Showing posts with label college savings. Show all posts
Showing posts with label college savings. Show all posts
Saturday, April 7, 2018
How to Make A Big Tax-Free Gift to Your Child or Grandchild
Anyone who has considered giving a substantial gift to a child or grandchild has to think about the potential consequences under federal law. These could include the federal gift tax, estate tax and generation skipping transfer tax. And we haven't gotten to potential state taxes yet, which don't necessarily work the same way as federal taxes.
But there's a simple workaround to all these taxes: pay for your child's or grandchild's college education. The burden of college loans is well-known. If a student borrows $100,000 for college and/or medical, law, or other graduate school, and pays 8% per year over a 20-year repayment process, the interest costs actually exceed the $100,000 principal amount of the loan (by about $750). If you contribute $100,000 to that student's education, you just in effect transferred over $200,000 to that student, all without any consequences under federal or state estate, gift or similar laws. If the student potentially has to borrow larger amounts ($200,000 of educational debt is hardly unusual these days), the amount you can give tax-free to your child or grandchild increases proportionately.
Some parents think it's better to make kids bear the costs of college in order to teach them responsibility. There are many ways to teach responsibility, and they should begin well before the child reaches college age. If a kid isn't responsible by age 18, dumping a truckload of student debt on him or her isn't likely to improve the situation.
If you can't pay the full cost of a kid's education, consider how much you can pay. Whatever you provide reduces the potential need for loans, and the tax-free gift you give confers lifetime benefits on the kid. And if you're not wealthy enough to face liability for gift, estate or similar taxes, remember that whatever amount of educational costs you cover still provides a large gift because the child might otherwise have to borrow the money and pay a lot of interest. Even if you don't get to thumb your nose at the tax man, you give your kid a big lifelong hug and kiss.
Sunday, January 25, 2015
Obama's 529 Mistakes
President Obama's proposal to tax earnings distributed from 529 college plans derived from future contributions is one of the worst ideas he's had in tax policy. He would make withdrawals derived from earnings on new contributions taxable to the student (although withdrawals derived from earnings on funds already contributed would remain tax-free). Let us count the ways this makes no sense.
Defies Tax Logic. The redistribution of income through a progressive tax structure is a concept that virtually all Americans agree on, including many who are very wealthy. However, Obama's 529 proposal creates a much smaller redistribution loop consisting of college students (and perhaps indirectly their families). Students from more prosperous families will pay taxes that will subsidize students from less well-off families. Why have a redistribution loop consisting of only the student community? If that makes sense, why not have wealthier farmers subsidize less wealthy ones? And why not have higher earning servers and bartenders (e.g., those at high end restaurants and hotels) subsidizing the employees at Mickey D's. Since college educations are so important to America's future, subsidies for middle-class and less fortunate students shouldn't come at the expense of other students who, through no choice of their own, were born into more prosperous families. If redistribution of income is a societal goal, it shouldn't be done in a distorted way like this.
Bad Social Policy. Having children and raising them well is beneficial for America as a nation. A healthy birth rate is crucial to America's future success as a nation. More prosperous families are better able to afford to have children and raise them well. The extremely low birth rates in Japan and Europe have seriously impaired the economies--and futures--of those nations. Disincentives to have and educate children shouldn't be built into the tax code.
Bad Trickle Down. Obama's 529 proposal effectively raises the cost of college for students from more prosperous families. It defies economic logic to believe that won't have consequences. Some students might lose opportunities when this happens. Let's take this hypothetical example to see how that could work. Valedictoria, a brilliant high school student from a well-off but not rich family, might barely be able to afford the unconscionably high costs of an Ivy League school if 529 plans remain unchanged. But she would opt for a less expensive school (the well-regarded University of Home State) with the Obama changes because she doesn't want to or can't take on the additional debt required for the Ivy League (and wants to spare her parents that burden). She opts for the less expensive school. Her enrollment there could bump out a student who was marginally able to gain admission to the University of Home State. The marginal applicant then goes to a less-well regarded school, perhaps losing educational quality and opportunities he might have had at the University of Home State. Is the nation somehow better off if this happens?
Punishes Self-Sufficiency. The people who fund 529 plans are the kind of people who, in past generations, would have been viewed as good citizens prudently saving for the future education and improvement of their children. They hope not to rely on handouts or loans or governments to finance their childrens' educations. They'd like do it themselves, thank you. Indeed, self-sufficiency was once regarded as one of the most golden of American virtues. In a land where there were many opportunities, but also many hazards, the self-sufficient were the bedrock and pillars of a growing nation that wanted to keep growing. To be self-sufficient, you necessarily have to build your wealth. Why penalize self-sufficiency by taxing college savings? We have become a nation obsessed with instant gratification, the faux celebrity status offered by social networking, easy credit for all, and bailouts for almost every need imaginable. Will discouraging self-sufficiency improve things?
Defies Tax Logic. The redistribution of income through a progressive tax structure is a concept that virtually all Americans agree on, including many who are very wealthy. However, Obama's 529 proposal creates a much smaller redistribution loop consisting of college students (and perhaps indirectly their families). Students from more prosperous families will pay taxes that will subsidize students from less well-off families. Why have a redistribution loop consisting of only the student community? If that makes sense, why not have wealthier farmers subsidize less wealthy ones? And why not have higher earning servers and bartenders (e.g., those at high end restaurants and hotels) subsidizing the employees at Mickey D's. Since college educations are so important to America's future, subsidies for middle-class and less fortunate students shouldn't come at the expense of other students who, through no choice of their own, were born into more prosperous families. If redistribution of income is a societal goal, it shouldn't be done in a distorted way like this.
Bad Social Policy. Having children and raising them well is beneficial for America as a nation. A healthy birth rate is crucial to America's future success as a nation. More prosperous families are better able to afford to have children and raise them well. The extremely low birth rates in Japan and Europe have seriously impaired the economies--and futures--of those nations. Disincentives to have and educate children shouldn't be built into the tax code.
Bad Trickle Down. Obama's 529 proposal effectively raises the cost of college for students from more prosperous families. It defies economic logic to believe that won't have consequences. Some students might lose opportunities when this happens. Let's take this hypothetical example to see how that could work. Valedictoria, a brilliant high school student from a well-off but not rich family, might barely be able to afford the unconscionably high costs of an Ivy League school if 529 plans remain unchanged. But she would opt for a less expensive school (the well-regarded University of Home State) with the Obama changes because she doesn't want to or can't take on the additional debt required for the Ivy League (and wants to spare her parents that burden). She opts for the less expensive school. Her enrollment there could bump out a student who was marginally able to gain admission to the University of Home State. The marginal applicant then goes to a less-well regarded school, perhaps losing educational quality and opportunities he might have had at the University of Home State. Is the nation somehow better off if this happens?
Punishes Self-Sufficiency. The people who fund 529 plans are the kind of people who, in past generations, would have been viewed as good citizens prudently saving for the future education and improvement of their children. They hope not to rely on handouts or loans or governments to finance their childrens' educations. They'd like do it themselves, thank you. Indeed, self-sufficiency was once regarded as one of the most golden of American virtues. In a land where there were many opportunities, but also many hazards, the self-sufficient were the bedrock and pillars of a growing nation that wanted to keep growing. To be self-sufficient, you necessarily have to build your wealth. Why penalize self-sufficiency by taxing college savings? We have become a nation obsessed with instant gratification, the faux celebrity status offered by social networking, easy credit for all, and bailouts for almost every need imaginable. Will discouraging self-sufficiency improve things?
Wednesday, July 24, 2013
Managing Personal Risk
Modern businesses put a lot of effort into managing risk. They take risks, because that's how they might make big money. But they also work to mitigate the downsides of their risks, because employee stock options don't pay off real well if the CEO, or someone or something else, blows up the business.
Individuals need to manage risk as well. Bankruptcies most often result from unexpected problems, like a medical crisis or job loss. If you don't deal with the ways that life can fall apart, the chances of your life fallling apart increase. The need to manage personal risk may be one of the most under-appreciated aspects of financial planning. While there's no perfect or complete way to analyze personal risk, here are some things to think about.
Age. As you grow older, reduce risk. If anything goes wrong, you will have less time to recover, and less ability to recover as your value in the labor force declines (and it eventually will). There are variety of ways to reduce risk discussed below. The important point is that as time passes and you accumulate more gray hair, reduce personal risk.
Occupation. Your occupation can be a major risk factor. Some types of work can't be performed by older people. This would include construction, law enforcement, military service, fire fighting and other jobs that demand physical strength and endurance. It could also include jobs that don't demand physical strength, but do require certain abilities that deteriorate with age, such as flying, working as an air traffic controller, or performing surgery. If your job has a relatively limited time span, start building wealth at an early age and persist. You may be able to have a second career when the first one ends. But then again, maybe not. Don't count on what's highly uncertain. Assume your first occupation is all that you'll ever have and base your financial planning on it.
Employment stability. If your job security is unstable, build up a large pool of savings to tide you over the rough spots. A year's worth of living expenses, or more, in an emergency fund would be a good idea. If you work in a boom-bust industry, like construction or oil and gas drilling, or an unpredictable job, like entertainment, your savings account is your best friend. If you have to take on debts, or lose a car and/or house, because you didn't prepare for a layoff, your long term financial future may be cloudy.
Health. Factor into your financial planning your health problems, especially any chronic ones you have. There is no way to avoid having health problems, especially as you get older. That's why having health insurance is so important--you will definitely use it. Also have some savings available for health care expenses not covered by insurance--these expenses are one of the leading reasons for personal bankruptcy filings. If your health is good, save plenty because you may need to finance a long life span.
Debts. Debts are one of the most dangerous risks. Jobs may not be secure, but debts, once incurred, are a certainty. If you're poor, but debt free, you won't end up in bankruptcy. Poverty doesn't lead to bankruptcy; unmanageable debts do. But debts are also one of the most controllable risks. Avoid taking on debt unless it's really necessary. Pay off debts as quickly as possible, especially as you get older. A mortgage-free house is better than a sleeping pill. There are some financial planners who will tell you to have a mortgage and invest your cash in stocks. Well, if stocks maintained a nice, steady upward trend all the time, this might well be a smart move. But if stocks are sometimes volatile--well, some people do manage to eat dog food. Avoid debt and you avoid risk.
Moral and voluntary obligations. Lots of people help their kids pay for college--and then help some more when the kids rebound home after graduating. Many help their aged parents. Quite a few help siblings, nieces, nephews, friends and so on when the going gets tough. If you are likely to accept these obligations, manage your finances to be able to meet them. Being nice can be a major financial risk factor.
Riskiness of your assets. This isn't quite the same as asset allocation. This is preparing for things to go wrong with your choice of assets. Don't think your allocation is necessarily right. Almost no one predicted the financial crisis of 2008 and hundreds of millions of savers worldwide got a big tummy ache as a result. If you really think that you and your financial planner have it all figured out, contact me about buying a very nice bridge in Brooklyn, and at a bargain price, too.
But back to the first point. Stress test your investments (see http://blogger.uncleleosden.com/2010/11/stress-test-your-retirement.html). If you are uncomfortable with the potential losses you could incur, change your allocation. Of course, no matter what you do, you'll end up with some kind of allocation. The important thing is to end up with something that you can live with on good days and bad.
Insurance. Only Congress is less popular than insurance companies. But having some insurance coverage is important to mitigating risks. We've already covered health insurance. Have homeowners or renter's coverage. Maintain plenty of liability coverage on your auto policy, and buy an umbrella policy if you have a significant net worth. Get disability coverage (first check to see what your employer offers, and supplement it if appropriate). If you have dependents, like minor children, buy life insurance. Think about long term care coverage if you have significant assets. Granted, writing a check to an insurance company feels like eating sawdust. But if life takes a u-turn, it's comforting to be able to forward the bill to an insurance company.
Boost your benefits. Work as long as possible to build up your Social Security credits and any pension benefits for which you are eligible. Okay, Congress, the White House, City Hall, the boss, or somebody is always threatening to trim or take away these benefits. But they will very likely survive in one form or another, and you benefit from maximizing them because they may offer the best shelter available when cold economic winds blow.
Individuals need to manage risk as well. Bankruptcies most often result from unexpected problems, like a medical crisis or job loss. If you don't deal with the ways that life can fall apart, the chances of your life fallling apart increase. The need to manage personal risk may be one of the most under-appreciated aspects of financial planning. While there's no perfect or complete way to analyze personal risk, here are some things to think about.
Age. As you grow older, reduce risk. If anything goes wrong, you will have less time to recover, and less ability to recover as your value in the labor force declines (and it eventually will). There are variety of ways to reduce risk discussed below. The important point is that as time passes and you accumulate more gray hair, reduce personal risk.
Occupation. Your occupation can be a major risk factor. Some types of work can't be performed by older people. This would include construction, law enforcement, military service, fire fighting and other jobs that demand physical strength and endurance. It could also include jobs that don't demand physical strength, but do require certain abilities that deteriorate with age, such as flying, working as an air traffic controller, or performing surgery. If your job has a relatively limited time span, start building wealth at an early age and persist. You may be able to have a second career when the first one ends. But then again, maybe not. Don't count on what's highly uncertain. Assume your first occupation is all that you'll ever have and base your financial planning on it.
Employment stability. If your job security is unstable, build up a large pool of savings to tide you over the rough spots. A year's worth of living expenses, or more, in an emergency fund would be a good idea. If you work in a boom-bust industry, like construction or oil and gas drilling, or an unpredictable job, like entertainment, your savings account is your best friend. If you have to take on debts, or lose a car and/or house, because you didn't prepare for a layoff, your long term financial future may be cloudy.
Health. Factor into your financial planning your health problems, especially any chronic ones you have. There is no way to avoid having health problems, especially as you get older. That's why having health insurance is so important--you will definitely use it. Also have some savings available for health care expenses not covered by insurance--these expenses are one of the leading reasons for personal bankruptcy filings. If your health is good, save plenty because you may need to finance a long life span.
Debts. Debts are one of the most dangerous risks. Jobs may not be secure, but debts, once incurred, are a certainty. If you're poor, but debt free, you won't end up in bankruptcy. Poverty doesn't lead to bankruptcy; unmanageable debts do. But debts are also one of the most controllable risks. Avoid taking on debt unless it's really necessary. Pay off debts as quickly as possible, especially as you get older. A mortgage-free house is better than a sleeping pill. There are some financial planners who will tell you to have a mortgage and invest your cash in stocks. Well, if stocks maintained a nice, steady upward trend all the time, this might well be a smart move. But if stocks are sometimes volatile--well, some people do manage to eat dog food. Avoid debt and you avoid risk.
Moral and voluntary obligations. Lots of people help their kids pay for college--and then help some more when the kids rebound home after graduating. Many help their aged parents. Quite a few help siblings, nieces, nephews, friends and so on when the going gets tough. If you are likely to accept these obligations, manage your finances to be able to meet them. Being nice can be a major financial risk factor.
Riskiness of your assets. This isn't quite the same as asset allocation. This is preparing for things to go wrong with your choice of assets. Don't think your allocation is necessarily right. Almost no one predicted the financial crisis of 2008 and hundreds of millions of savers worldwide got a big tummy ache as a result. If you really think that you and your financial planner have it all figured out, contact me about buying a very nice bridge in Brooklyn, and at a bargain price, too.
But back to the first point. Stress test your investments (see http://blogger.uncleleosden.com/2010/11/stress-test-your-retirement.html). If you are uncomfortable with the potential losses you could incur, change your allocation. Of course, no matter what you do, you'll end up with some kind of allocation. The important thing is to end up with something that you can live with on good days and bad.
Insurance. Only Congress is less popular than insurance companies. But having some insurance coverage is important to mitigating risks. We've already covered health insurance. Have homeowners or renter's coverage. Maintain plenty of liability coverage on your auto policy, and buy an umbrella policy if you have a significant net worth. Get disability coverage (first check to see what your employer offers, and supplement it if appropriate). If you have dependents, like minor children, buy life insurance. Think about long term care coverage if you have significant assets. Granted, writing a check to an insurance company feels like eating sawdust. But if life takes a u-turn, it's comforting to be able to forward the bill to an insurance company.
Boost your benefits. Work as long as possible to build up your Social Security credits and any pension benefits for which you are eligible. Okay, Congress, the White House, City Hall, the boss, or somebody is always threatening to trim or take away these benefits. But they will very likely survive in one form or another, and you benefit from maximizing them because they may offer the best shelter available when cold economic winds blow.
Wednesday, March 6, 2013
Idolatry in the Financial Markets
A lot of investors, it would appear, are throwing money at increasingly esoteric investments in order to prevent inflation from eroding their capital. Junk bonds, asset-backed securities and real estate investment trusts have become fashionable. With the Fed waging a 24/7 scorched earth campaign against positive interest rates, risk is being embraced. One can only hope that the end result isn't like embracing a cobra--"risk on" investing strategies aren't risk-free.
A false premise widely circulated by financial sales people and cable TV pundits is that you have to preserve your savings from the ravages of inflation. And, certainly, over long periods of time, inflation can significantly diminish your capital. But you can't overlook the costs and risks of trying to protect yourself from inflation. If those risks smack down your net worth, you haven't accomplished anything except lose money and then suffer inflation's death of a thousand cuts. There's nothing wrong with losing a little ground now and then to inflation, while saving and investing with a view to long term financial equanimity. If you lose ground to inflation for one, two or even a few years, don't panic. Try to position your portfolio so that you can make up the "losses" later on. Also spend less and save more. This will increase your net worth without requiring you to dial up the risk.
The same is true of keeping pace with market averages. The Dow Jones Industrial Average, the S&P 500, or whatever benchmark you might follow may be convenient ways to assess the performance of money managers who want to take your savings. But market indices don't need to be your financial goals. If your portfolio is conservatively deployed and doesn't keep pace with the S&P 500, you haven't "lost" unless you decide you're a loser. As long as you are saving enough for retirement, your kids' college costs, and whatever other goals you might have, it doesn't matter a rat's left ear whether or not your investment returns match one market index or another. If your portfolio is more cautiously invested than the stocks found in an index, you won't suffer the volatility of the index. Maybe the Dow just reached a record level (although this really isn't a record once you factor in inflation). But looking back at what happened in 2000 and 2007 after the Dow previously reached record levels will tell you that keeping up with market indices can be a losing proposition.
Keeping pace with inflation and with market averages are, for individual investors, false idols that they need not worship. Building your net worth isn't a contest. It's a process. There are lots of ways to make your retirement years golden. Do whatever helps you sleep at night.
A false premise widely circulated by financial sales people and cable TV pundits is that you have to preserve your savings from the ravages of inflation. And, certainly, over long periods of time, inflation can significantly diminish your capital. But you can't overlook the costs and risks of trying to protect yourself from inflation. If those risks smack down your net worth, you haven't accomplished anything except lose money and then suffer inflation's death of a thousand cuts. There's nothing wrong with losing a little ground now and then to inflation, while saving and investing with a view to long term financial equanimity. If you lose ground to inflation for one, two or even a few years, don't panic. Try to position your portfolio so that you can make up the "losses" later on. Also spend less and save more. This will increase your net worth without requiring you to dial up the risk.
The same is true of keeping pace with market averages. The Dow Jones Industrial Average, the S&P 500, or whatever benchmark you might follow may be convenient ways to assess the performance of money managers who want to take your savings. But market indices don't need to be your financial goals. If your portfolio is conservatively deployed and doesn't keep pace with the S&P 500, you haven't "lost" unless you decide you're a loser. As long as you are saving enough for retirement, your kids' college costs, and whatever other goals you might have, it doesn't matter a rat's left ear whether or not your investment returns match one market index or another. If your portfolio is more cautiously invested than the stocks found in an index, you won't suffer the volatility of the index. Maybe the Dow just reached a record level (although this really isn't a record once you factor in inflation). But looking back at what happened in 2000 and 2007 after the Dow previously reached record levels will tell you that keeping up with market indices can be a losing proposition.
Keeping pace with inflation and with market averages are, for individual investors, false idols that they need not worship. Building your net worth isn't a contest. It's a process. There are lots of ways to make your retirement years golden. Do whatever helps you sleep at night.
Wednesday, February 16, 2011
Prepaid College Tuition Plans: Too Good to Be True
More and more states are closing their prepaid college tuition plans to new participants, raising the cost of participation, or limiting the benefits provided by not bailing out underfunded plans. Many parents are unhappy. Some have sued.
These plans, which promised to cover state university tuition costs for beneficiary students residing in the state offering the plan, were like a futures contract. Someone, usually the parents, would buy now, and years later the student would take delivery of a college education without paying the tuition in effect at the time of enrollment. A few years ago, prepaid tuition was a pretty good deal if you could be sure your child would attend a state university covered by the program. It was less good if your child went to another school, although you could apply some of the value of your account to other schools' tuition charges.
But just as roses have thorns, fine print in the policies of many programs took the state off the hook if tuition costs rose faster than expected. There was no guarantee that the programs would stay open, or that new participants wouldn't have to pay higher costs than previous participants.
Since the financial crisis of 2007-08, state university tuition charges have, on average, risen faster than private college tuition. Pinched by falling tax revenues from the Great Recession, states cut their support to higher education, at a time when endowments took investment losses while alumni contributions became more uncertain. Not surprisingly, the state legislators who cut support for their state's university system wouldn't want to be backdoored by rising costs from the prepaid tuition program. So in some instances they whacked away at that program, too.
Looking at the problem on the state level misses an important point, though. Prepaid tuition programs are really structured financial products, not unlike so many other fancy engineered investments from Wall Street that haven't worked out so well. Money managers sold state officials on the idea that investment skill could mitigate the risks of rising tuition costs. Nice story and it would play well with the voters. But the boom-bust cycles that have skewered asset values time and again over the past decade have made laughing stock of money managers (except that it really wasn't funny when everyone's 401(k)s got clobbered). And no state has escaped pressure from falling tax collections due to the Great Recession. It's easy to offer guarantees when asset values are stable and usually rising, and the economy is growing. But when asset values are volatile, and times are tough, things that are too good to be true won't be true.
There are plenty of potential candidates for blame, from Wall Street to the Fed to money managers to state officials to university administrators. But placing blame doesn't much help kids now strapped for college funds. If you want to play it safe, forget about prepaid college tuition plans, and save as much as you can for your kids' education. Using 529 college savings plans can be a good idea if the expenses are low and you can get a deduction on your state income taxes. You'll be better off if you accept the fact that there really are no guarantees in life and plan on taking care of things yourself.
These plans, which promised to cover state university tuition costs for beneficiary students residing in the state offering the plan, were like a futures contract. Someone, usually the parents, would buy now, and years later the student would take delivery of a college education without paying the tuition in effect at the time of enrollment. A few years ago, prepaid tuition was a pretty good deal if you could be sure your child would attend a state university covered by the program. It was less good if your child went to another school, although you could apply some of the value of your account to other schools' tuition charges.
But just as roses have thorns, fine print in the policies of many programs took the state off the hook if tuition costs rose faster than expected. There was no guarantee that the programs would stay open, or that new participants wouldn't have to pay higher costs than previous participants.
Since the financial crisis of 2007-08, state university tuition charges have, on average, risen faster than private college tuition. Pinched by falling tax revenues from the Great Recession, states cut their support to higher education, at a time when endowments took investment losses while alumni contributions became more uncertain. Not surprisingly, the state legislators who cut support for their state's university system wouldn't want to be backdoored by rising costs from the prepaid tuition program. So in some instances they whacked away at that program, too.
Looking at the problem on the state level misses an important point, though. Prepaid tuition programs are really structured financial products, not unlike so many other fancy engineered investments from Wall Street that haven't worked out so well. Money managers sold state officials on the idea that investment skill could mitigate the risks of rising tuition costs. Nice story and it would play well with the voters. But the boom-bust cycles that have skewered asset values time and again over the past decade have made laughing stock of money managers (except that it really wasn't funny when everyone's 401(k)s got clobbered). And no state has escaped pressure from falling tax collections due to the Great Recession. It's easy to offer guarantees when asset values are stable and usually rising, and the economy is growing. But when asset values are volatile, and times are tough, things that are too good to be true won't be true.
There are plenty of potential candidates for blame, from Wall Street to the Fed to money managers to state officials to university administrators. But placing blame doesn't much help kids now strapped for college funds. If you want to play it safe, forget about prepaid college tuition plans, and save as much as you can for your kids' education. Using 529 college savings plans can be a good idea if the expenses are low and you can get a deduction on your state income taxes. You'll be better off if you accept the fact that there really are no guarantees in life and plan on taking care of things yourself.
Sunday, December 5, 2010
Looking for Bernie Madoff
If you could get the candid assessment of the financial markets from a lot of investors today, it would probably be something like returns are low and risks are high. That explains why so much money, especially that held by individual investors, remains in bank accounts, money market funds, ultra short bond funds and other relatively low risk places. The financial markets have given us so many unpleasant surprises in the last 3 years, people are afraid the future holds more.
At the same time, with incomes stagnant and inflation increasing (regardless of government statistics and what high ranking government officials claim), many are under pressure to seek higher returns from their savings. There's nothing wrong with looking for a better return. Just remember that, even though we now live in the era of the endless bailout, there still isn't a free lunch. Unless you're a major bank, a sovereign nation, or a very large business corporation. Stocks and lower rated bonds might offer greater potential for profit, but they also offer greater potential for loss. Risk and reward walk hand-in-hand down Wall Street.
Some investment products include guarantees against loss. These often are touted by insurance companies and should be scrutinized closely. The promise against loss is going to cost you. It could be in the form of tight limits on upside returns (i.e., if the product generates a return, the insurance company is going to keep a good portion of it), stiff penalties for early termination or withdrawal, and in other forms. Remember that if the markets perform poorly and your return is zero, even though your losses are also zero, you would have been better off in passbook savings. (That's not a theoretical point; anyone who put money in passbook savings ten years ago instead of stocks is ahead of the market.) While no one knows what the future will bring, investing in a no-lose product doesn't mean you'll win.
Even though many insurance companies might want to sell you a lousy deal, in general they aren't fraudsters. The worst thing you could encounter in your quest for higher returns is the markets magician who claims to consistently produce good, albeit not spectacular yields, day in and day out, year after year. No one can do that, period. If you meet anyone who says he or she can, put your hand on your wallet and run away. Fast. No matter how tempted you are, and no matter how good the sales pitch sounds, don't invest.
The biggest frauds are perpetrated, not because the bad guy lies, but because investors lie to themselves. They convince themselves that lead can indeed be turned into gold. They brush aside contrary evidence and the rationality of naysayers. They want to hear, however improbably, that good returns can be secured with no risk. They seek out the con artists who promise the sun, the stars and the moon.
Bernie Madoff didn't have to find many of his victims. They found him, and they were ready to believe every word of his web of lies. He'll be in prison for the rest of his life. But there are plenty of latter day Bernie's around. Often, the gullible and greedy will find them. As a matter of law, the con artist is liable and should be punished sternly. As a matter of reality, if you go looking for a latter day Bernie Madoff, you'll probably find him. And you'll regret it.
At the same time, with incomes stagnant and inflation increasing (regardless of government statistics and what high ranking government officials claim), many are under pressure to seek higher returns from their savings. There's nothing wrong with looking for a better return. Just remember that, even though we now live in the era of the endless bailout, there still isn't a free lunch. Unless you're a major bank, a sovereign nation, or a very large business corporation. Stocks and lower rated bonds might offer greater potential for profit, but they also offer greater potential for loss. Risk and reward walk hand-in-hand down Wall Street.
Some investment products include guarantees against loss. These often are touted by insurance companies and should be scrutinized closely. The promise against loss is going to cost you. It could be in the form of tight limits on upside returns (i.e., if the product generates a return, the insurance company is going to keep a good portion of it), stiff penalties for early termination or withdrawal, and in other forms. Remember that if the markets perform poorly and your return is zero, even though your losses are also zero, you would have been better off in passbook savings. (That's not a theoretical point; anyone who put money in passbook savings ten years ago instead of stocks is ahead of the market.) While no one knows what the future will bring, investing in a no-lose product doesn't mean you'll win.
Even though many insurance companies might want to sell you a lousy deal, in general they aren't fraudsters. The worst thing you could encounter in your quest for higher returns is the markets magician who claims to consistently produce good, albeit not spectacular yields, day in and day out, year after year. No one can do that, period. If you meet anyone who says he or she can, put your hand on your wallet and run away. Fast. No matter how tempted you are, and no matter how good the sales pitch sounds, don't invest.
The biggest frauds are perpetrated, not because the bad guy lies, but because investors lie to themselves. They convince themselves that lead can indeed be turned into gold. They brush aside contrary evidence and the rationality of naysayers. They want to hear, however improbably, that good returns can be secured with no risk. They seek out the con artists who promise the sun, the stars and the moon.
Bernie Madoff didn't have to find many of his victims. They found him, and they were ready to believe every word of his web of lies. He'll be in prison for the rest of his life. But there are plenty of latter day Bernie's around. Often, the gullible and greedy will find them. As a matter of law, the con artist is liable and should be punished sternly. As a matter of reality, if you go looking for a latter day Bernie Madoff, you'll probably find him. And you'll regret it.
Friday, June 15, 2007
529 College Savings Plan Alert
You've probably heard of the 529 College Savings Plan. It's a program, usually sponsored by a state, that allows you to open an account and save on a tax advantaged basis for college expenses. There are dozens of 529 Plans to choose from, and no two plans are alike. A parent, grandparent, aunt or uncle trying to walk through the thicket of 529 plans could easily become confused and feel lost. They might naturally look for help.
Many 529 plans are sold by stock brokers. It may seem easier to ask a financial professional which of the confusing array of 529 plans is best. That certainly takes less time than wading through the details of even a couple of 529 plans. But stock brokers don't work for free. They work for commissions, and if they persuade you to open an account with a particular 529 Plan, you can be pretty certain they get a commission from it. If fact, they may have disclosed that commission to you. (If they didn't, ask.)
But there's a cloud on the horizon. The SEC (U.S. Securities and Exchange Commission), which regulates stock brokers, posted a "compliance alert" on its website on June 14, 2007: (http://www.sec.gov/about/offices/ocie/complialert.htm). The alert says that the SEC staff has uncovered problems with the way that brokerage firms supervise the sale of 529 plans. (You have to scroll about two-thirds of the way through the alert to get to the part about 529 plans.)
Brokerage firms have a legal duty to supervise their sales people (i.e., their brokers). The SEC staff has learned that many brokerage firms lack adequate processes and procedures to supervise the sale of 529 plans. That's not good, because 529 plans are hot ticket items these days, with the cost of college educations rising faster than the rate of inflation.
The SEC reported that one problem was a lack of evidence that brokerage firms were reviewing 529 sales to see that they were suitable for the customers. Brokers are supposed to recommend only investments and financial products that are "suitable" for their customers. Suitability is one of the crucial protections you, as an investor, have. Brokers should focus on your individual needs and wants. For example, if you and your spouse are in your 20's and have a one-year old child, the type of investments you'd use for college savings would probably be more heavily weighted towards stocks and their potential for long term growth, because the child has 17 years to go before college and the stock market may offer good returns over a long period of time like that. But if you and your spouse are north of the big 5-0 and the baby of the family is entering college in two years, you'd want to ratchet down the risk levels of your college savings so that you'd have less chance of losing entire tuition payments in the stock market because a big hedge fund has a tummy ache. If the brokerage firms aren't adequately supervising for suitability, there's a greater risk you might end up with a 529 plan that isn't right for you.
The SEC's compliance alert also revealed that, at many brokerage firms, 529 plan transactions were not entered into the firm's computer records. Why does recordkeeping matter? Because it is one of the keys to effective supervision. If a supervisor can't learn about a sale to a customer, how can the supervisors supervise? A supervisor could be responsible for numerous brokers and can't watch all of them every minute. So the supervisor has to rely on records much of the time. Without good recordkeeping, there may not be effective supervision and that heightens the risk of unsuitable sales of 529 plans.
The SEC also expressed concern that many brokerage firms didn't train supervisors or brokers adequately about the suitability of 529 plans the firms were recommending. This makes us furrow our brows more deeply.
Does the compliance alert mean that a 529 plan account that you opened through a stock broker is wrong for you? Not necessarily. Does it mean that your stock broker cheated you? Not necessarily. But it means that circumstances may have made it easier for a naughty stock broker to deal unfairly with you. Review your plan closely and see if it really suits your needs and wants. Think about whether you're comfortable with the risk levels of the investments in the plan. Look at the fees and expenses of the plan. Are they 2% or 3% a year? If so, that's pretty steep. Less expensive 529 plans are readily available. The plans with high fees and expenses may also be the ones that pay brokers generous commissions. If you have an expensive plan, you'd have to consider whether the broker might have put you in that plan in order to get a juicy commission.
If you're going to talk to a broker about 529 plans, be careful. Do your homework first. Learn as much as you can about these plans before you talk to the broker. Sure, the broker is supposed to be the expert. But the broker is also a salesperson. Would you rely on a salesperson at a car dealership to choose the best vehicle for you? No. You'd study up on cars first and have an idea of what you really want. Buying a 529 plan, which can involve a lot of money, deserves your time and attention, before you meet with the salesperson.
For more information about saving for college, please go to our earlier blog at http://blogger.uncleleosden.com/2007/05/downsides-of-saving-for-college.html.
Celebrity News: Guess who was once a cheerleader (it's weirder than you'd think): http://www.nbc4.com/slideshow/entertainment/13010870/detail.html.
Many 529 plans are sold by stock brokers. It may seem easier to ask a financial professional which of the confusing array of 529 plans is best. That certainly takes less time than wading through the details of even a couple of 529 plans. But stock brokers don't work for free. They work for commissions, and if they persuade you to open an account with a particular 529 Plan, you can be pretty certain they get a commission from it. If fact, they may have disclosed that commission to you. (If they didn't, ask.)
But there's a cloud on the horizon. The SEC (U.S. Securities and Exchange Commission), which regulates stock brokers, posted a "compliance alert" on its website on June 14, 2007: (http://www.sec.gov/about/offices/ocie/complialert.htm). The alert says that the SEC staff has uncovered problems with the way that brokerage firms supervise the sale of 529 plans. (You have to scroll about two-thirds of the way through the alert to get to the part about 529 plans.)
Brokerage firms have a legal duty to supervise their sales people (i.e., their brokers). The SEC staff has learned that many brokerage firms lack adequate processes and procedures to supervise the sale of 529 plans. That's not good, because 529 plans are hot ticket items these days, with the cost of college educations rising faster than the rate of inflation.
The SEC reported that one problem was a lack of evidence that brokerage firms were reviewing 529 sales to see that they were suitable for the customers. Brokers are supposed to recommend only investments and financial products that are "suitable" for their customers. Suitability is one of the crucial protections you, as an investor, have. Brokers should focus on your individual needs and wants. For example, if you and your spouse are in your 20's and have a one-year old child, the type of investments you'd use for college savings would probably be more heavily weighted towards stocks and their potential for long term growth, because the child has 17 years to go before college and the stock market may offer good returns over a long period of time like that. But if you and your spouse are north of the big 5-0 and the baby of the family is entering college in two years, you'd want to ratchet down the risk levels of your college savings so that you'd have less chance of losing entire tuition payments in the stock market because a big hedge fund has a tummy ache. If the brokerage firms aren't adequately supervising for suitability, there's a greater risk you might end up with a 529 plan that isn't right for you.
The SEC's compliance alert also revealed that, at many brokerage firms, 529 plan transactions were not entered into the firm's computer records. Why does recordkeeping matter? Because it is one of the keys to effective supervision. If a supervisor can't learn about a sale to a customer, how can the supervisors supervise? A supervisor could be responsible for numerous brokers and can't watch all of them every minute. So the supervisor has to rely on records much of the time. Without good recordkeeping, there may not be effective supervision and that heightens the risk of unsuitable sales of 529 plans.
The SEC also expressed concern that many brokerage firms didn't train supervisors or brokers adequately about the suitability of 529 plans the firms were recommending. This makes us furrow our brows more deeply.
Does the compliance alert mean that a 529 plan account that you opened through a stock broker is wrong for you? Not necessarily. Does it mean that your stock broker cheated you? Not necessarily. But it means that circumstances may have made it easier for a naughty stock broker to deal unfairly with you. Review your plan closely and see if it really suits your needs and wants. Think about whether you're comfortable with the risk levels of the investments in the plan. Look at the fees and expenses of the plan. Are they 2% or 3% a year? If so, that's pretty steep. Less expensive 529 plans are readily available. The plans with high fees and expenses may also be the ones that pay brokers generous commissions. If you have an expensive plan, you'd have to consider whether the broker might have put you in that plan in order to get a juicy commission.
If you're going to talk to a broker about 529 plans, be careful. Do your homework first. Learn as much as you can about these plans before you talk to the broker. Sure, the broker is supposed to be the expert. But the broker is also a salesperson. Would you rely on a salesperson at a car dealership to choose the best vehicle for you? No. You'd study up on cars first and have an idea of what you really want. Buying a 529 plan, which can involve a lot of money, deserves your time and attention, before you meet with the salesperson.
For more information about saving for college, please go to our earlier blog at http://blogger.uncleleosden.com/2007/05/downsides-of-saving-for-college.html.
Celebrity News: Guess who was once a cheerleader (it's weirder than you'd think): http://www.nbc4.com/slideshow/entertainment/13010870/detail.html.
Monday, May 14, 2007
The Downsides of Saving for College Expenses
Just as a parent will wake up at 3:00 am to feed a hungry new born, a parent will save for the child's college expenses. Many commentators recommend that you first fund your retirement, and use any remaining money for college savings. The idea is that you don't want to be a burden on your kid(s) when you're old. Given the amount of money it takes to retire comfortably, most people would have little left for college expenses if they actually took care of retirement first. But the parental instinct to provide for the child--be it with food or with an education--extends beyond financial rationality. People will save for the educational expenses of their children, even at the cost of adequately funding their own retirements.
That being the case, they should be aware of some of the pitfalls and downsides of saving for college expenses. The 529 Plan and the Coverdell account are heavily promoted today, especially the 529 Plan. Both a 529 account and a Coverdell account offer tax advantages--the money you put into them isn't tax deductible, but the earnings are not taxed if they are used to pay college expenses. Coverdell accounts can also be used to pay primary school expenses. Some states offer deductions from state income taxes to their residents who open an account in a 529 Plan offered by that state.
However, there are the downsides, which you not hear much about. Each 529 Plan has only a limited number of investment options. The plan itself, and the investment options, may impose high costs and fees on your account (as much as 3% per year in some cases). That's a hefty burden. Even with the tax shelter offered by the 529 Plan, fees at that level seriously reduce your long term returns. If you compare an expensive 529 Plan against an inexpensive taxable account (one where you pay taxes on realized investment gains each year), the inexpensive taxable account can produce greater wealth.
Another problem with 529 Plans is that if the money in your 529 account isn't used for college expenses, you can retrieve it only after paying state and federal income taxes, and a 10% penalty on the earnings. So you have an exit strategy problem if Junior doesn't go to college; or does go, but doesn't graduate. Something like 1/3 to 1/2 of all college freshman do not graduate. If you save for college expenses in an inexpensive taxable account, you have no exit strategy problem and may even come out ahead.
A 529 Plan is a good idea if you can find one with low costs. You can search for low cost 529 Plans at www.savingforcollege.com. Among the plans that appear to have low costs are the Utah Educational Savings Plan Trust, the Virginia Education Savings Trust, the South Carolina Future Scholar 529 College Savings Plan (Direct-sold), and the New York 529 College Savings Program--Direct Plan. Note that you don't need to be a resident of a state to participate in its 529 plans. Also, you have to contact each of these states directly to open an account--these plans are not sold by brokers (which probably accounts for much of their low costs, since no one gets a commission for selling you one).
Finding Coverdell accounts with low costs tends to be easier than it is for 529 Plans, since you can open a Coverdell with a wide array of financial institutions. One downside of the Coverdell account is that you can only contribute $2,000 a year (the 529 Plan's limit is $12,000--or $24,000 for a married couple--a year). Also, the Coverdell can only be used by people subject to certain income limits. The Coverdell has a severe exit strategy problem: if the account assets aren't used for educational purposes by the time the child who is the beneficiary of the account is 30, the child gets the remaining assets (subject to payment of state and federal income taxes and a 10% penalty on the earnings). You don't get any of the money back for your retirement or any other purpose.
Persons having incomes below $78,100 if they're single, or $124,700 if they're married filing jointly, may be able to avoid paying some or all of the taxes due on the interest income of U.S. Savings Bonds that is used for college expenses. So U.S. Savings Bonds actually provide a tax shelter for college savings for persons meeting the income requirements. Since Savings Bonds can also be used to fund your retirement, they don't have an exit strategy problem. They're also simpler than 529 Plans and Coverdell accounts.
The tax sheltered plans--529 and Coverdell--also require extra work at tax time, especially when your taking money out to pay for educational expenses. If you're concerned about the downsides of 529 Plans and Coverdells, just save for college expenses in low cost taxable investments like well-diversified mutual funds or U.S. Savings Bonds.
Seafood Lovers: Fishy things are happening at restaurants. Order the cheapest fish on the menu, because that's what you might be getting anyway. Here's why: http://abcnews.go.com/GMA/Consumer/story?id=3171346&page=1&CMP=OTC-RSSFeeds0312.
That being the case, they should be aware of some of the pitfalls and downsides of saving for college expenses. The 529 Plan and the Coverdell account are heavily promoted today, especially the 529 Plan. Both a 529 account and a Coverdell account offer tax advantages--the money you put into them isn't tax deductible, but the earnings are not taxed if they are used to pay college expenses. Coverdell accounts can also be used to pay primary school expenses. Some states offer deductions from state income taxes to their residents who open an account in a 529 Plan offered by that state.
However, there are the downsides, which you not hear much about. Each 529 Plan has only a limited number of investment options. The plan itself, and the investment options, may impose high costs and fees on your account (as much as 3% per year in some cases). That's a hefty burden. Even with the tax shelter offered by the 529 Plan, fees at that level seriously reduce your long term returns. If you compare an expensive 529 Plan against an inexpensive taxable account (one where you pay taxes on realized investment gains each year), the inexpensive taxable account can produce greater wealth.
Another problem with 529 Plans is that if the money in your 529 account isn't used for college expenses, you can retrieve it only after paying state and federal income taxes, and a 10% penalty on the earnings. So you have an exit strategy problem if Junior doesn't go to college; or does go, but doesn't graduate. Something like 1/3 to 1/2 of all college freshman do not graduate. If you save for college expenses in an inexpensive taxable account, you have no exit strategy problem and may even come out ahead.
A 529 Plan is a good idea if you can find one with low costs. You can search for low cost 529 Plans at www.savingforcollege.com. Among the plans that appear to have low costs are the Utah Educational Savings Plan Trust, the Virginia Education Savings Trust, the South Carolina Future Scholar 529 College Savings Plan (Direct-sold), and the New York 529 College Savings Program--Direct Plan. Note that you don't need to be a resident of a state to participate in its 529 plans. Also, you have to contact each of these states directly to open an account--these plans are not sold by brokers (which probably accounts for much of their low costs, since no one gets a commission for selling you one).
Finding Coverdell accounts with low costs tends to be easier than it is for 529 Plans, since you can open a Coverdell with a wide array of financial institutions. One downside of the Coverdell account is that you can only contribute $2,000 a year (the 529 Plan's limit is $12,000--or $24,000 for a married couple--a year). Also, the Coverdell can only be used by people subject to certain income limits. The Coverdell has a severe exit strategy problem: if the account assets aren't used for educational purposes by the time the child who is the beneficiary of the account is 30, the child gets the remaining assets (subject to payment of state and federal income taxes and a 10% penalty on the earnings). You don't get any of the money back for your retirement or any other purpose.
Persons having incomes below $78,100 if they're single, or $124,700 if they're married filing jointly, may be able to avoid paying some or all of the taxes due on the interest income of U.S. Savings Bonds that is used for college expenses. So U.S. Savings Bonds actually provide a tax shelter for college savings for persons meeting the income requirements. Since Savings Bonds can also be used to fund your retirement, they don't have an exit strategy problem. They're also simpler than 529 Plans and Coverdell accounts.
The tax sheltered plans--529 and Coverdell--also require extra work at tax time, especially when your taking money out to pay for educational expenses. If you're concerned about the downsides of 529 Plans and Coverdells, just save for college expenses in low cost taxable investments like well-diversified mutual funds or U.S. Savings Bonds.
Seafood Lovers: Fishy things are happening at restaurants. Order the cheapest fish on the menu, because that's what you might be getting anyway. Here's why: http://abcnews.go.com/GMA/Consumer/story?id=3171346&page=1&CMP=OTC-RSSFeeds0312.
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