529 Overview

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NICSA
529 Overview September 19, 2002
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Agenda

• Introduction
• High-Level Background
• Historical Developments
• Current Market
• What is a 529 plan?
• Definition
• Plan Requirements
• Product Highlights
• Tax Advantages
• Other Advantages
• Prepaid Tuition Plan vs. Savings Plan
• Misconceptions

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Agenda (cont)

• Process
• New Account Opening
• Contributions
• Distributions
• Role of
• Administrator
• Marketing
• State

• Auditor
• Account Owner
• Beneficiary

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Agenda (cont)

• Administration Issues
• Tax considerations
• Market Players
• Future Growth Drivers
• Q A

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Introduction
High Level Background

• Both public and private higher education is very
  expensive
• 50 of Americans underestimate the cost of
  college
• Since 1980, college prices have been rising at a
  rate two to three times the increase in the
  Consumer Price Index

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Introduction (cont)
Historical Developments

• 1996 - Section 529 enacted
• 1997 - 529 improved and a few small plans are
  launched
• 1998 - New Hampshire and Fidelity offer age-based
  portfolios and national marketing
• 1998 - New York and TIAA-CREF offer tax break,
  first of 13 TIAA-CREF states

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Introduction (cont)
Historical Developments (cont)

• 1999 - Merrill Lynch, Salomon Smith Barney offer
  investment menus and broker-sold accounts
• 2000/2001 American Century, Putnam, Alliance,
  Strong, Morgan Stanley and T. Rowe
  Price launch programs
• 2002 Changes to tax treatment and increased
  flexibility in investment allocations

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Introduction (cont)
Current Market

• All states have approved legislation for 529
  plans
• Savings plans have accumulated over 8 billion in
  assets by year-end 2001, up from 2.5 billion at
  year-end 2000
• Prepaid tuition plans have accumulated over 8
  billion in assets by year-end 2001

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Introduction (cont)
Current Market (cont)

• Over 1.9 million accounts evenly divided between
  pre-paid and savings plans
• Average account balance in 2001 was 6,700 with
  80 of accounts holding less than 5,000
• Average state contract is 5-10 years

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What is a 529 Plan?
General Definition in IRC Section 529(b)

• The program must be established and maintained by
  a State, agency or instrumentality under which a
  person may purchase tuition credits or
  certificates on behalf of a designated
  beneficiary to use as a payment of qualified
  higher education expenses, or under which a
  person may make contributions to an account which
  is established for the purpose of meeting the
  qualified higher education expenses of a
  designated beneficiary.

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What is a 529 Plan?
Economic Growth and Tax Relief Reconciliation Act
of 2001

• Earnings used for qualified withdrawals are
  federal-income tax free beginning in 2002
  previously tax deferred at childs rate
• Increased contribution limits encouraged for each
  state
• Expansion of the definition of family member to
  include first cousins beginning in 2002
• Participants may change investments once a year
  previously unable to redirect investments

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What is a 529 Plan?
Plan Requirements

• Must provide that purchases or contributions to
  the program may only be made in cash
• Must provide adequate safeguards to prevent
  contributions on behalf of a designated
  beneficiary in excess of those necessary to
  provide for the qualified higher education
  expenses of that beneficiary

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What is a 529 Plan?
Plan Requirements (cont)

• Must provide separate accounting for each
  designated beneficiary
• Must provide that any contributor or designated
  beneficiary may not directly or indirectly direct
  the investment of any contributions to or
  earnings derived from the program
• Must not allow any interest in the program to be
  used as security for a loan

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What is a 529 Plan?
Product Highlights

• A 529 plan is a qualified tuition program (QTP)
• Fund of funds approach - diversification
• A relatively safe and advantageous way to save
  for college (focus on mutual funds)
• Estate and wealth management planning
• All 50 states currently have a 529 plan in
  operation or under development

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What is a 529 Plan? (cont)
Product Highlights (cont)

• Federal tax-free growth of earnings for qualified
  expenses. States offer varying tax inducements
• Available for any accredited post-secondary
  institution in the United States
• Flexibility to change beneficiary within the
  family of the original beneficiary without penalty

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What is a 529 Plan? (cont)
Product Highlights (cont)

• When the beneficiary is young, the investment
  strategy is moderately risky, allowing for higher
  returns
• Typically the investment strategy becomes more
  conservative as the beneficiary approaches an
  event driven date
• Low minimum investment, yet high contribution
  limits

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What is a 529 Plan? (cont)
Product Highlights (cont)

• Program must impose penalty on any refund of
  earnings from the account which are not used for
  the higher education of the beneficiary (non
  qualified)
• Program must provide separate accounting for each
  designated beneficiary
• Program must not permit any interest in the
  program to be used as security for a loan

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What is a 529 Plan? (cont)
Tax Advantages

• Federal
• Withdrawals before 2011 are free to federal
  income tax when used to pay college related
  expenses
• Later withdrawals will be taxable to the student
• State
• 24 states provide a state tax deduction for some
  or all of the contributions
• In some states the withdrawals are free from
  state taxes

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What is a 529 Plan? (cont)
Other Advantages

• Estate and Gift
• Availability and flexibility
• Investment benefits
• Asset Protection

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What is a 529 Plan? (cont)
Prepaid Tuition Plan vs. Savings Plan

• Prepaid Tuition Plan
• A prepaid tuition plan is one type of 529 plan
  allowing the purchase of a prepaid tuition
  contract that pays for one or more years of
  future college tuition.
• Future tuition is being purchased today at
  current prices
• The three types of prepaid tuition plans are the
  contract plan, unit plan, and guaranteed savings
  plan

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What is a 529 Plan? (cont)
Prepaid Tuition Plan vs. Savings Plan (cont)

• Savings Plan
• A savings plan allows a donor to make a
  contribution to an account that grows in value
  over time from the investment of the contribution
  
• The goal is to allow the account to grow in value
  over time to maintain pace with or surpass the
  cost of a college education

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What is a 529 Plan? (cont)
Prepaid Tuition Plan vs. Savings Plan (cont)

• Both types of plans employ professional
  investment managers to maximize potential returns
  within a certain level of risk
• In a prepaid tuition plan, the investment
  management is applied to the program fund to
  ensure that the obligation of the 529 plan to pay
  for future tuition is covered
• In a savings plan, the investment management is
  applied directly to the assets in a participants
  account

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What is a 529 Plan? (cont)
Misconceptions

• I have to send my child to an in-state school
• My broker says I am better off using his
  recommended mutual funds
• Congress will shut down the 529 plan
• Expenses

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Process
New Accounts

• Plans allow various mechanisms for opening a new
  account
• Application
• Lock box
• 529 department
• Online
• Certain data elements are required
• Accountholder stencil information
• Beneficiary
• Successor
• Investment Strategy

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Process (cont)
Contributions

• Plans allow for various forms of contributions
• Payroll deductions
• Automatic Clearing House
• Electronic funds transfer
• Cash, check or debit card

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Process
Distributions

• Three types of distribution
• Qualified
• Tuition, fees, books, supplies and equipment
  required for the enrollment or attendance of the
  designated beneficiary at an eligible educational
  institution.
• Room and board for students who are a attending a
  qualified education institution at least
  half-time.
• Non Qualified
• Non Qualified with exception
• Distributions consist of two parts for tax
  purposes
• Return of principal
• Earnings portion

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Role of
Administrator

• Recordkeeper
• Primary conduit with state
• Enforce compliance of program with state
• Tax reporting

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Role of (cont)
Marketing

• Because the 529 vehicle is still in the start-up
  phase, many investors are still unsure of all the
  options and benefits of these plans
• In-state
• National
• Worksite / employer

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Role of (cont)
State

• Product is a municipal security
• Responsible to ensure all constituencies can
  participate
• Ultimately responsible for compliance
• Assign the administrator and oversee investment
  option selection
• Pricing / fees

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Role of (cont)
Auditor

• Perform financials
• Agreed upon procedures
• Tax criteria

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Role of (cont)
Account Owner

• Open the account
• Make contributions on behalf of expanded family
• Investment selection
• Accountability of distributions

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Role of (cont)
Beneficiary

• Go to college
• Track expenses

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Administration Issues

• Extremely manual
• Labor intensive
• Many idiosyncrasies
• Technology is maturing / accelerating to meet
  changes

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Market Players
TIAA-CREF

• Entered the market in 1998 with New York
• Using a fund of funds approach
• TIAA manages the program for 13 states,
  including New York, California, Connecticut,
  Kentucky, Minnesota, Missouri, Oklahoma,
  Tennessee, Georgia and Vermont
• For New York, 60 bps fee charged per account
• Has captured nearly 2.5 billion in assets as of
  Q1 2002

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Market Players (cont)
Full Service Brokerages

• Merrill Lynch
• Launched their program in Maine and subsequently
  won Arkansas and Wyoming
• Using Mercury brand for Arkansas and Wyoming
• Third-party distribution through AG Edwards
• 1 billion in assets as of Q1 2002
• Salomon Smith Barney
• Won Colorado and Illinois

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Market Players (cont)
Additional Market Players

• Once a provider has won a state, they look to
  roll it out nationally
• A number of players compete less aggressively in
  this market including
• Vanguard who administers the Iowa and Utah plans
• BankOne who administers the Indiana plan
• Morgan Stanley who services the North Dakota plan

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Market Players (cont)
Additional Market Players (cont)

• There have been a few new entrants to this market
  including
• MFS in Oregon
• USAA in partnership with Strong for Nevada
• Alliance Capital in Rhode Island with over 2
  billion as of Q1 2002. Launched a second RI plan
  with JP Morgan Chase in Q3 2002.

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Market Players (cont)
Additional Market Players (cont)

• Some providers have aggressively added
  distribution alliances to best leverage their
  state mandate
• Schoolhouse Capital
• Strong

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Future Growth Drivers

• Enhanced distribution through advisors
• State tax incentives
• Payroll deduction plans
• Rising cost of college

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Final Thoughts

• Nationally, the potential for Sec. 529 Funds
  (QSTPs) is huge!!
• The flexibility of the Programs - particularly
  with regard to high investment limits, the broad
  base of eligible schools, and the absence of
  income limitations on participants - make for a
  broad prospective client base
• 529 Plans are one of the most rapidly growing
  financial investment vehicles in the United
  States of America

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Q A

• ???