529 Exposed

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529 College Savings Plans Exposed

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Table of Contents

Chapter 1

Introduction to 529 plans

Chapter 2

529 fund issues and flaws

Chapter 3 Alternatives to the 529 plan

Chapter 4

What if you already have a 529 fund?

Chapter 5

Research and resource tools

Chapter 6

1

Key questions to ask your financial adviser

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Chapter 1 - Introduction to 529 plansBased upon the statistics from the United States Bureau of Labor

Statistics, it shows that employers show favor to applicants with acollege degree over another candidate with only a high school

diploma. College graduates may even receive a higher salary than

those with job related experience, but who have never been to

college. This can prove to be discouraging for some and stressful for

others. Unfortunately, knowing that college is one path to success is

not productive unless one can actually attend and graduate from one.

Below is a graph showing the increase of college costs over a four

year span. 1

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1Source: Trends in College Pricing 2005 , The College Board ® .

Assumes a 5% increase in college costs each year and a child

entering college at age 18.

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The continuing increase in price for college tuition and related

educational expenses may cause alarm for some who have not taken

the time to financially prepare to send a loved one off to school.

Years of strict budgeting and knowledge of savings plans are usually

needed in times like this, but sometimes the decision to go to school

is not made in enough time to take the proper course of action.

Section 529 plans were devised in 1996 to offer families a tax-

advantaged medium for college expenses. Using this plan can help

aid in a successful journey to college for the beneficiary, but there is

key information to take into consideration when making a decision to

invest in a Section 529 plan.

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Stocks and investment bonds have already been chosen by Section

529 plan sponsors to give contributors an option where to invest their

money. Section 529 plans will mandate that you divide your

investment contribution geared towards an asset allocation based

upon the age of the beneficiary. Basically, the plan will advise for

your investment choice to be more aggressive for younger

beneficiaries and less aggressive for students nearing entrance into

college.

Sponsored by educational facilities, states, and state agencies, there

are two plan types available for section 529. They are pre-paid tuition

plans and college savings plans. The United States and the District of

Columbia supports the minimum of either one of these plans. Also,

there are a number of private universities that sponsor a pre-paid

tuition plan as well.

There are also several marketing techniques that were developed for

the Section 529 plan where an employer can offer a Section 529

Section plan as a payroll deduction or other options to their

employees. They also can offer an affinity rebate program that funds

college savings plan accounts from funds rebated by participating

merchants from where the investor purchases goods or services.

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Pre-paid tuition plans

Generally, pre-paid tuition plans are supported by state agencies and

have a residency requirement for the participant and offer a plan

guarantee backed by the state. This type of plan allows a person to

buy tuition credits, at the current rate, for future use and some can

include housing expenses. Eligible public and private universities and

colleges will lock in their price to avoid tuition inflation. Some policies

are applicable for a two or four year tour of college. It can include a

combination of a two year community college and then transferring

to a four year university. A few plans can go towards graduate school.

They have an age and a grade limit for the participant and carry

limited enrollment periods. Some of these plans also have pre-

determined lump sum goals before purchase based upon age of the

beneficiary and the amount of time the student plans to attend

college. Additional expenses such as housing are not covered, so

another savings plan might have to be considered to cover this cost.

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The general idea of a pre-paid tuition plan is to hone in on a tuition

rate based upon the current rate. This is supposed to create a way to

save money in a frugal way. Payments are made in installments overa number of years. There are things to consider such as the added

restrictions when choosing a college and strict terms and conditions

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to follow for withdrawals. A list of schools is given so that a student

will know his or her college choices.

If the beneficiary of the pre-paid tuition plan decides they want to

choose another school that is not on the pre-approved list, it can be

transferred to another school, but it may reduce the value of the

policy. For example, if you have a policy that locked on to a

community college’s tuition rate, then those rates might be lower

compared to another school whose tuition might be higher. Therefore,

you still may have to pay out of pocket to make up the difference in

tuition rates.

It is possible to transfer a policy to another sibling, if the beneficiary

decides to forego college altogether, but age restrictions can

complicate matters if there is an older sibling involved. If there is no

one to give the pre-paid plan too, the investor can get his or her

money back, but only what they contributed and there might be a

cancellation fee involved.

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Most of the states guarantee funds contributed to the pre-paid tuition

plan with the assurance that if the Section 529 plan should find itself

in financial distress, the states will give the program what is neededto help them out of distress. Some states will help out financially

while others have no formal guarantee, but will make decisions as

deemed appropriate to the state’s legislature to keep the Section 529

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plans flourishing. A select few offer no guarantee whatsoever and will

do nothing to intervene if the plan starts to fail financially.

Pre-paid tuition plans have residency requirements and mandates

that either the purchaser or the beneficiary reside in the state

offering the tuition savings plan. They do not offer year round

enrollment, so it is necessary to be aware of application deadlines.

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There are no investment options available for pre-paid tuition plans.

The price of the policy is calculated before the purchase and depends

on the following factors: type of contract, the current age of the

beneficiary, current tuition rates, and projected future rates. This

money is pooled together and is used for long term investments so

the return on investments will meet or exceed the cost for tuition as

it increases over time.

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College savings plans

Savings plans that are offered differ from pre-paid tuition plans in

various ways. They do not guarantee a lock on tuition prices but

contributing to a savings plan covers housing, tuition, mandatory fees,

and miscellaneous items such as books. They have contribution limits

in excess of $200,000.

They have no state guarantee and most investment choices are

prone to market risk. This option may not be profitable and can also

decline in value. The plan offers neither age restrictions nor residency

requirements for the contributor or the beneficiary of the plan. Out of

state residents would possibly have to purchase a college savings

plan through a broker or financial adviser, but the plan offers year

round enrollment.

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Unlike the pre-paid tuition plan, a student is not confined to a list of

schools they can attend. Contribution limits vary depending on the

state, but there are no household income limits or annual

contribution limit. Large annual contributions of $12,000 or more may

require a special tax form to be completed called a federal gift taxform. There are state tax deductions a contributor may be eligible for

if they are a resident. Earnings are tax deferred in the Section 529

plans.

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The investment options are plentiful with the college savings plan.

Investors have an assortment of mutual fund portfolios and age-

based mutual fund portfolios. Generally, the portfolio’s funds are

invested in stock funds when the beneficiary is younger and as the

child ages the asset allocation changes to other bond funds.

There are some states that offer investment options that are not age-

based. You can choose different portfolio risk levels. Some states also

have an option to get a certificate of deposit that associates their

interest rates with a file that measures the average tuition rate.

Recently, the IRS has allowed investors to change their options once

each calendar year.

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This graph outlines the difference between plans:

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Prepaid Tuition Plan College Savings Plan

Most plans allow you to prepay

tuition at eligible public and

private colleges and universities

at today's price.

No lock on college costs.

All plans cover tuition and

mandatory fees. A few plansallow you to purchase a room &

board option, use excess tuition

credits for other qualified

expenses or cover all qualified

education expenses.

Covers all "qualified higher

education expenses," including:

• Tuition

• Room & board

• Mandatory fees

• Books, computers (if

required)

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Most plans set lump sum and

installment payments prior to

purchase based on age ofbeneficiary and college tuition

years purchased.

Many plans have contribution limits

in excess of $200,000.

Many state plans guaranteed or

backed by state.

No state guarantee. Most

investment options are subject to

market risk. Your investment may

make no profit or even decline in

value.

Some state plans have

age/grade limits for

beneficiaries.

No age limit. Open to adults and

children.

Most state plans require eitherplan owner or beneficiary to be

a state resident at the

enrollment time.

Most plans do not have a residencyrequirement. However,

nonresidents may only be able to

purchase some plans through

financial advisers or brokers.

Most plans have limited

enrollment period.

Enrollment open all year.

Source: Smart Saving for College , NASD®

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Potentially, you can receive a state tax benefit for contributing to a

college savings plan, but carefully review the plan offers before

participating in one. It is good to know if rolling money over into

another state account is allowable if the participants move out of

state. Some states provide other benefits for investing into a Section

529 plan with a matching grant. Unfortunately, matching grants

benefits are for in state residents. Withdrawals from the Section 529

plan will come with a 10% penalty and income tax on earnings if not

used for college expenses, but there are also numerous fees involved

with the plan, which can reduce your returns overall.

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Chapter2 - 529 fund issues and flaws( flaws, issues, costs, etc)

Section 529 plans can be purchased in two ways:

The first option is to purchase the college savings plan directly from

the state that supports the plan with no broker or third party involved

in the transaction.

The second option is “advisor sold,” where investors purchase a

college savings plan through a brokerage firm or bank. When this

option is utilized then there are hefty fees that need to be taken into

consideration such as a sales load or fee.

Regulation of Section 529 plans

The U.S. Securities and Exchange Commission decided in 1999 that

interests in Section 529 plans are community securities for reasons of

the federal securities laws. With that being said, the Section 529

plans are not mandated to be registered as investment businesses

under the Investment Company Act of 1940. The interests in these

plans are not cataloged under the Securities Act of 1933 or the

Securities Exchange Act of 1934. Even though they are not registered

under these acts, it does not mean they are not subject to the laws

of the states that sell the Section 529 plans, because they are.

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Interests in Section 529 plans are grouped under the regulatory

regime of the Municipal Securities Rulemaking Board, MSRB, because

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they are municipal securities. Security firms that issue Section 529

plans must show general knowledge or pass a qualification exam that

is favored toward Section 529 plans. The MSRB proposed some rules

that would enforce advertising and no cash paid compensations

customs on the issuance of Section 529 plans that are comparable to

mutual fund sale standards under NASD rules.

The NASD, Inc. is an organization that represents individuals and

companies that do business in the securities industry. They regulate

trading practices, license individuals, and also discipline those who

fail to abide by regulatory compliance and written rules that are

sanctioned by the U.S. Securities and Exchange Commission, SEC.

Securities are a combination of debt and equity categories such as

savings bonds, mutual funds, corporate stock options or other stock

options that can be bought or sold.

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In 2003, NASD, Inc. recorded multiple enforcement actions and

suspended a larger number of individuals in the securities industry

than in prior years. They also monitor trade transactions on the

NASDAQ Stock market and have employees based nationwide. Over

2,000 employees are governed by a Board of Governors, with the

majority being unassociated with the securities industry.

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NASD, Inc. does not govern the state issuers of Section 529 plans.

They do enforce MSRB rules for the securities companies that issue

Section 529 plans. They also apply their own advertising rules to the

promotion of the fundamental investments needed to make the plan

work.

High Fees

There are various fees involved with the Section 529 plans that

diminish the purpose of purchasing a college savings plan in the first

place. It is imperative to understand the fine print associated with the

plan. Administration and enrollment fees can vary by state and the

plan chosen. If you are an out of state resident and purchase a

college savings plan through a broker, you are subject to the broker

fees, as well as the plan fees.

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A broker is a mediator between a buyer and a seller. Generally, incommerce a broker is used to assess suitable solutions in the best

interest of the client. Commerce deals with the supply and demand of

business transactions. If there is something you want to buy, but do

not have the knowledge to obtain it, then a third party represents

you and obtains the information or product for you, for a fee. When

dealing with Section 529 plans, people rely on the knowledge abroker has about college savings plans to help them choose the best

option. No fees are paid up front; the brokers are typically

commission based.

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The term that is used for this hefty fee is called a “load.” Along with

the commission the broker gets for selling a Section 529 plan, there

are also annual distribution fees that range from .25% to 1.00% of

your total investment. A broker usually receives most of these fees. A

lot of plans that a broker might offer have more than one class of

shares. Each class consists of various expenses and fees. Listed

below are definitions of each of these classes:

Class A shares: Requires you to pay a fee up front, called a front-end

sales load, therefore reducing your contribution into the savings plan.

For example, an investor has $2,000 and purchases a plan from a

broker that has a 10% front end load fee, then that amount is taken

from the original investment of $2,000. Subtract $200 from $2,000

and you have $1800. According to the National Association of

Securities Dealers, also known as NASD, Inc. for mutual funds, a

front end load can not be more than 8.5% of your investment.

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Class A shares typically have lower annual fees and expenses

associated with other Section 529 share classes. Also, if you

contribute more than a certain monetary amount, you can possibly

receive a breakdown discount. Some savings plans base breakdown

discounts on the condition that more than one plan is purchased or

discounts could be dependant on the total amount you invested into

the plan. If the plan has a breakdown discount, this can possibly

reduce your front end sales load fee, but not by much. Breakdown

discounts are not applicable to Class B or Class C shares.

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Class B shares: This class does not require you to pay a front end

sales load. A fee may be charged if you take money out from an

investment option. This is known as a back end load fee and is

money you pay when you sell your shares. This fee typically goes to

the broker who sold the Section 529 plan. The amount of the load

depends on the duration of the shareholder’s ownership of his or her

shares and generally reduces to zero if they hold on to it long enough.

An example is if the investor sells their shares within one year of

purchasing, they may have a high back end load fee. If he or she

waits until five years of ownership and then decides to sell they may

not get charged a back end load fee.

Class B shares can have higher annual distribution fees and expenses

than Class A shares. Sometimes Class B shares will convert

automatically to Class A shares if you keep your shares for a lengthy

amount of time.

Class C shares: This class can have a front or back end sales load,

annual distribution fees, and other expenses. This class does not

automatically convert into another class over time, which can become

costly if you hold on to these shares over time.

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Below is a College Plan Share Class Costs Comparison Chart

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How the fees are used

There are various levels of fees that can differ from state to state for

the Section 529 savings plan, but it is the plan’s responsibility toshow how the fees are being used, however a main concern lies with

the varying cost of administrative fees. For example, Some people

feel Tennessee’s plan is lower than average because of low cost

index funds they use and they do not utilize the broker sold option.

They have a cost structure that is easy to follow because it charges a

flat rate of 0.95% regardless of the investment choices selected.

Unfortunately, Tennessee’s administrative costs are ridiculously

expensive. The program’s disclosure documents make no effort to

explain why it costs nearly 50% more than similar plans offered by

Missouri and Michigan. Tennessee charges as much as 0.88% in

administrative fees, without explanation as to why it is so expensive.

Ironically, Utah reported that is has been able to maintain operating

costs with administrative fees as low as 0.25%.

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States should be held accountable for the fees and expenses that

they charge. A proactive way to improve their seemingly deceitful

ways is to justify their administrative fees and to explain where the

monies from these fees are ultimately being used. Currently, thereare few answers for those important questions.

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Questionable broker practices

As previously mentioned, the NASD, Inc. is an organization that helps

enforce regulations and guidelines put in place by the SEC toencourage ethical security business practices. Based on numerous

customer complaints, Section 529 savings plans have been under

investigation. Several consumer complaints have been filed about the

fees associated with purchasing a Section 529 plan and also the lack

of supervision of brokers selling these plans.

Consumers are afraid that brokers do not have adequate knowledge

to provide them with the best savings plan for their financial situation.

There was an investigation involving 20 securities firms and the

majority of those firms sold out of state Section 529 plans, which

benefited the commission earning broker more than the client. But,

even if a plan is purchased directly through the state, important

information could still not be disclosed to the contributor.

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MSRB Rule G-19 mandates that a broker-dealer “have reasonable

grounds” for their recommendations they deem to be in the best

interest of their client. NASD knows that, according to the MSRB’s

perceptions of rule G-19, an out of state college savings plan sale can

be a suitable option based upon the applicant’s situation.

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For example, an underlying investment company can offer an in state

plan that would provide substandard portfolio management or a

limited selection of investment options. The fees and expenses

included with the in state plan could be very expensive. In some

states, the in state plan may not offer a state tax deduction or

benefit. A broker should consider an array of factors in addition to

the possible in state benefits, before offering a suggestion.

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NASD, Inc. chose twelve additional firms to review to include small

broker-dealers, mid-size firms, and bank and insurance affiliated

firms. They also included firms that offered different kinds of Section

529 plans rather than just one to see if it had an impact on sales

procedures and the in-state/out-of-state statistics. Their March 2004

investigation focused on sales of out-of-state applicants of 26

jurisdictions that seem to have the best tax incentives to use in state

plans.

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The findings of the review are listed below:

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The NASD, Inc. investigation is ongoing and will work together with

other regulatory authorities to ensure that interests in Section 529

plans and their investments are advertised and issued in an ethical

manner that protects buyers.

Inadequate disclosure

NASD, Inc. also was concerned that information was not being fully

disclosed to investors about the potential state tax benefits that are

lost if an out of state Section 529 plan was purchased. It is also

cause for worry when other options are not presented to the investor.

Sales brochures were also a part of the investigative process, due to

the fact that suspicious tactics were being used by not disclosing

certain terms and agreements and also not disclosing investment

risks. It has been stated by Congress that states are not bound by

the same regulations, with a few exceptions, as other securitiescompanies. Therefore, some Section 529 plan practices may prove to

be unethical, because they are not forced to include all fee

disclosures on any or all material. It is mandated that the annual

account statements investors receive show earnings, distributions,

and contributions.

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Most Section 529 Savings plans bury important fees and expense

information in the very back of a 100 page long program disclosure

document. This could form an opinion that, because of the lack of

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effort put into making the information more readily accessible, it is a

practice of deceit.

A good way to rectify that problem would be to feature fees andexpense information on their web sites or as a “snapshot” in their

publications. Costs could be highlighted at the base level as well as in

an investor’s summary of all the plan’s expenses. That way, investors

can see what they are paying for in a more convenient style than a

book filled with fine print.

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In 2003, more than 2,000 sales brochures promoting Section 529

plans were reviewed by NASD, Inc. The staff focused on questions

concerning adequate disclosure of risks as well as the benefits of

contributing to Section 529 plans, disclosures of sales charges and

other fees, as well as an accurate picture of tax penalties for

investing in Section 529 plans.

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Television commercials were also reviewed as part of their ongoing

investigation. One in particular was a commercial that discussed high

private college tuition costs and the focal point of the commercial

included a child holding a college savings plan withdrawal check for

$250,000. The advertisement pointed out that Section 529 plans

have “powerful savings benefits” and suggested that contributing in a

Section 529 plan will provide enough money to pay for the price of

expensive private college tuition.

The NASD, Inc. prohibited the broker-dealer from using the

commercial due to the fact that there are no guarantees when it

comes to investment plans. The opportunity to produce a $250,000

check at the conclusion of a college savings plan is a highly favorable

goal; there is no assurance it can be reached.

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NASD, Inc staff also corrected sales material that did not represent

the tax treatment of investments in Section 529 plans. There was a

print advertisement reviewed that highlighted the headline, “Pay for

college TAX-FREE!” The headline suggested that college tuition costs

would be covered and that there were no tax implications for in or

out of state applicants during the investment process. That is not a

true statement for out of state applicants; therefore NASD, Inc.

mandated the broker firm make changes to their advertising

campaign before using it again. They will continue to review Section

529 plan advertising campaigns to prevent incorrect information

being distributed.

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NASD, Inc. supports standardized disclosure of Section 529 plan fees

and expenses. It would specify the fees associated with contributions

in a Section 529 plan and would assist an investor’s capability to do a

cost comparison affiliated in an investment in Section 529 plans.

They also recommend concise disclosure in regard to the forms of

compensation paid to the dealers who issue the Section 529 plans.

In August of 2004, NASD, Inc. proposed to the MSRB and SEC that

each SEC and NASD, Inc. sales practice standard that applies to the

allocation of mutual funds to retail investors should also apply to the

sale of mutual funds in Section 529 plans. These standards should be

implemented by additional sales requirements to address the

distinctive traits of Section 529 plans. The point behind the

recommendations was that Section 529 plans present similar

disclosure and sales practices as that of mutual funds.

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NASD, Inc. closely worked with the SEC to develop what they hoped

to be favorable disclosures to investors when they purchase mutual

funds. It would be unfair to Section 529 plan holders to be reduced

to a lower standard of clarity than mutual funds. Also, the same

benefits that Section 529 plans proclaim to have, such as in state tax

deductions and fee reductions offer additional disclosure and sales

practice confusion.

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The different variations associated with the Section 529 plans

complicate the options for investors and the sales procedures for

those issuing the plans. While federal tax advantages are common to

all college savings plans, the state tax treatment of Section 529 plans

can vary between states. Knowing what the state tax treatment is for

the investor's state plan can help in the decision making process.

Investors receive a tax deduction or credit in the District of Columbia

and the 25 states that sponsor the Section 529 plans.

The difference in plan fees can also cause confusion to investors. All

Section 529 plans charge fees and expenses and contributors to the

plan have to look to compare the plans. Not only do these costs vary

between Section 529 plans, they also can differ within one solitary

plan.

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Section 529 plans are a cause for more alarm than basic mutual

funds and other savings bond options because they are not governed

closely by the SEC. They do not have the authority over the State

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Governments who are administrating the Section 529 plans. In an

ordinary mutual fund plan, a broker is paid a fee and then the

investor pays fees to the fund manager.

With Section 529 plans you are placed in a position to possibly pay

enrollment fees, form fees, account maintenance fees, administrative

fees, asset based fees, and program management fees. That is while

you are actively participating in the plan, which does not include

penalties for withdrawal.

These fees are being taken out of your savings plan and are greatly

reducing the money in your account. It could prove to be beneficial

to invest in another kind of savings plan where you are not paying

layers of fees associated with having middle men administrating the

Section 529 savings plan.

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Based upon the family's financial situation, having s Section 529could prove to do more harm than good. The excess money that

covers fees to the college savings account adds up and can be used

for another family obligation such as saving for a down payment on a

house or car.

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Investors’ resources

Section 529 savings plans can cause confusion for both brokers and

investors. Broker-dealers need more education so they can explain topotential customers the complexities of these plans. Customers also

need to be proactive in educating themselves about what Section 529

plans offer and what other investment options are available.

The NASD, Inc. web site gives guidance for both investors and

brokers who deal with Section 529 plans. See http://www.nasd.com/ .

NASD, Inc. has two resources online to help investors compare plans.

Their booklet, Smart Saving for College, features detailed information

on Section 529 plans and also other avenues for college savings.

They also have created a tool to aid investors to compare how fees

can affect returns. It also guides investors where to find Section 529

disclosure information.

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On the next page is a picture of the resource tool. Just plug in the

information as described and it can do a comparison among the plans

for you.

http://www.nasd.com/

http://www.nasd.com/

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MSRB

The MSRB is a self regulated organization created by Congress in the

Securities Acts Amendments of 1975 to write rules in regard to

security transactions in municipal securities issued by brokers,

dealers, and municipal securities dealers. A unique factor in the

legislation is specified in section 15B of the Securities Exchange Act

which dictates that the MSRB board shall include members who are

divided equally among non broker members, bank dealers, and

members who are affiliated with securities firms.

Also, a member has to represent an issuer of municipal securities.

The MSRB was designated as a sector specific legislation to regulate

broker-dealer securities transactions sold by state and local

governments.

Meetings are held periodically throughout the year to make policy

decisions, review developments and approve rules in the municipal

securities circuit. A full time staff takes care of the day-to-day

operations of the MSRB. The MSRB are funded by assessments made

on broker-dealers for initial fees, annual fees, fees for underwriting,

and transaction fees.

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More than 2,400 broker-dealers are registered with the MSRB to

participate in municipal securities activities. They range from small

firms to the very large with nationwide coverage. A considerable

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number of these broker-dealers issue Section 529 college savings

plans.

The MSRB was devised to write rules to help govern broker-dealerconduct in the municipal securities market, but the Exchange Act

gives the inspection of broker-dealers for compliance to be carried

out by other agencies. NASD, Inc. and the SEC perform the

enforcement and compliance inspections for securities firms.

The MSRB gave guidance to a Section 529 college savings plan to

offer the A, B, and C share class. Broker-dealers have to consider a

suitable share class for a particular investor. The MSRB also stated

that a customer’s investment goal can be a major factor when

deciding which share class is appropriate for their client. The goal

primarily consists of how long the customer plans to keep the

account and when funds are expected to be withdrawn.

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Broker-dealers are also forbidden from suggesting transactions to

investors that are excessive in size or frequency. If a broker-dealer

knows that an applicant is contributing to a Section 529 college

savings plan hoping to be eligible for a federal tax benefit, it could

violate Rule G-19 if he or she recommends roll-overs from one

Section 529 savings plan to another in such a pace that they lose thefederal tax benefit. Even if the federal tax benefit is not affected, if

there are multiple roll-overs suggested to a customer, depending on

the situation, it could be looked upon as illegal churning.

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Churning is the rapid buying and selling of an investor’s stocks, which

is an illegal practice because generally brokers get commission on

each trade they make for an investor. The best interest of the client

is not performed if the investor is paying fees on top of fees for

investment trading transactions.

Broker-dealers should not engage in transactions designed to

increase commission revenues in a way that is not beneficial to the

customer. Also, suggesting transactions to clients in an amount

created to avoid commission revenues such as sales under

breakpoints where the client would be permitted to lower commission

charges, or withholding benefits of breakpoints may also violate Rule

G-17.

The MSRB, in June 2004, proposed for comment a set of draft

amendments to its gratuities and gifts rule in progression of the

MSRB’s goal of lowering potential conflicts of interest and

empowering the merit-based environment in the municipal securities

market. The proposal would stop broker-dealers from accepting or

making payments of non-cash compensation with an offering of

community securities, with limited exceptions.

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The MSRB and NASD, Inc. are subject to provisions that prohibit eachto abide by rules that “impose any schedule or fix rates of

commissions, allowances, discounts, or other fees to be charged by”

the broker-dealers subject to their jurisdiction.

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The MSRB has proclaimed that the charges permitted by NASD under

its Rule 2830 for mutual fund sales is a factor in deciding what a

broker-dealer selling shares of Section 529 savings plans is charging

for a commission fee and needs to ensure that it’s a fair price.

Charges for a Section 529 savings plan transaction in excess of those

within limits are similar to mutual fund shares under NASD Rule 2830

can not, based upon the situation, meet the reasonable standard

under MSRB Rule G-30(b). Also, a sales charge for a Section 529

savings plan transaction should meet the NASD scale for scale of an

exact mutual fund, which should abide by the MSRB Rule G-30(b).

In respect to state tax treatment of investments in Section 529

savings plans, the MSRB is the forefront of ensuring that broker-

dealers are obligated to educate their clients that it is possible to lose

state tax benefits if he or she chooses to invest in an out-of-state

Section 529 savings plan.

Chapter 3 - Alternatives to the 529 plan

The Coverdell Education Savings Accounts (ESAs).

35

This is also known as Education IRAs. The Coverdell Education

Saving Accounts are another option to save for college education.

Their investment choices are almost endless. With the exception of

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life insurance policies, buying and selling can occur at any time. ESAs

can be purchased at most brokerage firms, a mutual fund company,

or any other securities institution.

In 2001, The Federal Tax Act allowed a tax exemption on earnings

on withdrawn funds for qualified education expenses. After the law

came into effect, almost a million-and-a-half United States children

with Section 529 accounts were valued at $9.5 billion. A few years

later, Section 529 plans became the preferred method to save for

college. Although this law was set to expire in 2010, it was extended

by the Pension Protection Act of 2006 and is now permanent.

Another advantage that ESAs provide is that money can be

withdrawn to pay for private elementary schools, high school

expenditures, and post secondary school expenses. You can combine

having an ESA account along with a Section 529 account.

There are two annual contribution limits for investors:

1. There is a limit, up to $2,000 for contributions, for one

beneficiary at any time.

36

2. If more than one ESA is purchased for one beneficiary by other

family members, it needs to be verified that they are not

exceeding the $2,000 annual contribution limit as a whole.

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There is a penalty for exceeding these limits and it is a 6% excise

tax on the excess money. This can be forfeited if the excess

amount is withdrawn within six months of the contribution.

37

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Coverdell ESA Contributions Graph:

To get a better example of how an ESA can work, if a father

invests $2,000 a year with an annual yield of 6% when his child

turns one year of age, then monies accumulated will be

approximately $61,000 that can be available for your eighteen

year old college bound student.

38

There are income restrictions associated with an ESA. If a couple

files a joint return on their federal tax return and their modified

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adjusted gross income is less than $190,000 a year, they can

contribute $2,000. If the modified adjusted gross income is above

$220,000, then couples are not able to contribute.

Your modified adjusted gross income is annual adjusted income

without taking IRA deductions, student loan interest, and other

deductions under the Internal Revenue Code.

If you are a single taxpayer, then you will be able to contribute up

to $2,000 if your modified adjusted gross income is less than

$95,000. If your modified adjusted income exceeds $110,000,

then you are not allowed to contribute to an ESA.

Organizations can contribute to ESAs without income limitations.

Below is an equation to figure your modified adjusted gross income:

If your income is between $190,000 and $220,000 (joint filers), or

$95,000 and $110,000 (single filers), you can figure your ESA

contribution limit by using the following equations:

Married Joint Filers

$2,000 - (Modified Adjusted Gross Income - $190,000 * $2,000) =

Contribution Limit

$30,000

39

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Single Filers

$2,000 - (Modified Adjusted Gross Income - $95,000 * $2,000) =

Contribution Limit$15,000

Fees and other associated charges will vary based upon the

investments that are chosen and the financial institution the ESA is

purchased from. It is still wise to understand that any plans with fees

can become costly over time and make or break the advantages to

any savings plan.

Rollovers

Assets can be rolled over from one Coverdell ESA to another or the

beneficiary can be changed. The beneficiary’s interest can be

transferred to a spouse or former spouse due to a divorce.

40

Amounts rolled over from a Coverdell ESA are not taxable if they are

rolled over into another Coverdell for the benefit of the same

beneficiary or a member of the beneficiary’s family who is under the

age of 30. The age limit is not applicable if the beneficiary is a specialneeds student.

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Members of the beneficiary’s family include:

• Child or descendant of a child

• Brother, sister, stepbrother, or stepsister

• Father or mother or ancestor of either

• Stepfather or stepmother

• Son or daughter of a brother or sister

• Brother or sister of a father or mother

• Son-in-law, daughter-in-law, father-in-law, or mother-in-law

• The spouse of any individual listed above

• First cousin

Custodial Accounts

A custodial account is a Uniform Gift of Minor ACT account or

Uniform Transfer to Minors Act account. A student’s guardian,

grandparent, or another adult acts as a custodian for these types ofaccounts. They are in charge of making investment decisions for the

beneficiary. The beneficiary can make investment decisions on the

account when they reach the age of maturity.

The Uniform Gift to Minors Act accounts are limited to cash and

securities. Conversely, the Uniform Transfer Minors Act account does

not have those limits. The Uniform Transfer Minors Act can include

other types of property.

41

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Custodial Accounts Advantages

The initial $750 in earnings in this account is tax free, for

beneficiaries ages 14 and younger. The subsequent $750 in earningsis taxed at the beneficiary’s federal tax rate. When earnings on the

custodial account reach over $1500, then that is taxed at the

custodian’s federal tax rate.

Beneficiaries aged 14 and older have a similar benefit where the first

$750 in earnings is tax free and any earnings afterward are taxed at

the beneficiary’s tax rate. To read about the tax rules for

beneficiaries, you should read IRS Publication 929: Tax Rules for

Children and Dependents.

42

Custodial accounts have a wide array of investment options. There

are no income or contribution limitations. Withdrawals can be made

without penalty. It does not have to be a qualified education expense.

http://www.irs.gov/pub/irs-pdf/p929.pdf




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Disadvantages

Based upon the state in which the beneficiary lives, he or she can

take ownership of the custodial account and use it however they wishwhen they reach a certain age. The ages can vary from 18 to 25

depending on the state in which they reside.

When the adult who purchased the custodial account loses ownership

to the beneficiary, this can cause conflict, if the beneficiary decides

they do not want to go to college and wants to use it for something

else.

In this instance, because the account is deemed as the beneficiary’s

asset, it can not be transferred to another sibling or another family

member who would want to use the money for college.

What Utah is doing

Studies revealed in 2004 that if a student wanted to complete a four

year degree at one of Utah’s universities or colleges, they could

expect to spend $32,000 or more by the time they graduate.

Projections show that the same degree can cost more than $80,000

by the year 2024.

43

The State of Utah wanted to create a low cost and basic college

savings program and devised Utah’s Educational Savings Plan. UESP

have been rated by many investment research groups, publications,

and other third parties as one of the top five Section 529 plans in the

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nation. UESP markets solely in Utah, but 80% of the savings plans

participants are out of state residents.

UESP provides matching funds for low income in-state residents.UESP will match incentives of up to $300 per year, for four years, for

the initial 50 children of resident families who apply with incomes up

to 200% of the federal poverty level.

UESP is a member of the College Savings Plan Network and joins in

on the effort to create a voluntary disclosure system between the

various plans. UESP is developing and redefining materials to meet

the standards of the disclosure principles, so that information they

provide will help customers make an informed decision when

comparing savings plans.

Series EE & I Savings Bonds

44

U.S. Series EE savings bonds that were issued after 1989 or Series I

savings bonds are another tax advantaged way to save for college.

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Positives

This is backed by the credit of the United States government; the

interest from these bonds is tax free when used for qualified collegeeducation expenses. The interest on Series EE and I Savings bonds is

exempt from state and local taxes.

Negatives

The entire interest exclusion is available to married couples filing

jointly with a modified adjusted gross income of $91,850 and less.The same goes for single filers with a modified adjusted gross income

of less than $61,200 in 2005. The interest exclusion does not apply if

your modified adjusted gross income is between $91,850 and

$121,850 for joint filers and between $61,200 and $76,200 for single

taxpayers.

Income is not a factor if you are married and filing separately

because you can not take advantage of the Series EE & I Savings

Bonds program. Additional information is readily available at the IRS

Publication 970: Tax Benefits for Education .

45

To get more information about using savings bonds for educational

purposes, you should visit the Bureau of Public Debt’s website . TheBureau of Public Debt phone number is (800) 487-2663 and you can

inquire about current rates for savings bonds. Another number that

can provide rate information as well is (877) 811-SAVE. You can also

use that number to purchase savings bonds from the federal



http://www.publicdebt.treas.gov/bpd/bpdfaq.htm

http://www.publicdebt.treas.gov/bpd/bpdfaq.htm



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government. Or you can call the Federal Reserve at (866) 388-1776

to get additional information on savings bonds for education.

Scholarships, Fellowships, Grants, and Tuition Reductions

Scholarships represent money given on behalf of an undergraduate

or graduate student, to a college or university, to help pay for classes.

A fellowship is money given, on behalf of a student, to help pay for

research studies.

46

Below is a table that gives an overview of tax treatment of money

received as a scholarship or fellowship.

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A tax free fellowship or scholarship is only available if:

• You are a student for a degree at an eligible college or

university or trade school• You use the fellowship or scholarship to pay for educational

expenses

Here is a definition of a student eligible for a degree. You are

considered eligible for a degree if you:

1. Attend a primary or secondary school or are pursuing a degree

at a college or university, or

2. Attend an accredited educational institution that is authorized

to provide:

A. A program that is acceptable for full credit toward a bachelor’s

or higher degree, or

B. A program of training to prepare students for gainful

employment in a recognized occupation.

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Eligible educational institution: An eligible educational institution is

one that maintains a regular faculty and curriculum and normally has

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a regularly enrolled body of students in attendance at the place

where it carries on its educational activities.

Qualified education expenses : For purposes of tax free scholarshipsand fellowships, these are expenses for:

• Tuition and fees required to enroll at or attend an eligible

educational institute, and

• Course related expenses, such as fees, books, supplies, and

equipment that is required for the courses at the eligible

educational institution. These items must be required of all

students in your course of instructions.

For these to be qualified education expenses, the conditions of the

fellowship and scholarship can not be used for other purposes

such as housing. It also should specify that it can not be used for

tuition or course related expenses.

Ineligible expenses : These costs are not considered as qualified

educational expenses:

• Room and board

• Travel

•

Research• Clerical help, or

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• Equipment and other expenses: those that are not required

for enrollment in or attendance at an eligible educational

institution.

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These statements are true even if the fee has to be paid to the

educational institution as a requirement of enrollment orattendance. Fellowship amount or scholarship amounts used to

pay these costs are taxable.

The worksheet below can help figure out the tax free and taxable

parts of your fellowship or scholarship.

Example 1:

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A student receives a scholarship of $3,000. The scholarship was

not given under either of the conditions listed above. As a

requirement to receive the scholarship, the student must work as

a part-time teaching assistant. Of the $3,000 scholarship, $2,000

represents compensation for teaching. The provider of the

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scholarship gives the student a Form W-2 showing $2,000 as

income. The student used the entire amount of the scholarship for

qualified educational expenses. If all of the other conditions listed

above are met, $1,000 of your scholarship is tax free. The $2,000

you received for teaching is taxable.

Example 2:

51

A student is a candidate for a degree at a dental school. The

student received a scholarship for dental education and training.

The conditions of the scholarship require the student to perform

potential services. Penalties will apply if the student does not

comply with their terms and conditions. The entire amount of the

scholarship is taxable as payment for services in the year it is

received.

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Qualified Tuition Reduction

If a student is allowed to study without paying tuition or at a

discounted rate of tuition, the student may not have to pay tax onthis benefit. This is what is called a “tuition reduction.” This would

not be a part of a student’s income.

A tuition reduction is only available if you receive it from an

eligible educational facility and use is at an eligible institution. A

student does not have to use the tuition reduction at the

educational facility that gave it.

For example:

If a student is an employee at a eligible community college, but

they arrange for the student to take classes at a four year

university without paying tuition, he or she may not have to

include the full tuition rate in their income.

The rules for knowing if a tuition reduction is qualified, which

would make it tax free, are different if the courses taken are

below the graduate level or are graduate education.

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The student must include in their income any and all tuition

reduction if it was payment for services rendered.

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Other kinds of educational assistance

Fullbright Grants

A Fullbright Grant is treated as a scholarship or a fellowship in

regard to how much of the grant is tax free. The only thing

reported is the taxable amount.

Pell Grants

Pell Grants are need based grants that are treated as scholarships

for reasons of deciding their tax treatment. It is tax free as long as

its used for qualified education expenses during the year the grant

is awarded. The only thing reported is the taxable amount.

Payment to military personnel

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Payment received as a cadet or midshipman at an armed services

academy is pay for personal services and will be reported in box 1

of Form W-2. A student will include this in the year he or she

received it unless it is one of the exceptions.

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Payment for services

A student must include any part of their scholarship, fellowship, or

tuition reduction that represents payment for any teachingreceived or other services. This is mandatory even if the students

who are pursuing a degree perform the services to receive a

degree.

Exceptions to the rule

The student does not have to include in income any part of ascholarship or fellowship that represents payment for teaching,

research, or other services if the money is received under:

• The National Health Services Corps Scholarship Program, or

• The Armed Forces Health Professions Scholarship and

Financial Assistance Program,

And you:

• Are a student pursuing a degree at an eligible educational

institution, and

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• Use that part of the scholarship or fellowship to pay qualified

education expenses.

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Veterans’ Benefits

The Department of Veterans Affairs gives compensation to veterans

for education and training and it is tax free. If a veteran qualifies foreducation benefits, they can contact their local VA office for

assistance.

Hope and Lifetime Learning Credits

The Hope and Lifetime Learning Credits are available to help a

student offset the costs of expensive higher education by reducing

the amount of your income tax.

The Hope credit

A student may be eligible for a Hope credit of up to $1,650 for

qualified education expenses paid for each eligible candidate. A tax

credit reduces the amount you may owe in income tax. This is not

like a deduction which could reduce the amount of income subject to

tax; it is a credit that reduces the tax itself. It can reduce your tax to

zero, but if this happens and the tax is more than your credit, then

the student will not receive a refund.

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A student can only take one education credit per year. If the student

claims the Hope credit on a 2006 return, they can not claim the

Lifetime Learning credit. If the total qualified education expense for a

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student is less than $7,500, it is favorable for the student to claim the

Hope credit.

If there are qualified education expenses for more than one studentin the same year, then a choice can be made to take credits on a

per-student, per-year basis. If a parent has paid for their childrens'

qualified education expense in any given year, they can claim the

Hope credit for one child, and the Lifetime Learning credit for the

other.

Lifetime Learning Credit

The Lifetime Learning credit will give you an opportunity to claim up

to 20% of the initial $10,000 paid for college tuition and fees, for up

to $2,000 per tax return. There is no limit on how many times you

can claim the credit, unlike the Hope credit. But, you can only claim

the credit once per tax year, even if you are paying for more thanone child to go to college within the same tax year.

A student can also be eligible for the Hope credit or the Lifetime

Learning Credit, even if they withdraw from a Section 529 savings

plan or Educational Savings Account. The credits can not be used to

pay expenses that have already been paid with a Section 529 plan or

Educational Savings Account.

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The chart below lists the differences between the Hope credit and

the Lifetime Learning credit:

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Eligibility for the credits

Basically, a student is eligible for the Hope credit if all three of the

following are met:

• A person pays for qualified education expenses

• A person pays the education expenses for an eligible student

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• The eligible student is the spouse, dependant, or yourself for

whom an exemption can be claimed on a tax return.

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The amount of your Hope credit is gradually reduced if your modified

adjusted gross income is between $45,000 and $55,000. If you file a

joint return then the limits are $90,000 and $110,000. The credit can

not be claimed if the modified adjusted gross income is $55,000 or

more.

Here is a chart to figure out your modified adjusted gross income:

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Credit disqualifications

A person can not claim the Hope credit if any of the following applies:

• Your filing status is married filing separately

• You are listed as a dependent in the Exemptions section on

another person’s tax return

• Your modified adjusted gross income is $55,000 or more

• You or your spouse were a nonresident alien for any part of the

current tax year and did not elect to be treated as a resident

alien for tax purposes.

• You can claim the Lifetime Learning credit or a tuition and fees

deduction for the same student in the same tax year.

Qualifying Expenses

Qualifying expenses for the Hope credit can be for yourself, spouse,

or a dependent for which you can claim an exemption on your tax

return. The credit can be claimed for qualified educational expenses

that were paid in a prior year for qualified expenses in a future

academic year.

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For example, if $1,000 was paid on a student’s behalf to a school in

November 2006 for qualified educational expenses for the Spring

2007 semester beginning in January 2007, the credit can be claimed

on a 2006 tax return.

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Example 1

Kennedy is a freshman in a college program in dentistry. For the first

year, in addition to tuition, she is required to pay a fee to the collegefor the rental of the dental equipment she will use in the course.

Since the rental fee must be paid to the college for enrollment and

attendance, Kennedy’s rental fee for the dental equipment is a

qualified expense.

Example 2

David and Kelly are both freshmen at a university and they are both

required to have specific books for their math class. The university

does not have any strict rules pertaining to where or how students

buy their books. If they choose to buy the books directly from the

school’s bookstore, then they will receive a bill directly from the

university. David bought used books from a friend, so the money hegave to his friend is not a qualified education expense. Kelly bought

her books directly from the school’s store, but the money she used is

also not a qualified expense because the books are not required to

be purchased from the university for enrollment or attendance at the

school.

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61

An example shown is of a single taxpayer who is enrolled full time at

a local college to earn a degree in computer science. In 2006, he

paid $2,600 for his qualified tuition. He received a form 1098-T from

the college. He and the college met all of the requirements for the

Hope credit. The taxpayer’s modified adjusted gross income is

$34,000. His income tax liability before credits is $3,404. He figures

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his credit of $1,650. Shown below is a copy of his tuition statement.

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Employer assistance and reimbursement educational

programs

Some companies offer their employees the opportunity to go toschool with incentives such as paying a portion or all of their college

education. Some of these benefits, which can be up to $5,250 each

year, should not be included as compensation on your W-2 form.

Benefits over $5,250 are taxable and should be included in your

wages. There are also exceptions to that rule, but the terms and

conditions can vary between employers.

Tax free educational assistance benefits can include payments for

tuition, fees, expenses, books, supplies, and equipment. These

payments can be made to either an undergraduate or graduate

student. They also do not have to include work related studies.

Educational assistance benefits do not include payment for:

• Meals, lodging, or transportation

• Tools or supplies (other than textbooks) that you can keep

after completing the course of instruction

• Courses involving sports, games, or hobbies unless they:

A. Have a reasonable relationship to the business of youremployer, or

64

B. Are required as part of a degree program

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Chapter 4 - What if you already have a529 fund?

There are various college savings choices to decide from that havetax advantage benefits, but it wise to know which option would be

best for your financial situation. State and federal laws can be

confusing and it's imperative to understand the different laws for

your state.

There are various fees and expenses with any of the Section 529

college savings plans that have been discussed, but that does not

mean that other options do not carry various fees and expenses as

well. Any amount, no matter how miniscule, can add up over time.

Investing in mutual funds through an Educational Savings Account or

custodial account still includes fees that should be looked up in their

prospectus. Every mutual fund has a prospectus. A prospectus isinformation provided to the investor that includes important factors

about the fund as mandated by securities regulators. A prospectus

can be found on the company’s website, requested by phone or mail,

or on the SEC’s EDGAR website.

65

Also, make sure that you understand the commission fees when

investing with stocks and decide how to calculate the benefits, or lack

thereof, between the stock transaction and probable loss or gain.

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If you already have a Section 529 savings plan, make sure you read

their prospectus. Most of the time it includes the investment strategy

and risks associated with the plan and its investment portfolios.

If you go over the prospectus and find that a Section 529 savings

plan is not right for you, you do have an option to roll over the

money into another college savings account or you can withdraw the

money. Be careful with those decisions and seek advice from a tax

professional. Rolling over money could still look like a cancellation or

withdrawal based upon your state’s specific regulations. Cancellations

are subject to severe penalties and a reduction in your withdrawal by

charging administrative fees.

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Below is a comparison chart between savings plans:

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College Savings Plan Comparison Chart

67

College

Savings

Plan

Prepaid

Tuition

Plan

ESA Custodial

Accounts

Savings

Bonds

Ownership/Control Contributor Contributor Contributor Custodian

until child

reaches

age of

majority

Contributo

nvestment

Choices

Typically,

plans provide

several

investment

options.

None No

restrictions

No

restrictions

Savings

bonds

Age Limits None Plan may set

age or grade

limits.

Except for

special

needs

children, nocontributions

can be made

after a child

Minor child Owner mu

be at lea

24 befo

the bondissue da

(not

purchase

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68

reaches age

18, and

withdrawals

must be

made before

beneficiary

reaches age

30.

date).

Expenses CoveredBesides Tuition &

Fees

Qualifiededucation

expenses

for post-

secondary

education

With a fewexceptions,

only tuition

and

mandatory

fees for post-

secondary

education

are covered.

Qualifiedelementary

and

secondary

education

expenses or

qualified

higher

education

expenses

Norestrictions

on types of

expenses

Tuition amandatory

fees

post-

secondary

education

and

contributio

to 529s an

ESAs

Contribution Limit Varies from

plan to plan.

Majority ofplans permit

total

contributions

Fixed by

terms of

contract youpurchase

Contributor:

$2,000 per

beneficiaryper year

Beneficiary:

No limit No limit

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69

in excess of

$200,000 per

beneficiary.

$2,000,

does not

matter how

many ESAs

are set up

Federal Tax

Advantages

Earnings

grow tax-

deferred and

are tax-freeif used for

qualified

education

expenses.

Earnings

grow tax-

deferred and


qualified

education

expenses.

Earnings

grow tax-

deferred and


qualified

education

expenses.

$750 in

earnings

are tax-

free.

Interest

grows ta

deferred

and is tafree if us

for qualif

education

expenses.

tate Tax

Advantages

Varies from

state tostate, but

some states

provide tax

deduction for

contributions,

tax-freeearnings

growth, and

tax-free

Varies from

state tostate, but

some states

provide tax-

deduction for

contributions,

tax-freeearnings

growth, and

tax-free

None None Interest i

usually taexempt fro

state an

local taxes

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Chapter 5- Research and Resource Tools

NASD, Inc. They have a page devoted to Section 529 plans.

http://www.nasd.com/RulesRegulation/IssueCenter/NASDW_006293

College Savings Network

The National Association of State Treasurers

http://www.collegesavings.org/index.aspx

Bureau of Public Debt

http://www.savingsbonds.gov/

Internal Revenue Service Publication 970, Tax Benefits for Education


Oversight Hearing On Section 529 College Savings Plans: High Fees,

Inadequate Disclosure, Disparate State Tax Treatment, and

Questionable Broker Sales Practices. Sept, 2004

U.S. Securities and Exchange Commission

http://www.sec.gov/investor/pubs/intro529.htm

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Chapter 6 - Key questions to ask yourfinancial advisorWhether you make the decision to invest in a Section 529 savings

plan, mutual fund, or stock plan, it's best to know what questions to

ask your financial advisor. Here are some examples:

Can you purchase a Section 529 savings plan directly from the

state or plan sponsor?

What fees and expenses are charged by the plan?

How much of the fees that are paid are given to a broker for

payment?

Are there exemptions or discounts given to reduce or waive certain

plan fees?

What are the plan’s qualified education expenses?

Which colleges, universities, and educational institutions participate

in the plan?

What are the terms and conditions to roll-overs or withdrawals

from the plan?

What investment options are made available by the plan?

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How long after money is contributed does it take to get invested?

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Are there special benefits for in state residents?

Does another state offer a better plan and what are the benefits to

me as an out-of-state resident?

What are the limitations in the plan?

How often will I be allowed to change investment options?

Can I switch or transfer beneficiaries?

Can I transfer the account to another accountholder?

Who manages the program and when does their contract expire?

How well has the plan performed in the past?

529 Exposed

Documents

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