MASTERCLASS: Small Caps - October 2020
October 7, 2020
Jenna Dagenhart: Hello and welcome to Asset TV's 529 Masterclass. College costs are skyrocketing, and student debt is at a record $1.6 trillion in the US. Today we'll cover how 529 savings plans work, their tax benefits, which education expenses qualify and more. Joining us now are three expert panelists, Tyler DeHaan, Director, Advisor Consulting Group at Scholar's Edge.
Jenna Dagenhart: Tom Rowley, Director, Retirement and Education Strategies at Invesco and Ryan White, Senior Product Manager at Columbia Threadneedle Investments. Everyone, thank you for joining us, and let's start with the basics here. What are 529 plans and how do they work? Tyler, why don't you kick us off?
Tyler DeHaan: Yeah. Well, as I travel around the country when I'm talking to people about 529 plans, a lot of times I'll hear, "Hey, are those plans that you save for college, right?" And while that's true, and the primary function of a 529 is designed to accumulate assets for future educational expenses, they can be a little bit more complicated than that.
Tyler DeHaan: But the basics here that you're going to contribute money either in a lump sum or maybe on a monthly contribution, and you're going to invest it in some combination of stocks, bonds, maybe some ETFs, maybe a target-date fund, maybe a target-risk fund, and it's going to accumulate tax deferred. And that's the big thing. It's going to accumulate tax deferral because that eliminates tax drag.
Tyler DeHaan: You're not paying taxes on your capital gains or your dividends or your interest every single year, and then five, 10, 15, 20 years from now, when you decide to distribute out those assets, if you use it for qualified educational expenses, it'll come out tax free. So that's 5,000-foot view of what 529s are and the basics. I know we'll obviously talk a little bit more about the in-depth here, but it's generally going to be used as a vehicle to accumulate assets for future educational expenses.
Jenna Dagenhart: And what kind of educational expenses qualify? Tom, you want to take that one?
Tom Rowley: Sure. Thanks, Jenna. Basically, there are about five categories, right? Tuition, the full amount of college tuition that most accredited post-secondary educational institutions... Basically, look for Form 1098-T from the institution. That's your tuition. And now still under the tuition category, back in 2017 they said you could actually use $10,000 of it for K through 12 provided the state plan recognized that feature.
Tom Rowley: So basically tuition, room and board, which is on campus dormitory room and board, that's a qualified expense. And if you go off-campus, your off-campus housing and meal costs are eligible up to the colleges published figures in their cost of attendance. And the student must be enrolled at least half time. So, tuition, room and board, fees, and those are all fees, like administration, lab, technology fees, any fees required by the school.
Tom Rowley: So we've got tuition room and board fees and books and supplies. So as long as they're required, these are qualified expenses. And supplies are pens, paper, printer, ink, any books or supplies required by specific classes are also qualified expenses. And then the last and the fifth is technology. Computer, software, printers, internet services and other programs required by specific classes are qualified expenses.
Tom Rowley: If the money for a 529 plan is used for anything that does not meet the qualified expense criteria, the earnings portion of that non-qualified distribution will be taxed as ordinary income and subject to a 10% penalty.
Jenna Dagenhart: And Ryan, how does the process of setting up a 529 work? Can anyone do it?
Ryan White: Yes. I mean, 529 plans can in essence be set up by anyone as long as they meet minimum age criteria often set by the programs, but there's really no relationship requirement from the owner to the beneficiary. So oftentimes you do see that parents will set up 529 plans obviously for their own children. It's also a great opportunity for grandparents to set up 529s for grandchildren. But certainly, you can be your own beneficiary as well.
Ryan White: And in today's marketplace, there's usually plenty of opportunity for even those that have entered the working world to perhaps pursue additional higher education in the form of a graduate degree or even a professional certification. Many of which programs require course credit which you can use a 529 ultimately to pay for in ways that Tom just mentioned. But enrollment in 529 plans really couldn't be easier.
Ryan White: Almost every state, if not every state in the country offers one form or another of a 529 program. Many of those have an online enrollment in the form of direct-to-consumer products. And of course, financial advisors all across the country, those associated with broker dealers and registered investment advisors are more than willing to help clients set up 529 accounts as well.
Ryan White: So there certainly is no problem of access and there is a lot of information available throughout the respective state’s programs available online, and again through financial advisors in your community.
Jenna Dagenhart: What about the contributions, Ryan who can contribute?
Ryan White: Anyone can contribute to a 529 plan. You do not have to be an owner to contribute to an account. So there again, 529 is a great opportunity for crowdfunding and there's even been some businesses that have been created sort of on the margins of the industry to help with that gift card companies and gifting platforms that are sort of agnostic of any one particular 529 provider or a program.
Ryan White: So again, 529 has represented an opportunity not only for the individual account owner to plan and invest for that specific benefit of education, but also representing an opportunity to really engage friends and family along with that goal.
Jenna Dagenhart: Yeah. Speaking from personal experience, I know I recently contributed to my nephew's 529 plan and it was a lot easier than I was expecting.
Ryan White: Yeah. And I myself have a two-year-old and I welcome any contributions to his 529 [crosstalk 00:06:39]
Tyler DeHaan: As do I, Ryan. I have a two-year-old as well and anybody can help fund our college education.
Ryan White: That's right.
Jenna Dagenhart: We'll put that all on the website for afterwards. Well Tyler, how does the tax structure work?
Tyler DeHaan: Yeah. When I think about 529s, they can be... The tax structure can be simple and also can be complex. And when I think about the tax structure, as I stated earlier you have that tax deferral. So, the tax deferred growth, and again, that eliminates the tax drag. You're not having to pay dividends, capital gains and interest taxes on that every single year so that can really, really help accumulate assets for the intended purposes.
Tyler DeHaan: And as Tom had mentioned, if it comes out for qualified educational expenses, it's going to come out tax free. So that's another big benefit. Now, when you think about the 529s from a federal standpoint, when you do contribute to them, there isn't a federal tax deduction on the contributions to a 529. However, when you take a look at individual states, there could be some tax deductions, there could be some tax credits depending on the state that you live in.
Tyler DeHaan: So when you're taking a look at it from a state income tax situation, depending on the state that you live in, there can be some additional benefits from a tax structure there. So just keep your mind out for that, because if you live in Indiana or Iowa or New York, depending on the situation, you may have some additional tax benefits that can be very helpful.
Jenna Dagenhart: But what if say I live in New York city and my child wants to go to college in California. How does that work?
Tyler DeHaan: Well, you can take that money and use it for educational expenses in California as long as it's for qualified educational expenses. Generally, that's not going to be a big deal. Now, there may be some state tax incentives, depending on the state that you live in that you might want to just make sure that tend to be aware of.
Tyler DeHaan: But if you have a child that's wanting to do some sort of a college education that's going to be qualified and the expenses are going to be used for that, you're still going to accumulate those assets and get those out tax free. Now there may be some state tax benefits, but again, that's going to be based off the state.
Jenna Dagenhart: And Ryan, I know you have a baseball Jersey there behind you. What if a child say, goes off and plays a sport in college and gets a scholarship? What happens to the 529 money then?
Ryan White: Yeah, certainly. And that's a great question. I've been in this industry for close to eight years now, and one of the first questions you always get from folks when you talk about a 529 plan is, "Well, what happens if I get a scholarship? What happens if I get my education paid for?" Maybe you have a child who attends one of the US military academies.
Ryan White: Any scenario where you're going to get money coming at you when your student goes to college, rather than coming out of your pocket. Scholarship is one of the many penalty waivers for 529 plans. So, when it comes time to take distributions from a 529 plan, we already said that if it's a qualified distribution for any of the criteria that Tom mentioned earlier, those dollars come out tax free.
Ryan White: In the event that you receive a scholarship, the amount up to the scholarship can be withdrawn from your 529 plan penalty free. A non-qualified withdrawal would normally be associated with taxes at your ordinary income rate on earnings, plus an applicable 10% federal penalty, unless a penalty waiver applies, and of course, scholarship is one of those penalty waivers.
Ryan White: So you're not going to be penalized if you have an athletic child or an overly bright child, someone musically inclined that gets either a portion or all of their education paid for from the university or from some form of a scholarship. However, I would always caution folks that just because you receive a scholarship doesn't mean that there still isn't quite a lot of value on that 529.
Ryan White: We live in a world where a lot of education doesn't stop at undergraduate education. And of course, qualified expenses are not only for undergraduate degrees, but also graduate school as well, and with no time limit effectively imposed on 529s by Federal Legislation or by the tax code, there certainly is no reason to necessarily go raid your 529 account in the event that you get a scholarship, because there always might be expenses that are incurred outside of the purview of that scholarship that may still be qualified.
Ryan White: Maybe the scholarship covers the cost of tuition but doesn't cover the cost of housing, which of course we know is a qualified expense or doesn't cover the entire cost of books or something to that effect. So, it certainly is important to keep in mind that 529 still can have a lot of value even in the event of a scholarship.
Ryan White: Unfortunately for the Jersey behind me, my parents still had to come out of pocket quite a bit. I was good enough to be on the team, but not good enough to have it completely paid for. So, their 529 account certainly came into use for me and my career was pretty short lived.
Tom Rowley: I would add that the number of parents who believe their children are going to get scholarships versus the reality of the number of people who are going to actually get scholarships is amazing. Wait till you get to Little League and you're looking at all the other parents that are thinking, "Oh, my kid's going to get a scholarship." You go, "No, they're not. No, they're..." Statistically you won't get a scholarship.
Tyler DeHaan: And one of the thing to add on that, even if you are blessed to get a scholarship, a lot of times the amount is as much as you might think it is. Ryan I was blessed. I was able to play for a small private school in Northwest Iowa. I was able to play football and I was in [NAI 00:12:31] School.
Tyler DeHaan: And I got a little bit of money from scholarship, but it wasn't the amount that you might think it was. It was only a couple of $1,000 a year. So even when you're thinking about scholarship money, it's not necessarily going to be as much as you might think it will.
Jenna Dagenhart: All important points to keep in mind, and like Ryan mentioned too, even if your child does get a scholarship for music, dance, sports, you name it, undergrad they might need a graduate program or something along those lines. Now, Tom turning to you, tell us a little bit more about your experience with 529 plans.
Tom Rowley: Well, my real-life experience is I send three kids to college on 529s, but more importantly, I got three college graduates. So those are the college degrees behind me and none of the kids got scholarships. In fact, some of them graduated in the half of the class that made the top half possible. And so, when I think about 529, and I think about Ryan and Tyler with their small kids, I think about three things.
Tom Rowley: One is my motivation, right? I had to use loans when I went to college and knowing firsthand the sort of stress associated with having to repay those debts when you're just starting out, provided me a strong motivation to create a sort of a better outcome for my kids.
Tom Rowley: And the second is a simple approach. Basically, taking manageable steps, like establishing a monthly automatic contribution plan, where money is automatically deposited into a 529 account, eliminated all the guesswork and made it easy to stick with the plan. No matter what came up, the investing never stopped. I never lost sight of the goal and a short 252 months later, I was glad I did.
Tom Rowley: And then the third is stress relief, right? When you have little kids, right now Ryan, Tyler, you're thinking. You can't comprehend the stress of the high school years, right? And I know what you're thinking, right? You're thinking, "High school kids, they're potty trained. They can feed themselves. They can dress themselves. They know how to read. They know how to write, what could go wrong." Right?
Tom Rowley: But I'm telling you, it feels great just to have a 529 plan in place as high school winds down and college is just around the corner. There's already enough stress in the teenage years, no need to put a college funding gap on top of it. And at that time, all the decisions Will be made based upon, "Well, how much money do we have for college? And what college do you want to go to? And would you please fill out your applications?" That would be one of the biggest stresses you could ever have, right?
Jenna Dagenhart: Tyler, could you share a little bit more about your multi-manager approach?
Tyler DeHaan: Yeah. So, principal has a history of a multi-manager approach when it comes to investing, and we really, really brought this up in our retirement side of our house, and then after a couple of years, we brought it into the retail side of the house. And now with scholars ed we brought this to the 529 and it really starts with our Due Diligence program.
Tyler DeHaan: And the whole idea around the Due Diligence program is really making sure that we're putting the right money managers in the right asset classes. I kind of think about it from a football analogy. You want to make sure you have the right player at tight end, make sure you have the right player at center. You want to make sure you have the right player at quarterback.
Tyler DeHaan: And even though you might have a really, really good quarterback, you may not necessarily want them as a tight end. Maybe you do, but generally you don't. So, the whole idea around the Due Diligence program is to make sure that we are hiring the right money managers in the right asset classes. So that provides us with a different layer of basically diversification.
Tyler DeHaan: You have a diversification from an asset management standpoint, and then you also have a diversification from a money manager standpoint, and it has worked really well for us in the retirement and the retail space. And we're really excited to be bringing that to the 529 space through scholars ed.
Ryan White: Jenna, if I can add on to something that Tyler is bringing up here, I really think my experience with 529 is aside from the fact that there are largely misunderstood opportunity for a huge portion of the US population, is that there're very robust products at this point from an investment standpoint. Tyler alluded to a very intensive due diligence process that goes into the selection of investment managers for the program.
Ryan White: We have a similar process at Columbia Threadneedle that goes into our investment selection for the program we administer out in South Carolina. And at this point you can get access to almost any asset class you would want within 529 plans. So certainly, from an investment perspective, you have access to a wide array of investment options, things that you can sort of set and forget.
Ryan White: And in the form of age-based investing, a customized portfolio choice, many programs offer a mix between active and passive. So, you can love an index and not like the active management or be completely the opposite and still get everything that you would want in many ways, all wrapped up within the same 529.
Ryan White: So when you look at them from a pure investment standpoint, the programs are really quite robust. And with nearly 140 529 plans available in the marketplace today, there really is no shortage of diversification and very strong investment options in the industry.
Tom Rowley: I would add to Ryan and I would say that most Americans aren't misunderstanding 529s, most Americans don't know what a 529 is. It's not that they... Most, when you have kids and when you should be starting a 529, you're just finishing the book, What to Expect in The First Year of Life, right? And so, most Americans don't know what a 529 is. It's not that they're misunderstanding, it's they never heard of it.
Jenna Dagenhart: Yeah. It's just that 529 plan sometimes take a back seat to other more pressing issues that come with raising a child. And I'm glad you bring up the point too Tyler and Ryan about how to make sure that you're growing your money, because saving for a 529 is one thing, but you also need to grow that money. Tyler, anything you'd add there.
Tyler DeHaan: Well, I think the research shows that one of the easiest things that you can do to grow your assets is to consistently contribute to a tax deferred account and just let it ride. So, Tom had mentioned you're putting together some sort of plan where you're doing monthly contributions and it doesn't have to be a lot of money.
Tyler DeHaan: It can be $50 a month, but even if you're putting that $50 a month into, let's say a target-date Fund, and let that tax deferred growth continue for 18 years, you'll see that you're going to be able to accumulate a significant nest egg for future educational expenses. So, when you're looking at this, it isn't anything really complicated.
Tyler DeHaan: It's really as simple as saying, "I'm going to continue to make a monthly contribution and just going to let that money continue to grow, let the market do what it does. Let the tax deferred growth continue to grow. And then 18 years from now, I'm going to have a nice little nest egg here that I can use for education," whether it be for your kids or maybe even your grandkids.
Tom Rowley: I've always said, if you put away a little bit of money for a long period of time, you'll have a lot more money saved than if you didn't. And that's really the basis of the 529 is you got to get started. The first step is the most important step is starting the account and then contributing a little bit all the years that you need to.
Jenna Dagenhart: Tom, I know you mentioned you had to take out student loans and more and more people are doing the same. Student loan debt has surpassed credit card debt and auto loans, and there's no denying that education costs have skyrocketed. According to a Forbes article, the price of college is increasing almost eight times faster than wages. That being said, Ryan, how should people factor in the rising cost of college as they plan for the future?
Ryan White: Yeah. Well, it's a definite reality. I mean, again with a two-year-old, I think about it all the time. I make my decisions based on not what college costs today, but what I think it's going to cost in the future. And of course, the fact remains that college has gotten about 4% more expensive on average over the past couple of decades and education as a category has been the fastest growing component of core inflation over a very long period of time.
Ryan White: And of course there's a lot of reasons for that. A lot of them may be speculative. There certainly is a lot of money in the higher education system. A lot of subsidy introduced in the form of federal student loans and whatnot, but the fact remains that college is important in today's labor market, therefore there's a premium associated with higher education and the cost continues to go up.
Ryan White: I think the biggest key for most participants, however, is to understand that just because the cost is very high, it shouldn't be sort of a disincentive to try and reach that goal. Many people have to piece together the funding of higher education from multiple sources, financial aid being a component, scholarships being another component, and then investments and income.
Ryan White: But investments and income still does make up a very large portion of the college funding formula today. Sallie Mae puts out a study everyone to two years which shows that. So, it's very important to put a strategy in place. And one of the things that I like to talk to financial advisors about is sort of the misnomer that 529s are a small ticket item.
Ryan White: When you look at the cost of even attending a four year in-state public institution today in almost every state in the country it's over a $100,000 sticker price when you consider the cost of tuition, room and board, et cetera. When you consider that most families have more than one child, that number starts to get pretty big pretty quick and contextually it's probably your second or third largest expense next to the purchasing and paying off of a home, next to saving for retirement.
Ryan White: So when you think about the cost of education when compared to other big-ticket items that you're going to experience throughout your lifetime, college is right up there. And so, this notion that these are sort of the kids' college savings accounts really is quite untrue. Jokingly I would say if you want a savings account, you should go to a bank. If you want a tax deferred investment account, you should seek those out individually or through a financial advisor. And that's what 529s offer.
Tom Rowley: To jump on Ryan's point, the cost of college is more expensive than ever. A college degree is still one of the most reliable predictors of future income and wealth. So, helping family members obtain a degree is a goal for those who are in the position to take advantage of the unique tax benefits and flexibility offered by a 529.
Tyler DeHaan: And one other thing too to add on top of Ryan and Tom's point is, when you have times of market disruption and unemployment rates start to go up, those individuals that have a four year or a professional or a graduate degree, I don't have the numbers right off the top of my head right now, but the unemployment rates for those individuals are significantly lower than those that haven't obtained that type of education.
Tyler DeHaan: So when you're thinking about putting this money away, you're also helping put your kid, or grandkid for that matter, into the driver's seat to where there might be some market disruptors and we're always going to have recessions, they're not going to go away, but you're putting them in a position to succeed.
Jenna Dagenhart: And now looking closer at some of the benefits of these 529 savings plans, Ryan, what are some of the features and benefits that these investments offer?
Ryan White: Well, the first thing I would say is that we use the term beneficiary when we talk about 529 plans as oftentimes it is a child that's being named on the account in the form of beneficiary. However, if you really think about it, the student or the child named on an account really can't benefit from a 529 plan.
Ryan White: To take a quote from a colleague of mine, "The beneficiary of a 529 can really only hope to not ruin their relationship with the account owner long enough for the account owner to want to use it to pay for their education." If you look at the benefits of a 529, all the benefits really accrue to the account owner.
Ryan White: So again we should always be challenging this notion that these are in some way the kids savings accounts, because that's really not the case. Tyler mentioned earlier, the big [inaudible 00:25:40] without a doubt is the ability to get tax deferred growth of your contributions. And of course, it is not tax deferral if you use it for college.
Ryan White: 529s are simply tax deferred if we use them. And certainly, there are additional tax-free benefits if we use the proceeds from our 529 for qualified expenses. But in many cases, again, I'm getting tax deferral of my contributions. It's also one of the only places and not the only place in the internal revenue code where my contributions qualify for the annual gifting exclusion, which removes the assets that I'm contributing from my taxable estate.
Ryan White: But I still maintain control of those gifted dollars. In almost every other instance in order to get a completed gift for tax purposes, I have to give up my beneficial interest in an asset. 529 represents really the only opportunity I have to contribute to an account, maintain control and still get gifting estate benefit.
Ryan White: And I just think that personally, that's not at the forefront of most minds, whether you're on the consumer side for 529s, or even for financial advisers even the CFP curriculum doesn't spend that much time talking about the estate planning benefits of 529 when certainly there are quite a few.
Tom Rowley: I agree with Ryan that basically the beneficiaries have no rights to the money. A 529 owner can change a beneficiary to any other relative with no tax consequences. I used to threaten every night whoever would need their vegetables to switch their 529 to apparently one or the other kids who would eat their vegetables. So, as the owner, you have complete control and the beneficiary has no control.
Tyler DeHaan: I don't know if that'll work with my seven-year-old tonight, Tom, I think I'll probably use that formula.
Tom Rowley: Try that. Try that.
Ryan White: The other great thing about 529s is there's only so many avenues we have to position assets in a tax-advantaged way. When you think about 401ks and IRAs, Roth’s if your income allows you to qualify, 529s are relatively limitless access to tax deferral. Your only limitation is really the gifting limits, in which case there's another exclusive benefit of 529, which allows for five years of gifting to be contributed to an account in a single year without incurring gift tax, another exclusive benefit of course.
Ryan White: And it's also not means-tested. So, you can't earn out of the ability to contribute fully to 529 plans. And at this point, most programs allow contributions, well, in excess of $400,000, and again, that's only limited on a per beneficiary basis. So, you really have an opportunity to create what many would consider to be a very powerful legacy plan for education with 529s.
Ryan White: And you did it all for the cost generally of a retail mutual fund, as opposed to setting up a complicated vehicle like a trust or setting up other types of custodial accounts, which of course lead to the account owner ultimately losing control.
Tom Rowley: We also keep saying college, college, college, but it's really any post-secondary educational experience of... So, it's a community college, it's... There's all sorts of technical colleges. There's all sorts of programs that you can use a 529 for.
Jenna Dagenhart: Culinary school too, right?
Tom Rowley: Yeah. You can use it for K through 12 tuition. But the problem with say post-secondary education experience always sounds like a kegger party to me, so I never say it.
Ryan White: And we've had a lot of great legislative trajectory just in the past few years. I mean, if you think about... Again, I entered the 529 industry about eight years ago. Since that time, we went from one annual reallocation to two. We've gone to a K through 12 expenses up to $10,000 a year for tuition, now being a qualified expense of public private and religious elementary and secondary education institutions.
Ryan White: More recently we've added student loan repayment up to a $10,000 lifetime maximum as well as qualified apprenticeships registered with the Department of Labor. So, when you look at the trajectory of 529 plans, they're really headed in a very positive direction. And I think it's important that as the utilization of these accounts go up, the industry is well over I think $340 billion at this point.
Ryan White: The value becomes more and more perceived and certainly in the COVID environment that we're operating in today, 529s are going to allow for a lot of benefit and a lot of flexibility for those that maybe they weren't funding private school before, but now their public school may not be in session and their private school will, and that's becoming a consideration.
Ryan White: So I think 529 has a lot of applicability for a lot of different account holders. And certainly, there are reasons why you may not want to participate, but there's probably a very long list of reasons why you should consider investing in 529s.
Jenna Dagenhart: I'm glad you bring up online learning, because Brookings Institute just published a report on why the move to online instruction won't reduce college costs. Ryan, what are your thoughts on this?
Ryan White: Well, I won't pretend to be an expert on online education. I did listen to an interesting podcast the other day from a university in the Northeast, I'll leave their name out of it, but it was interesting to hear that they actually predict that in at least certain degree programs they might experience higher revenues by transitioning to online because of increased ability to reach more potential students, than limiting their enrollment to sort of the traditional in-person on-campus experience.
Ryan White: So I think the jury's still out in terms of what the increased web-based learning will mean to higher education and the cost of higher education. But if the past two decades have been any indication of future results, which I know is something we never want to say in the investment world, I don't see the costs coming down anytime soon.
Tom Rowley: 32:09 Even if the cost did come down. Let's say that the cost came down. Let's say that came down dramatically, you can never overfund a 529 because of the flexibility of changing the beneficiary, you could never overfund it. If let's say that there was money left over for number one, I could always rename it for number two. And let's say that it was leftover for number two, I could wait until they have kids and rename it for their kids.
Tom Rowley: I could wait and use it for their graduate degree. So even if college costs would come dramatically down because of COVID, you can never overfund your 529. If there was money left in the 529, I could change and put it in my name and go back to... There are golf courses, there're golf programs in Florida that I could use a 529 money for. There's a cooking school Le cordon Bleu. I could take up cooking. I won't, but I could.
Tyler DeHaan: I think the other thing too that gets missed is that 529s can be a very effective wealth transfer tool as well. So, let's say my two-year-old son Parker, we're funding a 529 plan for him and he gets to 18 and he comes up to me and he says, "You know what, dad? College is just... I don't want to go to college. I want to open up my own small business."
Tyler DeHaan: Well, here I have this bucket of money over here that I've been saving for his college education. And I can say, "You know what, Parker? Why don't you submit me your business plan?" He submits 'My Business Plan' and I look at it and I say, "You know what, Parker? This isn't very good." I still control [inaudible 00:33:43]. I still get to decide whether or not I'm going to distribute those assets to Parker or not.
Tyler DeHaan: Now, if I look at it and say, "You know what? This is a pretty good business plan. I would like to maybe fund some of this." I can then transfer that wealth to my son who presumably should be in a lower tax bracket at that point in time. I know he'll obviously have to pay taxes on the gains and potentially a penalty, but in his eyes, he's getting that seed money.
Tyler DeHaan: I've just effectively transferred that wealth to my son, this isn't going for college education. So, I think when you're thinking about 529s and overfunding it because college costs may potentially go down in the future, which I think they will eventually revert to the mean it's just the math. Just, is it going to be five, 10 30, 50 years from now? We don't know. But you can use it as an effective wealth transfer tool as well. And I think that sometimes people forget about that.
Ryan White: Yeah, I would certainly agree, Tyler. And I would also add that no RMDs, no Required Minimum Distributions on a 529 plan, which of course makes it unique from other tax advantage vehicles in that way as well.
Tom Rowley: And Tyler, if your son came to you at 18 and said, "Well, I'm going to start this business." You could always say, "All right. Well, in two years, let's see if you want to go back to school because there's no time limit applied for that. I can keep it for 20, 30 years." He might come back. At 18, you know everything, and your parents are idiots.
Tom Rowley: By 22, your parents amazingly get much smarter. And so, you can just say, "Well, let's wait and see. And so, your kids might decide to go to college at a later date. Your kids might decide, "I'm going to go to community college. I'm going to do this. I'm going to do this." You can never be over prepared for something with this large of a price tag.
Jenna Dagenhart: And Tom, anything you'd like to add in terms of how 529s can be used for estate planning or as a wealth transfer tool?
Tom Rowley: Well, grandparents can use 529 savings plans to transfer wealth pretty efficiently. For 2020, you can contribute $15,000 annually per recipient with no gift tax. That's $30,000 if you're a married couple filing jointly. And if they prefer to make a lump sum, they can contribute up to $75,000 and treat it as if it was spread over five years. That's 150,000 if you're married filing jointly.
Tom Rowley: Although the assets lead the estate, grandparents will retain control as we talked about earlier. In fact, they could always take the money back, right? But if they decide to revoke it, the value will come back to the estate and be subject to taxes. And so, for 529 there's no annual contribution limits, but rather a total maximum balance, which varies by state, but are quite substantial.
Tom Rowley: I know Rhode Island is $500,000, which means grandparents who have the means and the desire can fund a 529 or even overfund a 529, basically creating a generational 529 account, right? And it can be used to pay for qualified education expenses for their grandchildren, perhaps the grandchildren's children.
Tom Rowley: The point is that while colleges maybe more expensive than ever before, as I said before, college degree is still one of the most reliable predictors of future income and wealth. So, helping family members obtain a degree is a goal for those who are in a position to take advantage of the unique tax benefits and flexibility offered by 529 plans.
Tyler DeHaan: And the other thing I mentioned, flexibility and the way that 529s can be used, especially for those high net worth individuals that are approaching, or maybe even be in retirement. I talk with a lot of these individuals and they'll say, "Man, we're just getting killed on taxes." And as you peel back the layers, you notice that they have a lot of money sitting in a brokerage account, a non-qualified brokerage account, or maybe they're getting their RMDs from their IRAs every year.
Tyler DeHaan: Well, one of the things that you can do to kind of help minimize that potential tax burden into retirement is fund a 529. Again, you have that tax deferred growth and you can leave a legacy to your grandchildren, maybe your children if they want to go to grad school, depending on where they're at in their life. But that often gets overlooked for clients that are sitting there thinking, "Okay, well, how do I minimize my taxable estate here?" 529 can be a very effective tool to help manage that.
Ryan White: Certainly. And Jenna I would add too that it maybe would be a unified gift in estate tax credit being so high. At a threshold that offset such a large amount of assets and income upon death that you really have created an opportunity where a max funding of 529 may certainly make sense, even if it requires a little bit of gift tax, because again, the credit is so high.
Ryan White: You may have a lot of assets and still not need anywhere near the entire unified gift in estate tax credit. And of course, you're able to position, in many cases, up to half a million dollars for as many beneficiaries as you want to grow tax deferred with no time limit, no age limit and no required minimum distributions as we've stated.
Jenna Dagenhart: And while costs are skyrocketing, thankfully they aren't at $500,000 for a four-year education yet.
Ryan White: Fingers crossed.
Jenna Dagenhart: Fingers crossed indeed. Anything Tom that you would like to add in terms of some of the unique gifting options for 529 plans?
Tom Rowley: There are the... I mean, we go back to, it takes a village to raise a child, so to speak, right? That not only your grandparents, but your godparents, your aunts, your uncle, everybody can be involved. But when we've talked specifically about the state planning, we're talking about people who have the means to do so.
Tom Rowley: And so as we touched upon, there's a tremendous amount of contribution flexibility, if you will, meaning you can probably put more money than you have in there, and you can create a generational 529. Because again, no time limit, I can move the beneficiary to my children, then their children, then their children. And so, it is basically as close to it the best sort of estate planning vehicle that you could design.
Jenna Dagenhart: Now, turning to misperceptions. Tom, what do you think are some of the common misperceptions that you see among investors about college savings plans?
Tom Rowley: I think many people see the sticker price of college and do nothing, because it looks unachievable. Here's a little reality check. You don't need to save the full sticker price, but every little bit helps. I've always said, if you put away a little bit of money for a long period of time, you'll have a lot more money saved than if you didn't.
Tom Rowley: And the most important step is getting started and it doesn't have to be all you, anyone can contribute to your kids' 529 account. Grandparents, godparents, aunts, uncles, right? And so, the first misconception is it looks too hard. The second misconception is, "I have to be an investment expert and that's really the role of a financial advisor," but most of the 529s have years-to-use portfolios or target-date portfolios where it's a set it and forget it type of investment.
Tom Rowley: And so I think that the biggest misconception is that I don't know what to do. And really the value added of a financial advisory is somebody who can sit down with you one-on-one face-to-face and say, "Here are your options. These are the things that you have choices about, and let's get started."
Tyler DeHaan: Now, Jenna I think of [inaudible 00:41:45] and I remember the conversation I had with my wife when we first had Isabelle and we were sitting and starting talking about what are we going to do when Isabelle turns 18 and, well, presumably is going to go off to college. And my wife got stuck on this notion. She's like, "Well, what happens if she doesn't? What if that money is just lost?"
Tyler DeHaan: And that was what was in her mind was that we were going to save and put this money in a 529 and then if Isabella or Parker don't go or they get a scholarship that's just money lost. And I remember saying this to my wife, I said, "Well, if Isabelle doesn't go to college or she gets a scholarship, you and I are going to go on a trip to Europe." And she just looked back at me.
Tyler DeHaan: She's like, "What?" "Yeah. I said we're going to take that 529, we're going to make you the beneficiary. You're really interested in musical history, so we'll find an accredited college through the United States, somewhere over in Rome and we'll use that money to pay for qualified educational expense." Now, I mean that may not pay for the plane ticket over there, but it's going to pay for a lot of that.
Tyler DeHaan: And I remember my wife's eyes just getting so large being like, "Now, I get it. I get that this money isn't just going only for education. We can use it in other and different unique ways." So, I think there's a myth out there that you're just prepaying for college and then if they don't go, it's done. The reality is that 529s are very much more flexible than that.
Jenna Dagenhart: And not everyone is married to a 529 expert, so thus these myths persist. Ryan, anything you would like to add.
Ryan White: Yeah, certainly no. And everything Tyler just said is completely spot on. I hope that I get to do a similar thing with my 529 plan when the time comes. But from my perspective... Again, one of the questions that just comes up and it seems so simple, but it comes up all the time is, "Am I locked into the institutions that are within the state for the program that I'm investing in."
Ryan White: And of course, 529 in the state and municipal investments are administered by the states. And many people have a misconception that, "Well, if I'm participating in the South Carolina 529 plan or the Rhode Island plan or the New Mexico plan, I'm limiting my potential student's choice to institutions within that state."
Ryan White: I think some of that comes from the many prepaid tuition programs that operated across the country, many of which are now closed. But many of those of course did limit your participation somewhat to in-state universities.
Ryan White: But the 529 point is that we sort of know and love today allow you to ultimately use those phones anywhere in state, out of state, public, private, two year, four year, the list goes on and on, and may even enjoy some tax benefits at the state level by participating in certain programs. But ultimately, it's not going to impact your decision on where your student ultimately goes to school.
Tom Rowley: Tyler, I think that if your child comes to you in high school and says, "Well, I'm not thinking of going to college," you might be saying, "Oh, I'm thinking that you are going to college." Right?
Tom Rowley: I mean I remember my oldest said, "I'm thinking of going to the community college." I said, "I think of something a little farther away." Right? That when the high school years come, you're going to watch your kids go to college, right? You want them to have that college experience and many times as far away from you as possible.
Jenna Dagenhart: And 529 plans have a lot of different benefits as we've discussed today, but they still seem to be underutilized as well. Why don't more people use them? And what are some of the hurdles? Tyler?
Tyler DeHaan: I think there's a couple of hurdles. I'll talk about it from my age group, and I'm 38 years old. And I talked a little bit about kind of how my wife perceived it. That this was just going to be going towards education and kind of the hurdle of getting people to understand that 529s are much more flexible than that.
Tyler DeHaan: The other aspect is, well, how much money are we going to put away? I think sometimes people my age think we have to put away 250 to $500 a month. And where are we going to get that money because we're saving for retirement? We're putting money in insurance; we're paying a mortgage. We're having to pay childcare costs, which could cost 1,000 to $2,000 a month, depending on the area of the country that you live in.
Tyler DeHaan: The reality is, is that starting earliest, Tom had mentioned, you can start as low as $1 a month. And I mean, I wouldn't advocate for that, but even starting at 10 or 25 or $50 a month, that tax deferral over 18 years is going to have a nice nest egg at the point in time when your child or grandchild becomes 18 years old.
Tyler DeHaan: And I think there's the other myth that you have to pay for all of the college, when in reality, you're going to have some financial aid that's going to help pay for that. You can pay for a portion of it and you can also take out some debt. The problem is if you take out too much debt and it becomes burdensome.
Tyler DeHaan: So getting over that hurdle of, "I have to put away 250 or $500 a month." It can be as simple as starting at $10 a month. And then when your kid gets into grade school, maybe ration that up to $200 a month when you have some extra income. But just getting started, I think that's the hurdle. It's just getting people started.
Tom Rowley: I also believe that one of the misconceptions is that people think, "I don't know anything about investments." And I think that what you'll find is most 529s will have a target-date or a use-to-use fund where it's a 'set it and forget it' type of investment. That if you don't know anything about investing one, I would say that's a great reason to turn to a professional.
Tom Rowley: But the benefit of a years-to-use portfolio or a target-date fund is you can just invest, and it automatically changes from a stock portfolio to a bond portfolio within the 18 years that it takes to get the child ready for college.
Jenna Dagenhart: You don't have to be day trader to set up a 529 plan.
Tyler DeHaan: And from a financial advisor standpoint, that allows you the time to manage the relationship. You have the target-date fund essentially managing and rebalancing that portfolio, and you can focus on your clients. And I think that's also very helpful, whether it's a target-date or a target-risk fund, those types of asset allocation funds can have a very powerful impact from a practice management standpoint as well.
Tom Rowley: I would challenge any financial advisor to ask any of their clients who are grandparents to say, "Do you have a picture of your grandchild?" It will open up the conversation about a 529 faster than anything that you can do.
Ryan White: Yeah. I certainly agree. And I think one of the hurdles is really twofold. Number one, I think as an industry we've done ourselves a little bit of a disservice in the way that we've marketed 529 plans for a long time. We tend to include a lot of messaging and imagery around children, which again, sort of feeds this false narrative that these accounts are in some way the child's account.
Ryan White: And that usually is associated with losing control when we think about other types of minor accounts for UGMA or UTMAs. So, there's sort of that apprehensive nature of, "I can't predict what my son or daughter's going to like tomorrow. It probably won't be what they like today, much less what their behavior is going to be 10, 15, 18 years from now."
Ryan White: The other thing I would say is certainly from an industry perspective 529s have fallen victim to operational hurdles. Many of which those of course are being addressed today with more omnibus and firm name record keeping agreements going into place with respective programs, ultimately making the business easier for advisors to do.
Ryan White: Advisors are busy people; they don't have all the time to be filling out lengthy forms and spending time on calling into phone banks to process distributions. And so, the more we can get product integration amongst broker-dealer operations, the more, I think we're going to see utilization of 529s, especially from the financial advisers. Because at the end of the day, you don't need a financial advisor to get access to investment products. There's plenty of ways to get access.
Ryan White: What you go to a financial advisor for is advice, and we need to make it as easy as possible for advisors to be able to give and execute on that advice. And so certainly for any advisors that may ultimately watch this masterclass, be a squeaky wheel, encourage your broker dealer to pursue 529 under these partnerships to make it easier for all of us to do the business.
Tyler DeHaan: So one of the things about practice management that I think sometimes get overlooked is if you have a grandparent as a client and they're funding this for a grandchild, and the parent of that child is not a client, it brings up a great opportunity to have this multi-generational financial planning aspect.
Tyler DeHaan: So you can reach out to the beneficiaries of your clients and help bring them into your practice. And a 529 is a great way to open up that door from a practice management standpoint.
Jenna Dagenhart: And Tom, how do you think 529 savings plans can help advisors build their businesses?
Tom Rowley: Well, I think that we've been hitting the points here. It's a good conversation you can have with any client, whether about their children, their grandchildren, their great grandchildren. It's a conversation you can have about estate planning. It's a conversation you can have about the cost of things today, right? You know what I mean?
Tom Rowley: A lot of times grandparents look at their college experience and they don't realize how expensive college has become. And if you're pushed to using loans that debt can become really a weight on the shoulders of the young person just starting out, right? But I think that there's really two things to talk about here, practice management and the tactical aspects, right?
Tom Rowley: The practice management is all about getting the next relationship, whether it's the child of the clients that you're talking about, which may be a grown child, or it might be the grandchild that you're talking about. And so, the 529 client conversation is one you can have with almost all of your clients and really now is the best time to have it.
Tom Rowley: The second point was tactical. We've talked a lot about tactical rules and hopefully the people watching the masterclass are tuning in for tactical roles. But I think that as a vendor investor can help keep you up to date with all the tactical rules. And 529s came out in 1996 and 2017 there were changes. And almost every change that's happened to a 529 is a good change. They keep expanding, they keep getting better and better.
Jenna Dagenhart: Yeah. And as Ryan mentioned, a lot of new changes too.
Ryan White: Yeah. And I don't think we should overlook also the risk and sort of not bringing it up right if you're a financial advisor. I mean, again, clients are coming to their advisors for advice. And certainly, if you're a financial advisor and you don't talk about the 529, you're leaving open the opportunity for somebody else to bring it up and that somebody else could be a competing direct plan.
Ryan White: Many other programs that have robust marketing budgets they're beginning to be very heavily marketed in the States in which they operate. So there certainly is a risk in not talking about 529s from an advisor perspective. It's all about adding value, and simply when you can talk about someone's value in their children and grandchildren relationships, there's not too much more valuable than that. 529 has represented a great opportunity, and you wouldn't want to leave it on the table.
Jenna Dagenhart: Tom, any final thoughts on your end?
Tom Rowley: I think that I have lived through the creation of 529 in the mid '90s. I used it for three college graduates. I still think that if you look at almost any vehicle that the financial services industry has, the 529 is actually the best design. It's the best design for its use. It's best designed for the flexibility and the control issues. It's almost as if everyone got together and said, "What would be the best design for a financial product to help families get their kids educated?"
Jenna Dagenhart: Tyler, any final thoughts as we wrap up this 529 Masterclass?
Tyler DeHaan: When I'm talking to people out in the field and I asked them, "What's the most important thing to you?" Not all the time, but most of the time they're going to say, "My family. My family is the most important thing to me." And the 529 allows for us to do something for our family to make sure that our kids or our grandkids or our nieces or our nephews all have that next ability to have that step up to be able to go off to college, get a degree and set them up for success.
Jenna Dagenhart: Ryan, anything you'd like to add?
Ryan White: Well, I think when you consider what a 529 is and you consider that taxes are pretty much everyone's greatest impediment to wealth accumulation in our current sort of system of operating, you look at a 529 and you say, "Okay, I did relatively unencumbered access to tax deferred growth without any income limits. I have no time limits, no age limits, no required minimum distributions.
Ryan White: I can use a tax-free qualified expenses and can transfer it to the beneficiary of the next generation tax-free and also outside of my estate." It checks a lot of boxes in the financial planning process. And so, I think there, again, it merits attention and I stand ready along with all the colleagues that have joined me today in helping to add value to advisors and ultimately clients that want to use 529.
Jenna Dagenhart: Well, we've covered a lot of ground today from how to get your kids to eat their vegetables, to how to help them save for college. Thank you for joining us everyone. And thank you for watching this 529 Masterclass. I was joined by Tyler DeHaan, Director, Advisor Consulting Group at Scholar's Edge, Tom Rowley, Director, Retirement and Education Strategies at Invesco and Ryan White, Senior Product Manager at Columbia Threadneedle Investments. I'm Jenna Dagenhart with Asset TV. (silence)