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COLLEGE SAVINGS 101

Independent 529 Plan: No risk, no fees

Amy E. Buttell is a freelance writer based in Pennsylvania

by Amy E. Buttell

There's a lot to be said in favor of the Independent 529 Plan: no investment risk and no fees.

The independent 529 is a prepaid savings plan run by a consortium of more than 200 private colleges. The plan allows families the immediate opportunity to lock in a discounted tuition cost at a participating college in a future year.

It represents an attractive alternative for a family that wants to diversify its college savings portfolio.

But the plan does have its drawbacks.

If your child doesn't attend one of the affiliated schools, you don't lose your money because you can roll it over to a 529 savings plan, but your earnings will be capped at 2 percent per year. In addition, the plan covers only tuition and mandatory fees, not board or other expenses, making it more attractive as one option among several for funding college expenses.

Otherwise, the plan operates in a fashion similar to other prepaid 529 plans, except that it funds tuition at private schools that participate, which are located in all 50 states and the District of Columbia. As of mid-June 2009, 275 private colleges and universities participated, including Massachusetts Institute of Technology, Stanford University, Washington University in St. Louis, University of Miami, Tulane University, Duke University, Johns Hopkins University and Princeton University.

The plan positions itself as one option among several for parents wishing to build a more diversified college savings portfolio.

"We hope that families think about college savings especially in this environment and considering what has happened with investments in the past 18 months in a similar way they think about their retirement savings, and diversify," says Nancy Farmer, president and chief executive officer of the Independent 529 Plan, formally known as the Tuition Plan Consortium. "Put some money into a 529 savings plan, put some money into taxable mutual funds or a money market fund, and then put some money in our plan."

For parents and grandparents interested in diversifying their college fund portfolios and considering investing in this plan, here are seven issues to consider before you invest.

1. Investment risk. As a prepaid plan, the Independent 529 Plan allows parents and grandparents to make payments into the plan every year and grants "tuition certificates" for the amount paid. The certificates can later be redeemed for a predetermined percentage of the tuition at any of the participating schools when the beneficiary reaches college age. This means you don't have to make any investment decisions about the money you put into the plan as you would with a traditional college savings account sponsored by a state.

The lack of investment risk is one of the most attractive features of the Independent Plan, says Leslie Strebel, a financial adviser with the Strebel Planning Group in Ithaca, N.Y. This is especially the case in a market environment in which many investors in 529 savings plans have lost tens of thousands of dollars and may not have the time to make up those losses.

The colleges that participate in the plan offer a 1 percent discount off tuition certificates purchased in a given year. Certificates can be purchased for varying amounts, up to four years of future tuition and mandatory fees at a given school. The value of those certificates grows over time. Because each college that participates in the plan has different tuition rates, certificates represent a different value at each school.

You can purchase certificates at any time, including multiple times during a particular year. The plan imposes a minimum three-year holding period on certificates, and participants must redeem them within 30 years. This is in contrast to virtually all college savings plans, which have no minimum holding period, although some have an upper age limit on beneficiary redemptions.

2. College choice. Currently, certificates can be redeemed only at one of the 275 colleges that participate in this plan. A list is available at Independent529Plan.org (www.independent529plan.org/colleges/index.html). Although the consortium adds new private colleges frequently, this number represents only 10.6 percent of all four-year private colleges in the country, according to data from the National Center for Educational Statistics.

"The fact that you have to prefund this plan specifically in the expectation that your child will attend a private college is enough for many parents to reject this idea," says Strebel. "You'll have to do some crystal-ball gazing when your child is at a very young age and be certain enough that a certain private school is where your child is going to want to go."

"It certainly would be enough reason for most of my clients to not want to participate in this plan," she says.

Farmer says that many parents who participate in the plan attended a private college themselves and have a strong desire to see their child or children attend the same school. So they are willing to put money aside to help make that happen. The plan Web site makes it clear that purchasing tuition certificates for a specific school has no bearing on whether that child will be accepted to that school.

Any certificates you purchase can be redeemed at any of the private colleges participating in the plan. Even if the college withdraws from the plan before your child graduates from high school, it is still obligated to honor your certificates.

If your child decides to attend a state university or a private school that does not participate in the plan, you have several choices:

  • Withdraw your money and keep the 529 federal tax advantage by spending those funds on tuition, room or board at a qualified institution.
  • Roll over the money into a state 529 savings plan.
  • Transfer those funds to another beneficiary, such as another child in your family who may be more likely to attend one of the member schools.

3. Spending limits. Independent 529 certificates can be used only to pay tuition and mandatory fees at the private colleges that belong to the plan, leaving out the significant expense of board, textbooks and other fees that traditional 529 savings plan funds can cover.

This is exactly the reason that it might make sense to use the Independent Plan as one funding option among several. Still, if your child has unique talents, high grades and test scores and is aiming at a prestigious college, it can make sense to max out Independent Plan contributions, as tuition is so expensive generally above $30,000.

4. Plan fees. No plan fees are assessed by the Independent 529 Plan, which is a major contrast to state 529 investment plans, most of which sport an array of fees, including administrative and management fees. In general, investment management fees are based on a percentage of assets, which varies from 0.20 percent to 2 percent. So if you have $25,000 investment, a 1 percent asset investment management fee would cost $250 per year.

Some plans also impose annual administrative fees, which typically range from $20 to $30 annually, though many of those fees are waived for state residents, and some plans impose no fees at all.

5. Broker-sold option. Most state 529 savings plans have at least one, if not more, broker-sold options. With a broker-sold option, you can get the advice and expertise of a financial adviser who will help you choose a plan and specific investment options.

While the Independent 529 Plan currently operates solely as a direct-sold plan, it hopes to offer a broker-sold investment option shortly. This will mean that the plan will switch investment advisers from its current TIAA-CREF, to an investment adviser that will support both direct and broker-sold, says Farmer. Farmer hopes that adding a broker-sold option will increase fund assets under management, which are about $100 million now, less than the consortium running the plan would like.

6. Taxes. Contributions to the Independent 529 Plan receive the same federal tax treatment as contributions to state investment and prepaid 529 plans. Earnings on those plans that are used for qualified education expenses are exempt from federal tax. However, most states only provide a tax deduction or credit for their own plans. Arizona, Kansas, Maine and Pennsylvania are an exception to this rule, because those states allow residents to deduct contributions to virtually any 529 plan, subject to income restrictions.

7. Financial aid impact. In general, 529 plan assets owned by parents or grandparents are assessed at up to 5.6 percent of their account value.

Posted June 26, 2009