In College Savings Plans, Basic Account May Be Best Choice

By LIZ PULLIAM WESTON

July 7, 2000 12 AM PT

California’s college savings program, Golden State ScholarShare Trust, has expanded its investment choices as a way to lure more parents into starting accounts.

But the new choices come with new risks, and most college savers would be better off sticking to the program’s original formula.

About 12,000 accounts have been opened in the program’s first nine months, averaging $4,850 each. That account size is short of the $8,000 average that program administrator TIAA-CREF needs to break even, said Timothy E. Lane, TIAA-CREF’s vice president for tuition financing.

ScholarShare’s slow start is disappointing to anyone who understands college savings plans, which allow parents and others to put aside money that can grow tax-deferred for college expenses.

The money in a college account, when withdrawn, is taxed at the child’s rate; it receives favorable treatment when schools determine financial aid packages (it’s usually counted as the parents’ asset, rather than the child’s); and--best of all, for many parents and grandparents--the person making the contribution controls the account and can transfer the money to another family member if, for example, the child doesn’t need the money or chooses not to go to college.

California Program Excellent but Lagging

California’s plan is among the nation’s best. Program manager TIAA-CREF, one of the world’s largest pension providers and a respected administrator of other college plans, charges an annual fee of only 0.8% of account assets for its services. That’s about half the administration costs charged by some other states’ plans.

Parents and grandparents should be beating down the doors to get into this plan. But they’re not.

Part of ScholarShare’s problem is that California offers no upfront tax benefit for contributing to a college savings account--unlike New York, which allows contributors to deduct up to $5,000 on their state and local tax returns.

A bill being considered by the California Legislature would offer a $500 refundable credit which, in an after-tax sense, could offer more benefit to many families, since credits offset taxes dollar-for-dollar and thus tend to be more valuable than deductions, which reduce tax bills according to the taxpayer’s tax bracket. The fate of the California bill is unclear, however.

ScholarShare officials think the program’s other problem is its lack of investment choices. Like most college savings plans, ScholarShare was launched with a single investment option: The program uses a financial formula that mandates a specific mix of investments according to the child’s age. The mix is automatically shifted over time.

For example, newborns are given a mix of 75% stock and 25% bonds, with the fixed income and cash portion automatically increasing as the child ages.

That’s exactly how most financial planners would advise saving for college, although some would opt for a higher percentage of stocks in the beginning. In any case, the amount of investment risk taken should decline as college grows closer. By the time the first tuition bill comes due, the money should be safely stored in a low-risk money market account.

But ScholarShare’s original formula wasn’t good enough for many potential contributors who were used to hot-dogging it in the equities market. They wanted an all-stock, all-the-time option. So ScholarShare is giving them two.

The first all-stock alternative offers a mix of 80% domestic stocks and 20% international stocks, while the second focuses exclusively on socially responsible companies--no tobacco or gambling shares, for example.

Savings Options Can Moderate Risk

A third account option goes in exactly the opposite direction: It’s a guaranteed account with a minimum interest rate that will be reset each year. The first year’s rate is 6.75%.

ScholarShare officials say contributors can moderate risk by putting together their own “balanced fund”--opening one all-stock account and another guaranteed account, for example, and dividing their contributions to create their own ideal asset mix.

The problem is, you can’t transfer money from one account to another in a college savings plan. Once your cash is committed to the stock market under the 100% equity option, it stays there until withdrawn. If Junior hits Harvard at the exact moment the stock market takes a 40% dive, his college fund would take a serious hit.

You can moderate that risk by adding new money to the guaranteed option, but there’s no switching assets from an all-stock account to another account.

ScholarShare can’t be blamed for trying to make the program more attractive to more investors. Perhaps the mandated investment mix on its original plan is a little too conservative for those accustomed to a stock market that has for two decades offered high returns with few serious setbacks.

For those who know how unusual the market of the last 20 years has been, however, the original investment plan--with capital preservation becoming more important than capital appreciation as the child’s college years approach--probably is still the best bet.

Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times’ Web site at https://www.latimes.com/moneytalk.

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In College Savings Plans, Basic Account May Be Best Choice

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