New California Program Makes It Easier to Save for College

Parents and others hoping to save for a child’s education will get a new tax-deferred option starting Monday when California’s Golden State ScholarShare program begins accepting contributions.

ScholarShare, delayed for months while California sought Securities and Exchange Commission approval, becomes the 19th state-sponsored college savings program to be created since Congress officially sanctioned the plans in 1996.

The state-run program and its tax advantages are available to a wide variety of people--singles saving for themselves, grandparents seeking to help grandchildren, friends saving for friends’ children--as well as parents saving for their own progeny. Besides the tax savings, the plan also allows contributors to retain some control of the funds--which can also confer certain estate-planning advantages, financial planners say.

The plans, also known as 529 plans for the Internal Revenue Code that endorses them, let contributors put aside money that grows free of state and federal taxes. The giant pension firm TIAA-CREF was hired by the state to administer the program, and it invests each account’s money in a mix of stocks, bonds and cash that varies according to the time horizon for the recipient. When withdrawn to pay tuition and other education costs, the money is taxed at the student’s income tax rate.

Proceeds can be used at any accredited institution in the United States--unlike many prepaid-tuition plans that penalize students who don’t attend in-state schools.

ScholarShare “is a very powerful education-planning tool,” said Mark Gleason, a fee-only certified financial planner and chartered financial analyst in Glendale. “It’s not the answer for everyone, but it’s one more piece in the financial-planning puzzle that offers people flexibility.”

Many of Gleason’s clients use the Uniform Transfers to Minors Act, known as UTMA, to set up education accounts in their children’s names. But the money becomes the child’s to use at age 21, whether or not the child attends college.

By contrast, whoever opens a college savings plan retains control over who gets the money. The beneficiary can be changed to another member of the beneficiary’s family or even used by the contributor. If money is not used for education, it can be withdrawn by the contributor, though it then becomes subject to regular income taxes and a 10% penalty.

Grandparents or other people interested in reducing the size of their taxable estates can put as much as $50,000 in a child’s college savings plan account per year without making themselves subject to gift tax rules, as long as they make no other gifts to that recipient in the next five years.

*

The ability to move money out of an estate for estate tax purposes while retaining some control over the money is unusual among estate-planning tools, said Joseph F. Hurley, a certified public accountant who has written a book, “The Best Way to Save for College” ($22.95, BonaCom Publications), about college savings and prepaid-tuition plans. Donors usually must cede control of any money they give in order for the gift to be considered completed and thus valid for estate-reduction purposes, he said. (Estate taxes are currently levied on estates of more than $650,000, but that limit is scheduled to rise to $1 million by 2006.)

The new state-sponsored college savings plans have a number of disadvantages, however. Contributors cannot choose how the money is invested, since investment allocations are made according to the child’s age or the planned date of starting school. Also, withdrawals are taxed as ordinary income, whereas capital gains in UTMA accounts can be taxed at a lower capital gains rate.

Gleason said he will recommend that some clients use both UTMAs and ScholarShare for college savings. A family could fund the UTMA with the minimum amount needed to attend a state school, then put extra savings in the ScholarShare account. If the child does not use the extra savings to attend a more expensive private school, the ScholarShare money can be transferred to another child, Gleason said.

How college savings plans will affect financial aid packages remains unclear. Some schools are expected to treat the plans as an asset of the parents’, while others may treat the money as belonging to the student.

That determination can make a huge difference when it comes to financial aid. Most schools, before coming up with any kind of financial aid offer, will use a formula that requires parents to contribute 5.6% of their assets annually toward a child’s education. The student is required to contribute 35% of his or her assets.

But ScholarShare officials say that since most financial aid today consists of loans rather than grants or scholarships, funds saved in a ScholarShare account would serve to reduce the amount of debt the student would incur.

Some planners are concerned that Congress may reconsider the flexibility of these accounts because investment companies that operate college savings plans in other states have been aggressively advertising for out-of-state residents to invest in their plans.

Fidelity Investments is advertising its New Hampshire plan nationwide, and Merrill Lynch is marketing its Maine college savings plans through its brokers. Many Californians are participating in those out-of-state plans, and California has decided not to tax the gains from other states’ college-savings plans.

*

States that have adopted plans in the last year tend to have lower management expenses and more aggressive investment options than older plans, a fact that some have interpreted as a move to increase competition among plans, and encouraging donors to shop for the best deal.

But critics argue that the plans were designed for state residents and that efforts to attract outside residents could eventually lead Congress to crack down on such marketing or even to revoke the plans’ tax advantages. The competition could also stymie proposals seeking to make withdrawals from the plans tax-free.

For more information on California’s plan, visit https://www.scholarshare.com or call (877) SAV4EDU. For information on plans nationwide, visit https://www.collegesavings.org, a site operated by the National Assn. of State Treasurers.

Times staff writer Liz Pulliam can be reached at liz.pulliam@latimes.com.

*

* PLAN PRIMER

ScholarShare details, C4

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Education Expenses

College costs have been rising faster than inflation, a trend that is expected to continue. The typical cost, including room and board, for a prestigious private school is now $30,000 per year, For a U.S. public university, it’s $11,000 per year. Below, a projection of future costs, assuming a 6% annual increase.

*

Average Ivy League college: $96,214 a year in 2019

*

Avg. public college: $35,278 in 2019

*

Avg. public college: $35,278 in 2019