Originally Aired: September 21, 2011
Topic: Saving for College with guest Joe Hurley, CPA
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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The Best Way to Fund a College Education
James Lange, CPA/Attorney
Guest: Joe Hurley, CPA
|Click to hear MP3 of this show|
- Introduction of Guest – Joe Hurley, CPA
- Different Ways to Save for College
- The Basics of a 529 Plan
- Grandparent-Owned 529 Plans
- Prepaid Plan vs. Savings Plan
- Resources for Detailed Information on Saving for College
- Caller Q&A: Savings for Older Children
- Does Having a 529 Plan Affect Financial Aid?
- Caller Q&A: How to Handle the Remaining Money in 529 Account?
Hana: Hello, and welcome to The Lange Money Hour: Where Smart Money Talks. I’m your host, Hana Haatainen Caye, and of course, I’m here with James Lange, CPA/Attorney and best-selling author of the first and second editions of “Retire Secure!” and now, his new book, “The Roth Revolution: Pay Taxes Once and Never Again.” Jim’s guest tonight is Joe Hurley, CPA and best-selling author of “Family Guide to College Savings,” and founder of SavingForCollege.com. Joe is an expert on Section 529 plans, and has stated, “They are one of the most remarkable tax provisions in the Internal Revenue Code.” His articles have appeared in the Journal of Accountancy and The CPA Journal, and he has appeared at hearings in Washington D.C. to provide comments on the proposed regulations under Section 529. On tonight’s show, Joe will explain why a Section 529 plan is the best way to pay for college. We will be covering the basics of what a Section 529 plan is and how to choose between the different ones. There will also be discussions on many of the important rules, requirements and nuances of these plans. But before I turn it over to Jim, I want to remind our listeners that the show is live, so please fell free to call in with your questions for Joe. The number is (412) 333-9385. Good evening, Joe and Jim.
Joe Hurley: Good evening.
Jim Lange: Hi Joe. The only other thing I will tell my listeners here is that it’s a nice introduction that Hana gave you, but frankly, you are the 529 college tuition guy, so there isn’t one person in the country that is better recognized than you when it comes to coming up with the best ways to fund college education. You literally wrote the book, and you’re not a Johnny come lately. You’ve been in this field…I remember you gave me permission…I read your article in the Journal of Accountancy, I’m gonna say, like, fifteen years ago or something like that, and I called you and I said, “Wow! This is great stuff! Can I put something on my website?” And you were kind enough to give me, let’s say, a variation of that article. So I’ve been following your work. I’ve probably given out your website and the name of your book a hundred times, probably more, so we’re really just thrilled to have you here, Joe.
Joe Hurley: Thanks, Jim. It’s a real pleasure to be on the show and I appreciate your kind words. I have been at this for a while, and so it’s nice to hear from you that my word is getting out there and people are coming to the website savingforcollege.com, and picking up the book, and it’s a challenge that so many American families face, paying for college and saving beforehand, so anything I can do to help solve that mystery, you know, I’m glad to do that.
Jim Lange: Well, I’ll tell you what I think would be a challenge is keeping up with your website, keeping up with all of the latest information, and then, you not only have to understand the big picture, but then you actually go through all the analysis for the different states. Of course, we have a national audience at KQV, and particularly, I have a lot of listeners that listen on the computer in various locations…on the other hand, probably more Pennsylvania listeners than anybody.
Joe Hurley: Well, these 529 plans are changing all the time. They’re trying to improve their program. They’re competing against each other for investors, and so it is a challenge keeping up with all those changes. Luckily, I have a small staff that helps me do that, and we’re in there every day trying to track the investments, track the tax benefits of these programs, comparing them to each other and putting it all on the website.
Jim Lange: Okay, well Joe, first I’m gonna ask you an unfair question. The unfair question is…now, I know later on, we can get into some of the basics. What is a 529 plan? What happens if you have two kids? What happens…a lot of important questions. But I wanna just start out with your opinion, and you can qualify it in any way you like, so you might say it’s gonna be different for certain parents and different for others, but what do you think is the best way for a parent…and then, by the way, in preparation, I’m then gonna ask you about grandparents, to fund their child’s or grandchildren’s college expenses?
Joe Hurley: Well, that’s a…
Jim Lange: And I’m sure people say, “Well, what did you do with your kid?”
Joe Hurley: Right, right. I would like to qualify that by saying, you know, every situation is different.
Jim Lange: Of course!
Joe Hurley: And the quick answer is “Anyway you can!” Start setting money aside for college because your child’s going to age quickly, and before you know it, you are going to be facing some college bills and having to deal with that, and you know, Jim, there are several different ways to save for college. Certainly, the 529 plans, which have come along in the last twelve years or so, I believe are a very good solution for many families. They allow significant dollars to be put away tax free, as opposed to some other options that you have in saving for college. There’s a savings vehicle called the Coverdale Education Savings Account, which works in a way that’s somewhat similar to a 529 plan, but you’re very restricted in how much you can put into a Coverdale Education Savings Account, only $2,000 per year. There’s also putting money into your child’s name, shifting investments to your child and once it’s in your child’s name, any income that’s generated by those investments, and here I’m talking about a Uniform Gift to Minors Act, or a Uniform Transfers to Minors Act account, any income generated is taxed on your child’s tax return and for the first $1,900 dollars of investment income each year, that’s taxed at a very low rate. Once you exceed $1,900, of course, we have to worry about the Kiddie Tax, which makes that income tax bracket zoom up to the parent’s bracket, but we can get into more details about that later, if you want. And lastly, I’d just like to say, Jim, that for a lot of families, we’re talking about a combination of approaches. You don’t have to pick just one approach for your college savings. Sometimes it can be opening a 529 plan with a Coverdale Education Savings Account and with a UTMA account, or maybe even some other vehicles that are out there.
Jim Lange: Well, let me throw in my two cents because I’m gonna try to eliminate a couple choices here. What I used to do before these 529 plans came about is we used to draft trusts for the benefit of children and grandchildren, and we would fund these trusts, and then the trust would have to file a tax return and pay taxes on an annual basis, and there was money, of course, in setting up the trusts, there was money in maintaining the trust, there was money to the CPA to prepare the trust return, and frankly, I don’t think I’ve done one of those in the last twelve years because I can’t justify it because I think the 529 plans are so superior, both in terms of cost savings to the client and also tax reduction. The other thing that I’d kind of like to, maybe not eliminate, but at least reduce the attractiveness of, which you mentioned, which is shifting income to a child’s name, and one of the problems that I have with that is if you do that, it’s not your money and you can’t control it anymore. We’ll get into some of the control features of the 529, but it then becomes your child’s money, and at the age of majority, either 18 or 21 depending on what state you live in, the child can take it out and blow it and it could have nothing to do with college. So, I think…and the Coverdale, as you said, it’s $2,000, so I think that…and we can get into, again, the prepaid and the traditional 529 plan, but boy, I have a hard time beating the 529 plan as a method of saving for a college education. Maybe there’s an exception for people who are very wealthy who might be better off just paying it out of pocket and not using up their gift exclusion, but maybe leaving that one alone, is there really anything that really compares to 529, or were you just being nice to some of the other alternatives?
Joe Hurley: Well, when I say a combination, I’m really referring to a modest amount of money going into those other alternatives, because as you say, you don’t want to put a lot of money into your child’s name because, as you say, they have control over that and receive that account directly when they reach the age of majority, plus it’s not very good for financial aid purposes, either. So a modest amount into your child’s name is one that you could actually spend before they reach the age of 18 or 21, or whatever that magic age is in your state. So you don’t have to worry about that so much, and it doesn’t affect financial aid if you actually spend it for your child’s benefit before they get to college. So, that can be part of the picture. Coverdales? They don’t excite me either because they are so small in dollar amount, and there’re some other restrictions that really aren’t very well known that I think weigh against the Coverdale, and I certainly agree with you about the education trust. I don’t see any reason to open up an education trust through a drafted trust agreement anymore with the 529 plans that give you better control features, better tax features, more flexibility and without those costs. Of course, you know, some attorneys have made a nice living drafting trust agreements through the years, and I certainly have nothing against attorneys, but…
Jim Lange: I hope not!
Joe Hurley: This is part of the livelihood that I think they need to replace with other work.
Jim Lange: Yeah, like maybe helping people do good estate planning and using their influence to get parents and…my favorite thing is getting grandparents to put some money in a 529 plan. Why don’t we go back for a moment though, and talk about some of the basics of a 529 plan? I think a lot of our listeners know some of the basics, but I think a lot also do not, and maybe it would be a healthy review to just say what is a 529 plan, how does it work, what are the taxation features, how do you get money out, etc.
Joe Hurley: Sure. Well, a 529 plan is an investment program specifically designed for college and it comes with federal income tax benefits and state income tax benefits, as well as some other control features that we can talk about. These were initially enacted by Congress in 1996, so they’ve been around now for, you know, going on fifteen years, in some states anyway, but they are state-sponsored programs for the most part, so it’s up to each state to decide to start and operate a 529 plan, and what the state typically does is it goes out and hires a program manager, typically an investment firm, to come in and run the investments in that plan. When you join a 529 plan, you will open an account under your name, but you will name a beneficiary of that account, typically your child or your grandchild, and then you get to choose from a menu of investments that that plan offers and start making contributions to that plan which get inducted into your investment selection. Hopefully, it grows over time, so as your child gets older, that account grows in value and you keep making contributions to it, and once your child gets to college, you can withdraw funds from your 529 account. In any growth net account, any earnings comes out tax free, federally tax free and state tax free. So, it works almost like a Roth IRA, except it’s designed for college, not for retirement.
Jim Lange: Right. Now, just so people understand…so let’s say, for discussion’s sake, I don’t think very many people want to invest in the state of Pennsylvania or California or maybe the state in where they live, but you’re not really investing in Pennsylvania, so Pennsylvania has chosen Vanguard as their set of funds, so Pennsylvania, in effect, has hired Vanguard to invest the money and to do the administrative work, so what you’re really doing…is it fair to say you are investing in a menu of choices that Vanguard has prepared for you, if for example, you were going to invest in the Pennsylvania 529 plan?
Joe Hurley: That’s exactly right. Pennsylvania will set up portfolios of investments and these investments happen to be Vanguard mutual funds, and you might select a portfolio that’s 100% stock funds or 100% bond funds or something in between, or states have set up these so-called age-based options where your money is put into a portfolio that’s invested primarily in stocks while your child is young, and therefore has the most growth potential, and when your child reaches college age or gets close to college, the investment is shifted mostly to fixed income instruments to reduce the risk of the stock market falling just when you need to take the money out, and so those age-based options, which are a real staple in 529 plans, have become the most popular options because they do provide a lot of protection from stock market risks as your child gets older.
Jim Lange: And the other thing, they’re easiest. By the way, after reading your book and looking at your websites, I’ll tell you what we did for our daughter, who is now sixteen years old. At the time, Pennsylvania didn’t have Vanguard, and it had the Delaware funds and I was not thrilled with Delaware funds as an investment. So I said, well, what companies do I like investing my money more than the Delaware funds? Well, I liked Vanguard and, at the time, Utah actually had selected Vanguard, so even though I’m not a Utah resident (I’m a Pennsylvania resident), and my daughter’s a Pennsylvania resident, we have one of those old-fashioned marriages, you know, original husband, original wife, same child, all living in the same household, very boring type family, and even though it’s very unlikely that she’s gonna go to school in Utah, Utah, because it had Vanguard, was the most attractive for us. We put some money in there. We also liked TIAA-CREF as an investment vehicle. Again, that wasn’t offered in Pennsylvania, so we put some money in a New York plan. So there is money for my daughter in both the Utah 529 plan and in the New York plan, and then when Pennsylvania shifted…and by the way, I’ll also take the liberty of mentioning that we selected the option that you just mentioned, which is, in effect, the automatic asset allocation shifting method. What did you call that? It’s when it starts with a higher percentage of stocks, and then it shifts to more income items over time?
Joe Hurley: I referred to it as the age-based option.
Jim Lange: Age-based, sure. Alright, so, presumably, when we first put the money in when she was, you know, literally just a couple of years old, it was probably mainly…it was mainly stocks, and now that she’s sixteen and she’s…and I think just to, I guess, irk us, she’s gonna probably go to the most expensive school that she can find. I think that sometimes the children and grandchildren of some of my clients seem to be doing that. I think she would like to go to Carnegie-Mellon where he mother and her grandmother went. That’s a Pittsburgh school and it’s probably one of the most expensive in the nation. I think it’s somewhere around $50,000 or something like that. So we did the age-waited one, so some money was in stocks and it’s gradually being shifted over to bonds, and the other advantage of that, that I found for me personally as well as my clients, is that we didn’t have to think. Do you know what I mean? After selecting the state, we put it in the age base and then we haven’t thought about it.
Joe Hurley: Right, right. It’s really an autopilot approach, and the investment professionals that are involved with the plan determine to the best of their ability how much of your account should be allocated to stocks, bonds and money markets based on the age of your child. So, some people want to be able to control their own investments and make that decision themselves, but many people are happy to have someone else do it for them as long as it makes sense.
Jim Lange: Well, the other thing that I like about it is…and I know that there are some people who go to these 529 plans through a financial advisor or a stockbroker, and the stockbroker or financial advisor is making money on the deal. I don’t want to say anything bad about any other competing financial professional. I’ll just say that I have chosen not to earn any fees or get any commissions on a 529 plan recommendations. So there’s, at least to me, there’s no particular financial remuneration, and I assume that what you’re talking about is the financial people who are working for Vanguard or working for TIAA-CREF or working for the set of funds that does these age-based plans. Is that correct?
Joe Hurley: Yes, that’s exactly right.
Jim Lange: Okay, good. So, we’re really talking about pretty low investment expenses. Is that also fair?
Joe Hurley: We are, and the expenses keep coming down over time. So, when you’re investing in a 529 plan, your expense is the expense of the underlying mutual fund, and if the program is using index funds, that will typically be a very low expense ratio, and then the plan itself will have a management fee on top of that. So, there is an extra layer of fees in the 529 plan as compared to investing directly into a mutual fund, but that management fee in many cases has come down over the years to a very low level, and when I say low level, I’m talking about, typically, one quarter of one percent or twenty basis points, somewhere in that range, and if you look at the tax benefits of a 529 plan, you’ll see that the far out ways, that extra cost that you will pay in terms of a management fee for that plan.
Hana: Okay, thank you, Joe. We’re going to take a quick break right now, and when we come back, we’ll continue this conversation. I want to remind our listeners out there that we are live tonight, so if you have any questions, you can give us a call at (412) 333-9385. We’ll be right back with Joe Hurley and Jim Lange on The Lange Money Hour.
Hana: Welcome back to The Lange Money Hour. This is Hana Haatainen Caye, and I’m here with Jim Lange and Joe Hurley, CPA, best-selling author of “A Family Guide to College Savings,” and founder of savingforcollege.com. As a reminder, we are live and welcoming questions for Joe. Out number again is (412) 333-9385. Let’s get back to our discussion.
Jim Lange: Okay, Joe, you were just saying that we have very low expenses in these plans, you know, particularly if you have a Vanguard or a TIAA-CREF type investment, and the tax benefits, and you actually…by the way, you also said something that shows that you not only know the 529 area, but that you understand the total tax picture when you said that they’re really taxed in a very similar method to the Roth IRA. But basically, if I understand this right, you, or perhaps a grandparent, as a parent or grandparent is putting money into this 529 plan. nbsp; You don’t get a tax deduction for it, which is the same as a Roth IRA. The money grows income tax free, and then, when the child is ready to make withdrawals, and let’s say, for discussion’s sake, that you put in $20,000 and the account grows to $25,000 by the time some money is needed, that money can be taken out and there’s no income tax on the $5,000. Is that correct? No income tax on the growth.
Joe Hurley: That’s correct. The amount that you withdraw from a 529 plan has to be equal or exceeded by the qualified expenses of your beneficiary for that year, and those qualified expenses would include tuition and fees, books and supplies at an eligible college and room and board, as long as your student is at least half-time at that college. So, you look at pretty much the majority of college costs and those can be funded with tax-free distributions from your 529 plan.
Jim Lange: Okay. I’d like to shift it to some of our older listeners who might have some money that they are interested in helping their grandchildren with their college expenses. Could we talk for a couple of minutes about 529 plans and grandparents?
Joe Hurley: Sure. You know, in my opinion, 529 plans and grandparents were made for each other.
Jim Lange: Mine too!
Joe Hurley: It’s just a very useful tool for grandparents to help fund college for their grandchildren, and we know from surveys that a lot of grandparents have the intention of helping fund their grandchildren’s college education if they have the funds to do that, and the reason that I say it’s so appropriate is because grandparents can open a 529 account, contribute a little money or a lot of money to that account, and still have the right to control the account and still have the right to take the money back if they want to. So, some grandparents who are a little skittish about giving away a lot of money because they think they might need it in the future, 529 plans offer a unique way to make that gift, yet not lose the ability to take back the money if you want to. Naturally, most grandparents will never do that, but that option is there to do that. The other reason that grandparents might be attracted to 529 plans is that it’s an easy way to help. If the parents have set up a 529 plan, the grandparents, instead of opening up their own account, can simply make contributions to an account that the parents have opened. They won’t enjoy the same level of control because now the parents will have control of that account, but they also won’t be getting the statements every quarter and wondering, you know, what should they be doing to handle this account. It really depends on the objectives of the grandparents, but it’s very useful. It doesn’t cause a tax problem for the grandchild like a Uniform Gift to Minors Act would cause a tax problem potentially for that grandchild. It doesn’t cause much of a financial aid issue for that grandchild compared to other ways. So I think any grandparents who are wondering how can they best help out with college expenses and even save for that future college cost today really should look at 529 plans.
Jim Lange: Well, I think you hit the key, which is I have a lot of older clients and, frankly, their biggest fear is running out of money, and that’s…you know, when people say well, what do you do? I could go into the technical things like Roth IRA conversions and investments and estate planning and retirement planning, etc., but ultimately, the goal is to make sure that both the husband and wife have enough money to live comfortably for the rest of their lives no matter what happens. So, if putting money in a 529 plan, even for people who can easily afford it, in the back of their minds, and particularly for what I’ll call that “depression-era mentality,” which I think probably most people…I’m not exactly sure of the cutoff, but let’s say in the sixties and certainly seventies and beyond, have is, well, what if? What if the market is terrible? What if there’s a terrorist event? What if I get sick? What if I need the money? And what you’re saying is, if you put money in for a grandchild and then it turns out you need the money, you can take it back.
Joe Hurley: That’s exactly right, and the other flexibility is in choosing the grandchild who will eventually use that money. You can set up the account for your first grandchild, but let’s say that that grandchild decides not to attend college, and you have two or three other grandchildren who will be attending college. You can easily change the beneficiary on that account to any other grandchild without having to pay taxes on it and use it tax-free for them.
Jim Lange: Yeah, and that, by the way, is such a cool feature because you can not only change it to the child’s sibling, but you could change it to the child’s first cousin because they’re all your grandchildren.
Joe Hurley: Absolutely.
Jim Lange: Which is really cool because it’s sometimes hard to say who is going to need the money and how much they’re going to need, etc. The other thing that I’ll mention, and this is from an estate tax standpoint, 529 plans are the only item that I know of in the Internal Revenue Code when, if you make a gift, you have the ability to take the gift back, but it’s not in your estate when you die. So, let’s say that you had a Trust and you said, “Okay, I leave this money to my grandchildren for their education, but if I need it, I get to take it back.” If you had a Trust like that, or any kind of instrument like that and you died, that money would be deemed yours because you had the ability to take it back and it would be included in your estate for either Federal estate tax purposes or the state or, in our case, PA Inheritance Tax purposes, but with a 529 plan, even though you had the ability to take it back and you die, that money isn’t in your estate. So I think that’s a beautiful feature.
Joe Hurley: It is, and it is unique. There is no other way to actually remove money from your estate yet retaining complete control of that money, and when Congress put that law on the books, a lot of tax attorneys and CPAs just didn’t believe it could work that way. It was really too good to believe, and even the IRS has been somewhat flummoxed by this particular rule and isn’t really sure even how to prepare tax regulations because of the unique nature of the estate and gift tax provisions for a 529 plan. So, it’s something that’s out there. If you are doing estate planning and you have that level of wealth, then here is one opportunity that you’re really not going to see anyplace else.
Jim Lange: Yeah, and actually, I’d say, you know, I usually…if grandparents can afford to gift money, I always like to say I have three favorite gifts for grandparents, actually four. One’s not a direct gift. One is the 529 plan, which is perhaps, in a way, my favorite. Two is just gifts to children, say “Here. Here’s some money. Go and do whatever you want.” Three, I like second-to-die life insurance policies for the benefit of children, with the idea of having some of the IRA money for grandchildren, and the other thing that I like, which is maybe a little bit related, is I like grandparents to take the entire family on a family vacation. But certainly, 529 plans are probably one of the higher priorities because it tends to be consistent with the kind of clients that I attract who value education. So I think that that is a great thing. I’d like to get into a little bit of a technical discussion because I know that there’s different opinions on this, and I would very much value yours, and I’d like to ask you your preference on savings plans, which I consider the traditional 529 plan, and the prepaid plans, or purchasing courses or tuition credits. Do you have a preference, and is it an individual situation or do you actually like one or the other significantly more?
Joe Hurley: Well, a little bit of background is probably in order.
Jim Lange: Fair enough.
Joe Hurley: There are two basic types of 529 plans. We’ve been talking mostly about the savings-type 529 plan, but there is this so-called “prepaid tuition” type of 529 plan, and the first thing to know is that you really need to live in a state that offers a prepaid tuition plan in order to even think about that option, with the exception of one particular prepaid plan that covers private colleges around the country called the “private college prepaid plan,” but there are about a dozen states now that offer a prepaid tuition plan, and the way that these work is that you make a payment now into the plan in return for the plan’s promise to pay a certain amount of your child’s tuition in the future at a state school, you know, a community college or university in your state. And so, it’s almost like a pension in that the obligation is on the state to pay that tuition in the future. The attraction of that is you don’t have to worry about the stock market or whether your account’s going to go up or go down. Whatever that tuition does in your state is now on the shoulders of the plan to pay that. And so, you do have a basic choice to make here between the prepaid and the savings. People who feel like the stock market over time and bond investments are going to provide the greatest return would be happier with a savings plan. People who don’t want to worry about their investment performance might be happier with a prepaid plan, but the prepaids are trickier. You have to understand all of the rules of your particular prepaid plan, and there are a lot of rules. What happens when your child goes to a private college and not a state school? You have to look at what happens in that situation. What happens if your child doesn’t go to college at all and you want to use it for somebody else in the family? What will the plan allow you to do? And you also have to look at what you pay. It used to be, in the old days, that you would pay current tuition prices to get into your prepaid plan. Well, these prepaid plans have run into a lot of financial difficulties themselves because their investments are not keeping up with tuition, so they’ve had to hike their prices so now that you are actually paying a price that is higher than current tuition in order to join the prepaid plan. So, that lowers your investment return on those programs. So there are a lot of factors to consider.
Jim Lange: Well, I know that there are. Is it fair to say, and I hate to oversimplify, but I’d rather oversimplify as long as I’m giving this caution, than just say oh, it’s just complicated and you have to figure it out. Let’s assume, I only have one daughter, but let’s say that I had two, and one, her big thing was Pitt and Penn State. Man, she loved Pitt and Penn State, which are our local colleges, well, Penn State, when I say local, I’m saying it’s still within Pennsylvania, and I thought that, boy, I don’t know about the investments today. I’d rather…what I’m pretty sure of is that the price, or the tuition inflation is going to be higher than the investment return. For that child, I should perhaps consider a prepaid plan, but if my daughter wants to go to CMU, which is not a state school, then I might be better off with a traditional savings plan. Is that fair?
Joe Hurley: It’s fair in a sense. Of course, every plan is different and Pennsylvania actually has some options within its prepaid plan that are designed for kids who are going to a private college. So, it’s a little bit different than most other prepaid plans, but generally speaking, if your child is headed towards a state school and your state offers a prepaid plan, you should look at that option, but as I say, you really have to measure what the cost is versus the potential benefit in that plan and realize that these plans have to come up with the money to pay tuition and they come up with that money by investing your contributions, and they don’t have any magic. They can’t keep up with tuition any better than the investment managers and the 529 savings plan, and so if they run short, you have to understand that there may be some risk of the plan changing the rules in the future, or even there might be some risk of defaulting on that obligation. It hasn’t happened and I don’t want to scare anyone into thinking that it might happen in your state, but some states do back their prepaid plans with the full faith and credit of the state, but others do not, and it’s really up to the plan itself to make sure that it has the resources to pay out on its promises.
Jim Lange: Well, Joe, I know that you have to track fifty states, and frankly, I didn’t know that the prepaid plan in Pennsylvania had a provision in the event that you chose a private school, so now, all of a sudden, and this is partly for selfish purposes, but now the prepaid plan becomes at least something I should at least think about. Is that fair?
Joe Hurley: Absolutely. That Pennsylvania prepaid plan is really a group of indexes and you choose the index, and what you put in today is worth an amount in the future based on how that index inflates over time, and one of the indices is a private college index of cost. What some of the other options are state indexes of cost, so like I said, it does work a little bit different there in Pennsylvania. It’s a very interesting plan and a lot of people have been very happy beneficiaries that have participated in that particular plan over time.
Jim Lange: Now, let me ask you this: so, for years when Delaware funds was the investment vehicle for Pennsylvania, I would often tell people, well, pick a different state. Let’s assume people did, or people who are in my position where they’re sitting right now with money in, in my case, Utah and New York, could I shift that to Pennsylvania and then purchase or invest in a prepaid plan in Pennsylvania?
Joe Hurley: You probably could because you can do what’s called a rollover from one 529 plan to another, as long as you meet the rollover rule, which is either a 60-day withdrawal and recontribution of funds, or else a direct trustee-to-trustee transfer. It’s tax free, so it doesn’t trigger any sort of tax event when you do that rollover. What you do have to look at is the entry requirements for your prepaid plan, and I don’t know offhand, Jim, whether there’s an age limit on Pennsylvania’s prepaid plan. Some plans say that once children reach a certain age, they can no longer join that plan. I don’t really recall whether Pennsylvania has that particular restriction.
Jim Lange: Yeah, I should know that myself, but I guess I will have to deal with that.
Hana: Okay, Jim and Joe, I’m going to stop you here so we can take another quick break. I want to remind our callers that there is still time to ask Joe a question or two. Our number is (412) 333-9385. We’ll be right back to continue our discussion with Jim Lange and Joe Hurley on The Lange Money Hour, Where Smart Money Talks.
Hana: Welcome back to The Lange Money Hour. This is Hana Haatainen Caye, and Jim and I are here with our guest Joe Hurley, CPA and best-selling author of “Family Guide to College Savings” and founder of savingforcollege.com.
Jim Lange: And by the way, Joe, before we run out of time, could you tell our listeners what you think if they were interested, and let’s give them two options: one, the free option, which is your website, and one where they have to pay…I don’t know what it is, ten or twenty bucks for your book, which is, by the way, the way that I would recommend because I just think the information there is so good and, again, your website’s terrific, but I think the book is laid out very well. Could you give our listeners contact information for both your website and the book that you would recommend, and whether they should get it directly from you or through Amazon?
Joe Hurley: Sure. The website address is www.savingforcollege.com, and we have a lot of free information on the website including investment performance of the 529 plans. We actually rank the programs. We do a fee study that shows you which are the cheapest 529 plans. We provide details on all the different plans and ways to compare plans when you’re shopping for a 529 plan, and there’s a ton of articles on there just about saving for college in general.
Jim Lange: And by the way, Joe, your articles are wonderful. Again, I guess it wasn’t quite fifteen years ago, but I read one of your articles, asked you for something and I posted it on my website. I think it’s even still there. You’re a good writer. You get it, and I would highly recommend that people do that. What would be the paid option in the event that people were willing to invest in the book?
Joe Hurley: Well, we actually have two books. There’s “The Best Way to Save for College: A Complete Guide to 529 Plans,” which is about 300 pages, covers all the rules, estate planning, financial aid impact, all the differences between plans and a description of every 529 plan out there. And then, we have kind of the light version, which is called “The Family Guide to College Savings,” which is written really with the grandparent in mind. We wanted something that was easy to digest, covered all of the basic options in saving for college including the 529 plan in a very brief, I think it’s about 80 pages format, and either book is available on Amazon, so if you just go on there and you look under my name as author, Joseph Hurley, or the titles of the books, “The Best Way to Save for College” or “The Family Guide to College Savings,” you should be able to find them pretty easily.
Jim Lange: Alright, and by the way, I must admit that I’m really familiar with “The Best Way to Save for College,” so that one I can give an unqualified endorsement for.
Joe Hurley: Thank you.
Hana: Joe, we have Steve from Austin, Texas with a question on 529s. Go ahead, Steve.
Steve: Ah, yes, I’ve got grandkids ranging in age from 6 to 21, and the 529 sounds great for the younger kids, but what do you do about older kids? That’s one question, and then, the second question, is there a tax-efficient way to use double-E bonds by a grandparent to pay for college expenses?
Joe Hurley: Well, there is no age limit on the 529 plans, and so even for older children, you could actually save with a 529 plan and save on income taxes for whatever period that money stays invested. But as you say, for older children, you’re probably not going to see that much in savings. Of course, you could pay tuition on behalf of your grandchild. There’s a special provision under the gift tax laws that say that your payment of tuition directly to the school is not even treated as a gift, but you don’t have to worry about filing gift tax returns when you do that. Now, as far as double-E bonds go, there is a provision that allows for savings bonds to be purchased, and then redeemed tax-free for college, but it comes with several requirements, and one of those requirements is that the student be your dependent, and most grandparents don’t have their grandchildren as their tax dependents and therefore, grandparents typically cannot take advantage of that particular provision.
Jim Lange: Steve, can I ask you a question? And I guess this is also gonna be for Joe: is there a chance that any of your grandchildren will have any type of financial aid, either in the form of scholarships or loans or any other type of financial aid, or is the plan for the family to pay everything out of pocket?
Steve: No, no. It’s likely that they will need financial aid.
Jim Lange: Alright, and then, here’s my question to you, Joe: is putting money in a 529 plan going to hurt any of their chances of receiving financial aid?
Joe Hurley: Well, the financial aid rules are kind of funny. You know, they’re difficult to get a handle on in many cases. 529 plans that are owned by a parent, or even by the student directly, have very little impact on financial aid. They’re treated as an asset of the parent. They’re assessed in the formula that computes the expected family contribution at a low rate of 5.6%, as opposed to a custodial account for the child which is assessed at a 20% rate, and any distributions that come from the 529 plan are not counted as income in that financial aid formula. For grandparents, it’s a little bit different. If the grandparent owns the 529 account, then the asset value does not get reported on the financial aid application at all. So instead of 5.6%, it’s 0% of the value affecting the student’s financial aid. The potential problem, though, is that if a grandparent takes distribution from a 529 plan, on the following year’s financial aid application, that distribution has to be added to the student’s income, and it gets reported on the financial aid application, and that income can have a negative impact on eligibility. So, some grandparents actually prefer to make contributions to a 529 account that’s owned by the parent rather than themselves just to get better financial aid treatment, and I know I’ve made it sound complicated and that’s because it is complicated and you might have to push the pencil a little bit about doing that.
Jim Lange: But is it fair that, in general, the benefits of the 529 plan will usually far outweigh the detriments in terms of losing financial aid?
Joe Hurley: It is, and, you know, when it comes time to file the financial aid application, the parents typically are in control of that process, and they need to sit down with a grandparent who’s opened a 529 account and come up with a strategy that’s gonna make sense for financial aid purposes, because certainly some strategies are going to provide a better answer than other strategies, and parents are in a position to do that because to a large extent, they control a lot of the purse strings about which money’s going to be used for college.
Jim Lange: Okay. Anyway, Steve, thank you for your question.
Hana: We have another caller, Bob from Churchill. Hi Bob.
Bob: Hi. How are you?
Hana: And you have a question about 529s for Joe?
Bob: Yes I did. I have two quick ones: the first one is I have a son who is graduating in December, and he’s going to have a couple thousand dollars left in his 529 when he graduates. Is he allowed to apply that, without penalty, to his student loans, the remaining amount, or is that going to be faced with a 10% withdrawal?
Jim Lange: Or is there another alternative that I’m interested in? But I’m interested in what Joe’s gonna say, because I have a third choice for you.
Joe Hurley: Well, the answer to that question is that the repayment of student loans does not qualify as a qualified higher education expense, and so if your son doesn’t have any other qualified expenses in that final year, then it would be subject to income tax and penalties just on the earning portion. The principle always comes out tax-free, so Jim, did you want to follow up on that?
Jim Lange: Well, yeah. Bob, let me ask you this: do you have any other children, or is that either the last one, or…?
Bob: Yes, I do have a daughter at Johns Hopkins.
Jim Lange: Well, what about shifting the money from your son’s 529 to your daughter’s 529, and then you can use it for her?
Bob: Well, if these were created, this 529 I did in the Pennsylvania 529, basically they’re savings or investment plan, and if they have my son’s, you know, these were created with UGMA funds originally, so I guess my son would have to get permission to do that since essentially it was his money. I mean, I am the owner of the account, but…you know. So, yes, I think that would be an option that would end up also being explored.
Joe Hurley: The other option, Bob, is just to do nothing and let your son know that here’s a fund that should he get married and have kids in the future, can be passed down to his kids or your grandchildren. There’s no one forcing you or him to take the money out just because he’s graduated from school.
Bob: Right. And the 10% penalty is just on the interest amount that’s been earned. It’s not on the principle, correct?
Jim Lange: Yeah, that’s correct. It’s just on the interest. But actually, that brings up another issue, and Joe…in fact, this was on my list of questions, but this might have been something that we could have talked with Bob about a number of years ago. What percentage of the college tuition do you like to cover with the 529 plans? In other words, let’s just say for discussion’s sake that you’re looking at $25,000 a year or $30,000 a year for four years, plus there are other expenses like room and board and books and computers and stuff like that, and let’s just say that your estimate is maybe $125,000 for a four-year period. How much money, and I know, of course, you can’t predict investment results, but how much money, if there was sufficient money to fund it, would you fully fund it, or would you maybe leave it a little bit short so you don’t have the kinds of issues that Bob has?
Joe Hurley: Well, I think that if you don’t want to face the issues that Bob has, you would leave it a little short. You wouldn’t necessarily attempt to fund the entire cost of college. You’d want to fund a portion of it so that you don’t really run any risk of having excess funds left over, yet you get the full benefit of tax-free savings for the portion that you do put into the 529 plan. But as I said, there is flexibility to use the funds for other family members. You can even use it for yourself. I have a 529 account for myself and I intend to, at some point in the future, take a few classes at the local community college and use the money for that, and you know, if there’s still money left over, look around and maybe I’ll have some grandchildren by then. Who knows? But as I said, it’s a nice tax-free pool of money that’s gonna set aside, and if I actually do need it for myself for any other reason, I can get my hands on it with a tax cost attached to it, but as long as I don’t need it, I can just kind of keep it there.
Jim Lange: Now Bob, is there any chance that your son is going to go to graduate school?
Jim Lange: Alright. Let me ask you this: if he had said yes, could I assume that that money would be good for graduate school?
Joe Hurley: It would be good, yes. That would be able to be used for graduate school. And let me ask Bob one question here too.
Jim Lange: And by the way, we have about two minutes.
Joe Hurley: Okay.
Bob: And I had one quick question too, so it’s okay. What can I answer?
Joe Hurley: Has he received scholarships along the way?
Joe Hurley: So, what you could actually do, if you wanted to, is pull out your 529 money, attribute it to those scholarships and avoid the 10% penalty, and as long as the money goes to him, the earnings would go on his tax return and maybe his tax bracket is so low, he would end up paying no taxes on it anyway.
Bob: Right, okay. Can I ask my other question real quickly?
Jim Lange: Real quick, like a four-word question and a four-word answer.
Bob: Okay. My daughter is also in college. nbsp; Obviously, when my son leaves college this year, the FAFSA is going to be affected because I’m only going to have one person in school. How does that affect the financial aid calculations? I know it’ll affect the FAFSA, but what impact does that have relative to usually the calculations…
Jim Lange: I’m sorry. I’m getting all kinds of motions from the director here.
Bob: Alright. No problem.
Hana: Sorry Bob, we can’t get to that question today.
Bob: That’s alright.
Hana: I just want to thank you all for joining us for another Lange Money Hour, and thank you, Joe. With the escalating cost of a college education, we hope that we were able to show you ways to make it affordable. We will leave you with a final statistic and a quote from Bill Vaughan: “Economists report that a college education adds many thousands of dollars to a man’s lifetime income, which he then spends sending his son to college.”
James Lange, CPA
Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania. He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again. He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans. His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans. Jim’s advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger’s Retirement Reports and The Tax Adviser (AICPA). Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.