Lifetime Learning Credit
The Lifetime Learning credit will give you an opportunity to claim up
to 20% of the initial $10,000 paid for college tuition and fees, for up
to $2,000 per tax return. There is no limit on how many times you
can claim the credit, unlike the Hope credit. But, you can only claim
the credit once per tax year, even if you are paying for more thanone child to go to college within the same tax year.
A student can also be eligible for the Hope credit or the Lifetime
Learning Credit, even if they withdraw from a Section 529 savings
plan or Educational Savings Account. The credits can not be used to
pay expenses that have already been paid with a Section 529 plan or
Educational Savings Account.
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The chart below lists the differences between the Hope credit and
the Lifetime Learning credit:
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Eligibility for the credits
Basically, a student is eligible for the Hope credit if all three of the
following are met:
• A person pays for qualified education expenses
• A person pays the education expenses for an eligible student
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• The eligible student is the spouse, dependant, or yourself for
whom an exemption can be claimed on a tax return.
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The amount of your Hope credit is gradually reduced if your modified
adjusted gross income is between $45,000 and $55,000. If you file a
joint return then the limits are $90,000 and $110,000. The credit can
not be claimed if the modified adjusted gross income is $55,000 or
more.
Here is a chart to figure out your modified adjusted gross income:
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Credit disqualifications
A person can not claim the Hope credit if any of the following applies:
• Your filing status is married filing separately
• You are listed as a dependent in the Exemptions section on
another person’s tax return
• Your modified adjusted gross income is $55,000 or more
• You or your spouse were a nonresident alien for any part of the
current tax year and did not elect to be treated as a resident
alien for tax purposes.
• You can claim the Lifetime Learning credit or a tuition and fees
deduction for the same student in the same tax year.
Qualifying Expenses
Qualifying expenses for the Hope credit can be for yourself, spouse,
or a dependent for which you can claim an exemption on your tax
return. The credit can be claimed for qualified educational expenses
that were paid in a prior year for qualified expenses in a future
academic year.
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For example, if $1,000 was paid on a student’s behalf to a school in
November 2006 for qualified educational expenses for the Spring
2007 semester beginning in January 2007, the credit can be claimed
on a 2006 tax return.
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Example 1
Kennedy is a freshman in a college program in dentistry. For the first
year, in addition to tuition, she is required to pay a fee to the collegefor the rental of the dental equipment she will use in the course.
Since the rental fee must be paid to the college for enrollment and
attendance, Kennedy’s rental fee for the dental equipment is a
qualified expense.
Example 2
David and Kelly are both freshmen at a university and they are both
required to have specific books for their math class. The university
does not have any strict rules pertaining to where or how students
buy their books. If they choose to buy the books directly from the
school’s bookstore, then they will receive a bill directly from the
university. David bought used books from a friend, so the money hegave to his friend is not a qualified education expense. Kelly bought
her books directly from the school’s store, but the money she used is
also not a qualified expense because the books are not required to
be purchased from the university for enrollment or attendance at the
school.
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An example shown is of a single taxpayer who is enrolled full time at
a local college to earn a degree in computer science. In 2006, he
paid $2,600 for his qualified tuition. He received a form 1098-T from
the college. He and the college met all of the requirements for the
Hope credit. The taxpayer’s modified adjusted gross income is
$34,000. His income tax liability before credits is $3,404. He figures
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his credit of $1,650. Shown below is a copy of his tuition statement.
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Employer assistance and reimbursement educational
programs
Some companies offer their employees the opportunity to go toschool with incentives such as paying a portion or all of their college
education. Some of these benefits, which can be up to $5,250 each
year, should not be included as compensation on your W-2 form.
Benefits over $5,250 are taxable and should be included in your
wages. There are also exceptions to that rule, but the terms and
conditions can vary between employers.
Tax free educational assistance benefits can include payments for
tuition, fees, expenses, books, supplies, and equipment. These
payments can be made to either an undergraduate or graduate
student. They also do not have to include work related studies.
Educational assistance benefits do not include payment for:
• Meals, lodging, or transportation
• Tools or supplies (other than textbooks) that you can keep
after completing the course of instruction
• Courses involving sports, games, or hobbies unless they:
A. Have a reasonable relationship to the business of youremployer, or
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B. Are required as part of a degree program
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Chapter 4 - What if you already have a529 fund?
There are various college savings choices to decide from that havetax advantage benefits, but it wise to know which option would be
best for your financial situation. State and federal laws can be
confusing and it's imperative to understand the different laws for
your state.
There are various fees and expenses with any of the Section 529
college savings plans that have been discussed, but that does not
mean that other options do not carry various fees and expenses as
well. Any amount, no matter how miniscule, can add up over time.
Investing in mutual funds through an Educational Savings Account or
custodial account still includes fees that should be looked up in their
prospectus. Every mutual fund has a prospectus. A prospectus isinformation provided to the investor that includes important factors
about the fund as mandated by securities regulators. A prospectus
can be found on the company’s website, requested by phone or mail,
or on the SEC’s EDGAR website.
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Also, make sure that you understand the commission fees when
investing with stocks and decide how to calculate the benefits, or lack
thereof, between the stock transaction and probable loss or gain.
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If you already have a Section 529 savings plan, make sure you read
their prospectus. Most of the time it includes the investment strategy
and risks associated with the plan and its investment portfolios.
If you go over the prospectus and find that a Section 529 savings
plan is not right for you, you do have an option to roll over the
money into another college savings account or you can withdraw the
money. Be careful with those decisions and seek advice from a tax
professional. Rolling over money could still look like a cancellation or
withdrawal based upon your state’s specific regulations. Cancellations
are subject to severe penalties and a reduction in your withdrawal by
charging administrative fees.
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Below is a comparison chart between savings plans:
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529 College Savings Plans Exposed
College Savings Plan Comparison Chart
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College
Savings
Plan
Prepaid
Tuition
Plan
ESA Custodial
Accounts
Savings
Bonds
Ownership/Control Contributor Contributor Contributor Custodian
until child
reaches
age of
majority
Contributo
nvestment
Choices
Typically,
plans provide
several
investment
options.
None No
restrictions
No
restrictions
Savings
bonds
Age Limits None Plan may set
age or grade
limits.
Except for
special
needs
children, nocontributions
can be made
after a child
Minor child Owner mu
be at lea
24 befo
the bondissue da
(not
purchase
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529 College Savings Plans Exposed
68
reaches age
18, and
withdrawals
must be
made before
beneficiary
reaches age
30.
date).
Expenses CoveredBesides Tuition &
Fees
Qualifiededucation
expenses
for post-
secondary
education
With a fewexceptions,
only tuition
and
mandatory
fees for post-
secondary
education
are covered.
Qualifiedelementary
and
secondary
education
expenses or
qualified
higher
education
expenses
Norestrictions
on types of
expenses
Tuition amandatory
fees
post-
secondary
education
and
contributio
to 529s an
ESAs
Contribution Limit Varies from
plan to plan.
Majority ofplans permit
total
contributions
Fixed by
terms of
contract youpurchase
Contributor:
$2,000 per
beneficiaryper year
Beneficiary:
No limit No limit
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in excess of
$200,000 per
beneficiary.
$2,000,
does not
matter how
many ESAs
are set up
Federal Tax
Advantages
Earnings
grow tax-
deferred and
are tax-freeif used for
qualified
education
expenses.
Earnings
grow tax-
deferred and
are tax-freeif used for
qualified
education
expenses.
Earnings
grow tax-
deferred and
are tax-freeif used for
qualified
education
expenses.
$750 in
earnings
are tax-
free.
Interest
grows ta
deferred
and is tafree if us
for qualif
education
expenses.
tate Tax
Advantages
Varies from
state tostate, but
some states
provide tax
deduction for
contributions,
tax-freeearnings
growth, and
tax-free
Varies from
state tostate, but
some states
provide tax-
deduction for
contributions,
tax-freeearnings
growth, and
tax-free
None None Interest i
usually taexempt fro
state an
local taxes
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529 College Savings Plans Exposed
Chapter 5- Research and Resource Tools
NASD, Inc. They have a page devoted to Section 529 plans.
http://www.nasd.com/RulesRegulation/IssueCenter/NASDW_006293
College Savings Network
The National Association of State Treasurers
http://www.collegesavings.org/index.aspx
Bureau of Public Debt
http://www.savingsbonds.gov/
Internal Revenue Service Publication 970, Tax Benefits for Education
http://www.irs.gov/pub/irs-pdf/p970.pdf
Oversight Hearing On Section 529 College Savings Plans: High Fees,
Inadequate Disclosure, Disparate State Tax Treatment, and
Questionable Broker Sales Practices. Sept, 2004
U.S. Securities and Exchange Commission
http://www.sec.gov/investor/pubs/intro529.htm
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529 College Savings Plans Exposed
Chapter 6 - Key questions to ask yourfinancial advisorWhether you make the decision to invest in a Section 529 savings
plan, mutual fund, or stock plan, it's best to know what questions to
ask your financial advisor. Here are some examples:
Can you purchase a Section 529 savings plan directly from the
state or plan sponsor?
What fees and expenses are charged by the plan?
How much of the fees that are paid are given to a broker for
payment?
Are there exemptions or discounts given to reduce or waive certain
plan fees?
What are the plan’s qualified education expenses?
Which colleges, universities, and educational institutions participate
in the plan?
What are the terms and conditions to roll-overs or withdrawals
from the plan?
What investment options are made available by the plan?
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How long after money is contributed does it take to get invested?
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Are there special benefits for in state residents?
Does another state offer a better plan and what are the benefits to
me as an out-of-state resident?
What are the limitations in the plan?
How often will I be allowed to change investment options?
Can I switch or transfer beneficiaries?
Can I transfer the account to another accountholder?
Who manages the program and when does their contract expire?
How well has the plan performed in the past?