NO, NO, NO, NO

One of the TurboTax help screens, I’m told, tells users that interest on Treasury securities and federal agency bonds are exempt from federal tax but subject to state and local income tax. FYI: This is exactly backwards.

INDIANA AGAIN

I’ve been suggesting that those saving for college consider Indiana’s QSTP (Qualified State Tuition Plan). This does not mean you have to go to Purdue. The plan is open to people from any state, and the funds you accrue can be used to pay tuition inany state.

Indiana’s QSTP used to be pretty rotten, but they’ve fixed it. Now it seems to be pretty good. [And now, in January of 2002, it doesn’t seem so good anymore. Sorry. — A.T.]

Russell Ackerman: “Forbes has an article about the State College Saving Plans. They seem to be a lot more critical of Indiana’s plan than you are.”

I threw this one back to Less Antman, who has studied this subject in some detail and generously shared his findings. (Executive summary: Forbes goofed. Feel free to jump to the blue headline if you’re an executive.)

Less responds:

“The sensationalistic and attacking tone of the article is totally inappropriate in my mind. The comparison in the article is based entirely on the maximum expenses of all the funds, totally ignoring the major restrictions and inflexibility of the lowest cost states, rewarding states that offer no choices, and punishing a state like Indiana which offers alternatives. Their winner ‘by the numbers,’ Iowa, limits contributions to $2,054 per year, requires all funds to be distributed before the beneficiary reaches 30, and requires everyone to use a conservative LifeStrategy approach that will cost the average investor about 2% per year in returns, dwarfing the cost advantage. But Iowa did give Forbes his best election results, so I will chalk it up to gratitude.

“At the time of my comparison, only Arizona, Indiana, and Utah allowed 100% equity choices (while also permitting less aggressive allocations). I deleted Arizona because it only offered actively-managed investments from an obscure fund company with a lousy track record charging high fees. That left Indiana and Utah. Either could be an excellent choice, but Utah has some restrictions that could be DEVASTATING in some cases: once the beneficiary enrolls in a qualified college (even before any money is withdrawn), ALL the money must then be spent on THAT child’s education. If there is money left in the Indiana account, on the other hand, it can be rolled with no problem to another family member (not just siblings, by the way). If I ever recommended Utah to someone and they later found out they couldn’t roll the funds to their younger children when their eldest ended up not needing all the money, I’d feel terrible. I’d feel even worse when they found out that Utah would then take 10% of their earnings as a penalty and that the remainder would be taxed on THEIR return at their top tax bracket.

“This alone is reason enough to justify the higher Indiana fees, which AREN’T 1.4%, as Forbes implies, but 0.9% in an apples-to-apples comparison. Both Indiana and Utah offer an S&P 500 index fund (Utah offers nothing else). Utah’s maximum allowable fees are actually higher than those of Indiana — not lower — but they are currently charging less than the maximum. That’s great, but there is no guarantee how long it will last. For a $5,000 index fund account, Utah charges a total of $40.50 per year (reserving the right to charge up to $78) and Indiana charges $45 per year. For a $10,000 account, Utah charges $56 per year (reserving the right to charge up to $106) and Indiana $90 per year. I’ll pay the extra few dollars for the right to roll one child’s excess funds to other family members; for it’s minimal age restrictions; and for the ability to shelter an additional $25,000 on the off-chance the student might want to go on to grad school.”

Thanks, Less. As before, visit the excellent savingforcollege.com for more information. It rates the plans of both Indiana and Utah — but not Iowa — among the very best.

[See March 13, 2000 update: Indiana downgraded for poor customer service, administrative errors.]

But should you bother with any QSTP?

One of you asked why I — who always try to shave expenses to the bone — would recommend even the Indiana or Utah QSTPs. Why give up nearly 1% a year, or even more, rather than “do it yourself?”

It is a fair question. If you just bought and held a few stocks that went up, there’d be no fees, and your growth would be deferred from tax until you eventually sold — at which time you would likely be subject to a light long-term capital gains tax. (Any dividends would be taxed at your ordinary income bracket along the way.)

Advantages of a QSTP:

  • You get wide diversification and the ability to shift among different funds sheltered from tax. (As college nears, especially if the market is high, you could begin shifting some of the money into bonds.)
  • When the money is withdrawn for tuition, it’s withdrawn at the student’s presumably-lower tax rate — a rate that may well be lower even than your capital gains rate.
  • Your dividends are sheltered and tax-shifted to a lower bracket right along with the appreciation.
  • Many of the plans allow for easy periodic contributions, starting as low as $25.
  • It’s an easy way to segregate your savings so the college nest egg is less likely accidentally to get spent on a boat.
 

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