More advisors' clients are maxing out on 529 plans,
driving first-year contributions into the six-figure range.
The mere thought of education planning used to
elicit yawns-a reaction, no doubt, to the thought of another $250
monthly investment limping along. But for advisors who work with the
wealthy these days, 529 plans have gotten a lot more interesting. Just
ask Frank Marzano, a New York-based advisor who just had a prominent
business owner plunk down $240,000-the full amount he and his wife can
contribute to the 529 plans they established for their two kids.
"The client had just sold his business for a significant sum of money," says Marzano, whose firm GM Advisory Group Inc., in Port Washington, N.Y., manages $200 million for clients. "When you come into that kind of windfall, there are usually lots of things on your mind-a vacation home, retirement. But before I could even begin planning, he made it clear that first and foremost he wanted to fully fund 529 plans for his kids."
Marzano isn't alone in seeing an uptick in very serious parents and grandparents. A growing number of advisors we talked to are starting to see wealthy clients make the decision to sock away the full $60,000 per child the gift-tax exemption allows them to put into a 529 plan. For a couple, that comes to $120,000 per child or grandchild. That's a windfall for would-be students, care of the IRS, that allows taxpayers to accelerate their annual gifting to 529 plans, in effect contributing five years' worth of gifting in the first year.
An added perk? That money is off the books for estate tax purposes. "We think this is making 529s a big-ticket item and a great opportunity for advisors to integrate education savings with financial planning and estate planning," says Tobias Henriksson, product manager for education savings at Raymond James & Associates. "You can say, 'Let's take the money off the books now so it doesn't get included in your estate.' There is a great motivation to not delay, but rather do this sooner than later," Henriksson says.
One reason for the IRS's generosity when it comes to gifting for 529s is no doubt escalating college costs. Total costs for a public school hit $12,800 for the 2006-2007 school year. That same education at a private college cost $30,367. For a four year old, private college 14 years from now will cost more than $250,000, predicts the College Board. In fact, the group found that college expenses have surged 35% in the past five years alone.
Joe Hurley, president of savingforcollege.com, a comprehensive Web site that allows users to compare benefits and costs of all state plans, says there is currently $100 billion in 529 plans, not counting each state's prepaid tuition plans. "We're seeing substantial growth and it's been accelerating after the Pension Protection Act made tax-free withdrawals for qualified education expenses permanent last year," Hurley says.
Another reason for the generous contributions? Wealthy investors want to ensure that their kids can afford luxury educations, says David Hollands, president of David Hollands & Associates, an advisory firm in Plano, Texas. "I just got off the phone with a prospect who wants to make a $120,000 contribution to a 529 plan for his son. When I read articles about how 529 plans are a small-ticket item, I just shake my head. The biggest gift the millionaires next door talk about is the gift of education, and that is translating into large plans," says Hollands, a certified college planning specialist.
Of course, today's investors may be learning from the hard lessons of those parents who are either currently footing the bill or those who have already paid the price for kids in college. A new survey sponsored by the John Hancock Freedom 529 plan found that these parents didn't sock away enough, if they saved anything at all. In fact, more than half of parents (57.2%) said they didn't really save for their child's education and 16.7% said they did not even start thinking about saving for college until their children were at least 16 years old. So it's not surprising that more than half (53.6%) also said they'd be paying off student loans for years, says Hurley, who spoke about Hancock's findings to 20 different radio stations on the day we interviewed him.
Respondents were asked what they wish they had known or done earlier. Those surveyed said they wished they had known earlier how expensive college is (45.2%). They also wish they had started saving earlier (55%), opened a 529 plan (33%) and had their son or daughter save more (19.4%).
"We're hoping this survey gets people thinking and acting about saving," says Diana Scott, senior vice president and general manager of the John Hancock Freedom 529 plan. "As more people use 529 plans to save for college, we hope they may see that saving early and contributing often can help them on their way to achieving their college savings goals.
Lacking savings, the 500 families surveyed by John Hancock paid for their child's education using student loans (64.4%), scholarships (63.1%), the child's savings (31.3%), loans (such as home equity or 401(k) loans, 26.9%) and gifts from grandparents. But not all grandparents are waiting until the tuition bill comes due to make such gifts. "One client of mine, a grandfather, put away $60,000 for each of his six grandkids," says Gail A. Fialkow, president of Capital Planning Direct in Fairfax, Va. "He had a regular stock portfolio invested for them, but he was glad to cash it out and invested the entire amount in 529 plans."
"When the five-year time frame is up on his gifting deduction, he can make the same contributions all over again," Fialkow continues. "There are exceptions, but generally speaking baby boomers aren't the best of savers, so when I get them in the door, one of the first things we tackle is college savings, because it's the most immediate need."
Fialkow uses the American Funds Plan for Virginia clients and the T. Rowe Price plan for Maryland clients. "I like these plans, and both provide investors with a state tax credit for their deductions, so they have the benefit of sound money management coupled with the tax benefit."
Marzano says he uses plans managed by American Funds, Vanguard or Columbia, depending upon the client. "We look at three criteria: What are the internal expenses of the plan, what are the quality of investments and will the client get the state tax credit. The investment alternatives within plans have become so much more comprehensive. You can create your own portfolio and select actual funds, which is a big change and benefit," Marzano adds.
Of course, no one has to tell advisors that the 529 plan is one of the most tax-advantaged and flexible accounts in history, right up there with the Roth IRA. But investors, too, are starting to take note of all the benefits of the plans, which were created ten years ago. "I think it's in the vernacular now," Fialkow says. "A lot of people I talk to either know about the features of the plans or have at least heard something about them."
The tax benefits, of course, are a huge draw. Many states offer income tax credits for contributions, which typically max out at between $2,500 and $10,000. But more importantly, students and their parents will never pay a dime in taxes on any growth in the accounts. And all withdrawals can be made tax-free, provided they're for qualified education expenses. That benefit was set to expire, but then the Pension Protection Act made qualified withdrawals permanently tax-free last year.
The ownership of accounts and the ability to change beneficiaries is also critical to investors socking money away for kids' education. "People have always been looking for a vehicle to save for college, and now they have one that protects their money," says Fialkow, referring to the ownership of the accounts, which remains with the parent or grandparent who creates them.
With those vehicles that predated 529 plans (UTMAs and UGMAs), the child owned the fund upon turning 18. "You were always running the risk that when Jimmy turned 18, he'd get the 'Vette and the girl and head to the beach," Fialkow says. "Who that is saving $100,000 or $200,000 wants to worry about that happening? Frankly, when you start saving for a child at infancy, you have no idea what they'll be like."
With a 529 plan, however, parents and grandparents-or even generous aunts, uncles or family friends-don't have to worry at all. The investor and not the beneficiary (the student) retains ownership of the plan, plain and simple. And if Jimmy does up and become a beach bum, mom, dad or grandma can change the beneficiary to any of Jimmy's more studious siblings, or even first cousins.
As for how 529s affect a student's ability to get financial aid, they're actually counted very little, according to Hurley. "Parent-owned 529s are assessed at a very low rate, and distributions are not picked up as income in the following years' calculations for aid," he says. As for student-owned 529s, there's a real opportunity to save almost off the books because of a new tax law change that says student-owned plans aren't counted at all. That's in sharp contrast to the student's assets, which are assessed at the highest rate, Hurley says. (For advisors interested in learning more about 529 plans, Hurley holds an annual one-day boot camp. Details are available at www.savingforcollege.com).
"What I tell people is: 'Every dollar you save now is one you don't have to scrounge when the kids are going off to school," Fialkow adds.