So How DO You Pay for College? December 15, 1999February 13, 2017 We started the week with frozen grapes, and you figured I had slipped into egg nog mode. Pretty hard to write about Variable Universal Life after a glass or two of the nog. The ol’ noggin noddin’ and bobbin’ and wobblin’ — and yet there it was: everything you could possibly want to know about paying for college with a Variable Universal Life insurance policy. (Executive Summary: Don’t.) So how DO you pay for college? (Executive Summary: One state has a really good plan anyone can take advantage of.) One of the little-known provisions of the 1997 Tax Act, I am again indebted to Less Antman for knowing, was the federal government’s improved treatment of Qualified State Tuition Programs (QSTPs), also known as “529 plans.” Almost anybody saving for college would be crazy not at least to consider them. They put the wretched Education IRAs to shame, and are better than Uniform Trust to Minors Act accounts as college savings vehicles because they don’t turn control over to the beneficiary at 18 or 21 or any age, for that matter. The contributor owns and controls the account completely. The 1997 law allows QSTPs to have many special benefits. Unfortunately, most states are not taking advantage of them all. Then again, you don’t have to choose the plan of your own state! According to Less, here are some of the benefits Uncle Sam allows: (1) No “adjusted gross income” limits on participation (in contrast, the Education IRA isn’t available to contributors above a certain AGI). (2) Up to $100,000 or more can be saved in them (compared to the pathetic $500 per year Education IRA limit). (3) Tax deferral until withdrawal. (4) Income taxed at beneficiary’s rate (that often means the student’s 15% rate instead of the high-income parents’ 39.6% rate) if used for qualified higher education costs. (5) Total control by contributor (unlike UTMA accounts), but still excluded from contributor’s estate in case of death. The owner of the account can even withdraw all the funds personally, subject to a minimum IRA-like 10% penalty on the income from the plan, plus tax. If the beneficiary dies, becomes disabled, or gets a scholarship to college, funds can be withdrawn without penalty (but still subject to ordinary taxation at the contributor’s rate). (6) Can be deferred until the beneficiary reaches age 45. (Talk about being held back!) (7) Can be rolled to another family member (which is defined very broadly). (8) Gift tax can be avoided on contributions up to $50,000 ($100,000 couple) by use of 5-year averaging. (9) Can draw funds without stopping HOPE and Lifetime Learning Credits (when applicable). (10) Definition of qualified higher education expenses includes room and board in many cases. (11) Can be used in- or out-of-state. (12) No relationship between contributor and beneficiary required (“Rich man adopts elementary school with QSTPs . . . “) (13) No-fee plans starting with contributions as low as $25 per month. “After I finished pinching myself over and over again to be sure I wasn’t dreaming,” writes Less, “I started ordering the literature on plans from various states. I discovered that the plan of my home state (California) is one of those not taking advantage of all the potential benefits. Also, these plans don’t let you choose your own investments, and many states have picked some investment companies with miserable track records. Arizona, for example, limits you to an investment company whose equity fund choices have trailed the S&P 500 by more than 5% per year for the past decade. “Some of the states allocate the investments in absurdly conservative ways, such as 10% stock and 90% money market fund. And once you’ve allocated funds, you often can’t change the allocations. Some states prohibit rollovers to other beneficiaries or other states. Some impose penalties for non-qualified withdrawals massively exceeding those Uncle Sam requires. “But I quickly discovered that there are some excellent plans. Out of 18 states with plans that are currently open to non-residents, I think there is one state — Indiana — with a plan that stands head-and-shoulders above the others. [NOT ANY MORE — A.T. 1/17/02] I’ll be recommending this plan to all of my financial planning clients. Indiana’s 529 plan: “(1) Offers a low-cost S&P 500 stock index fund as one option, for those who want to maximize the potential growth of the account and minimize active manager risk. “(2) Offers another option that diversifies globally, uses a fund-of-funds approach to minimize the impact of any one manager, and moves automatically from reasonably aggressive to reasonably conservative as the beneficiary reaches college age. “(3) Takes advantage of virtually all of the 13 benefits allowed by the federal government, with maximum allowed contributions far exceeding $100,000 and penalties set at the absolute minimum level required by federal law. “The plan has a web site, but before you click, be aware that they haven’t yet updated the site for recently added benefits. So if you read it online, you’re not going to find out how good it is.” Better, Less suggests, to go to Joseph Hurley’s site. Hurley updates his site before the states update their own. He is also the author of The Best Way to Save For College, available for $22.95 at Amazon.com or $17.21 at buy.com. [See March 13, 2000 update: Hurley has downgraded the Indiana plan for poor customer service, administrative errors.] Thanks again, Less.