Be hands-on manager of kid's college savings plan

November 06, 2005|By EILEEN AMBROSE

We pump our gas, bag our groceries and even undertake major home remodeling on our own. But when it comes to choosing a college savings plan, many investors are not do-it-yourselfers.

States allow their residents - and often out-of-state investors - to invest directly into their so-called 529 plans without going through a broker and paying a commission.

Yet, experts estimate that about 80 percent of the billions of dollars that flow into the plans come through brokers and financial advisers.

It's understandable that parents and grandparents would turn to a professional. Just about every state offers a plan, and some have more than one. They have different rules, fees and state tax breaks, making comparisons often difficult.

More worrisome, a poor choice could mean a child would end up with less money for college. But as recent events show, consumers shouldn't be too hands-off.

This month, the NASD, which regulates its brokerage members, took its first enforcement action resulting from a two-year investigation into whether brokers at about 20 firms steered clients away from home-state plans with tax breaks and into plans with higher fees and commissions. Ameriprise Financial Services Inc. - formerly American Express Financial Advisors - agreed to pay $1.25 million to settle allegations that clients lost valuable tax breaks from their home state by being enrolled in another state's plan.

College savings plans, often called 529 plans for the tax code creating them, became popular after a 2001 law increased their tax friendliness. At the end of September, 529 assets reached $63.4 billion, according to Financial Research Corp.

Money invested in a plan's mutual funds can be withdrawn free of federal tax provided it is used for college. States typically don't tax the gains, either.

Plans are sold two ways. You can invest directly with the state or program manager, which is the case in Maryland, where T. Rowe Price Associates serves as manager. Or, you can go through a broker or adviser.

If you're not a do-it-yourselfer and want help, find a trusted adviser and ask a lot of questions why one plan is recommended over all the other available options, regulators say. After all, you are paying for this advice.

Here are some basic steps to take and questions to ask before investing:

Begin at home. Check out your home-state plan so that you understand what perks you could lose by investing in another state's plan.

About half of the states, including Maryland, allow residents to deduct some or all of their contributions to a 529 plan on their state tax returns. Some states waive certain plan fees for residents or even match contributions by low-income residents, experts said.

Some states even penalize people who veer from home. Illinois residents investing in another state's plan will pay Illinois income tax on earnings upon withdrawal. New York will reclaim state tax deductions and tax earnings if residents roll out of New York's plan and into another.

Often, it is difficult for investors to assess the value of these state tax breaks. Kerry O'Boyle, an analyst with Morningstar Inc., suggests families pay an accountant to do the math for them.

New Mexico helps cut through some confusion with an online calculator that can be used by residents around the country to compute the potential tax savings from investing at home. The calculator is at www.theeduca- tionplan.com/plan/toolsState- TaxCalc.shtml.

Be aware: the calculator generally doesn't take into account any local tax savings, like those in Maryland, so the tax break might be understated.

For most Marylanders, contributing $2,500 to the state plan would save about $187 in state and local taxes, said Anna Fink, a Baltimore accountant.

Why that one? If an adviser recommends going out of state, find out why. "Most brokers aren't going to put you in a ... direct-sold plan" that doesn't pay a commission, O'Boyle said.

Investors also should ask their brokers what plans they can offer, said Brian Mulford, a lawyer for the Securities and Exchange Commission's office of investor education and assistance. "The best plan for you might be the one your broker can't sell."

This was at the crux of the Ameriprise case. The firm's brokers sold only Wisconsin's plan and lacked procedures to adequately evaluate tax breaks from other states, according to the NASD. As part of its settlement, Ameriprise must pay $750,000 to compensate more than 500 customer accounts for lost tax breaks. Ameriprise, which didn't admit or deny the allegations, now offers nine plans.

Sometimes advisers trumpet a plan's performance, but this can be misleading, O'Boyle said. College plans are too new to have a proven track record, he said.

What's important is the quality of the investment company managing the program, O'Boyle said.

Fees and commissions. Each plan, whether direct- or broker-sold, will charge certain fees, such as an annual charge for the managers of the plan's mutual funds. Broker-sold plans have additional fees, and investors should ask about them.

Investors, for instance, might pay an upfront sales commission of, say, 5 percent each time they contribute to the plan, plus an annual fee of 0.25 percent of their account balance, experts said. Or, there might be no upfront sales charge, but investors will pay 1 percent of their investment each year.

The NASD offers a 529 expense analyzer, available at www.nasd.com, that allows consumers to compare plans and the impact of fees and commissions over time.

eileen.ambrose@baltsun.com

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