State Gets Closer to Program for Tax-Deferred College Accounts
A new tax break for Californians is a step closer with the selection of a manager for the state’s fledgling tax-deferred college savings plan.
After months of delay, the state has tapped the world’s largest pension manager, TIAA-CREF, to run the new savings program known as Golden State Scholarshare Trust.
The California trust hopes to begin accepting contributions by July, said Tina Orrock, spokeswoman for its development team.
The trust’s board is expected to vote April 9 to approve TIAA-CREF. The nonprofit organization, composed of insurance company Teachers Insurance & Annuity Assn. and investment manager College Retirement Equities Fund, runs a similar college savings plan for New York and has been appointed to run plans in Kentucky and Vermont. The firm is best known as the managers of retirement funds for 2 million college educators and staff.
California is one of the last states to create so-called 529 plans, named after the 1996 IRS code section that permits states to set up federal tax-deferred college savings plans and prepaid-tuition programs. So far, 32 states have created one or both programs, and seven others--Arizona, Maine, Minnesota, Missouri, Vermont, New Mexico and Oklahoma--have plans in the works. California does not have a prepaid-tuition plan.
The savings plans allow parents and others to set up investment accounts that grow tax-deferred until a child or other beneficiary reaches college age. The money can be used for any college in the U.S. and, if withdrawn to pay for tuition and other college expenses, is taxed at the student’s rate.
Some states even allow state tax deductions for the contributions, although California is not among them. In New York, for example, parents can deduct up to $5,000 on their state income tax return. Since opening Sept. 28, the New York plan has attracted $172 million in 50,231 accounts, with an average account balance of $3,400.
The state law authorizing California’s plan went into effect Jan. 1, 1998, and state officials originally predicted the trust would accept contributions by last July.
Almost immediately, however, the process bogged down as officials struggled to structure the bidding for investment firms and to coordinate the three state agencies running the program: the California Student Aid Commission, the treasurer’s office and the director of finance.
The state’s first attempt to attract bids was canceled in October, after investment companies complained that the three-year contract, with a two-year extension, would not give them enough time to recoup their setup and marketing costs.
The state then extended the contract to seven years, and it chose TIAA-CREF last week. Orrock said she could not discuss other bidders, although she said there were several.
Some states directly manage the college savings money, while others hire investment management firms such as TIAA-CREF or mutual fund giant Fidelity Investments, which runs plans for New Hampshire, Delaware and Massachusetts.
By federal law, parents and others who contribute have no choice in how the money is invested. In California, a three-member investment board comprised of state Treasurer Phil Angelides, California Student Aid Commission Executive Director Wally Boeck and state Director of Finance B. Timothy Gage will monitor the investments and set basic investment policy, such as determining what percentage of the trust funds will be invested in stocks, bonds and cash. The accounts themselves will be invested according to the beneficiary’s age.
“The money will be invested more aggressively for younger people. As they approach 18, the investment strategy will become more conservative,” said Tim Lane, head of tuition financing for TIAA-CREF.
There are no income limits for parents or others who contribute, and the maximum allowable contribution will depend on the child’s age and where the parents expect him or her to attend school. Parents who expect their teenager to attend Stanford or Harvard in a few years, for example, could put aside far more than parents who expect their toddler to attend a public university more than a dozen years hence.
Many details have yet to be worked out, including the formula used to determine how much parents will be able to contribute. The minimum contribution is expected to be $25, Orrock said.
The lack of income limits and the way maximum contributions will be figured make the plans potentially powerful tax and estate-planning mechanisms, said Joseph F. Hurley, a Rochester, N.Y., certified public accountant and author of “The Best Way to Save for College--A Comprehensive Guide to State-Sponsored College Savings Plans and Prepaid Tuition Contracts.”
For example, grandparents who want to avoid estate taxes could contribute to the savings plans, moving money out of their own estates and giving their heirs a tax-deferred college fund, Hurley said.
And unlike Uniform Transfers to Minors Act accounts, another popular college savings tool, the college savings accounts allow parents to maintain control of the money even if a child decides not to attend college. Under IRS rules, the account holder can transfer the balance for the benefit of another child or family member--or simply withdraw it and pay a penalty of at least 10%.
Times staff writer Liz Pulliam can be reached at liz.pulliam@latimes.com.
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Key Questions About Scholarshare
Many details are still being worked out about how Golden State Scholarshare Trust, California’s new tax-deferred college savings plan, will operate. Here are answers to some basic questions about the program:
Question: Who can participate?
Answer: Anyone can open an account on behalf of a beneficiary. Typically, parents and grandparents will open an account on behalf of a child.
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Q: How much can I contribute?
A: The maximum contribution will be based on a formula that estimates the cost of a four-year education at a private California university, given the child’s age and an as yet unknown discount rate. New York has a $100,000 contribution limit, while Massachusetts allows contributors to invest up to $158,750 per beneficiary. California has not set a dollar maximum, but the minimum contribution is expected to be $25.
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Q: Does my child have to attend a predetermined school?
A: No. Even if you use the projected tuition at Stanford to determine your maximum contribution, your child can attend any school in any state and still qualify for tax breaks on the Scholarshare account money.
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Q: What are the advantages?
A: Earnings in the account are tax-deferred and managed professionally. Unlike the education IRA, there are no income limits restricting who can contribute. Money in the account can be used for most college expenses, including tuition, housing and fees. When used for college expenses, the money is taxed at the student’s rate. Depending on the final rules, the plan may provide some new opportunities for estate planning.
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Q: What are the disadvantages?
A: Contributors have no control over how the money is invested. Because stocks, bonds and cash will be used, the accounts could lose, as well as make, money. Individual investors may feel they could get a better return, or have less risk, by investing the money on their own.
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Q: What if my child decides not to go to college?
A: You can change the designated beneficiary to another family member, such as a brother or sister of the original beneficiary, or you can cancel the account and get a refund of the money, minus income taxes and a penalty of at least 10%.
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For more information on the Golden State Scholarshare Trust, visit https://www.csac.ca.gov/scholar/scholar.htm. For information on other states’ programs, visit https://www.collegesavings.org.
