PERSONAL FINANCIAL PLANNING

January 2000

NEW YORK COLLEGE SAVINGS PLAN HAZARDS

By Joseph F. Hurley, CPA, Bonadio & Company LLP

New York's College Savings Plan was launched in the fall of 1998 as an IRC section 529 qualified state tuition program. (See "College Tuition and Savings Programs," CPA Journal, July 1999.) Offering Federal tax deferral of earnings, a New York State income tax deduction for contributions, and New York State exemption of earnings, the program got off to a fast start. In its first year of operations, more than 60,000 accounts were established and $215 million contributed.

Caveats

Those who have opened or are interested in opening a New York College Savings Plan account should be aware of some potential pitfalls. For example, an individual may fund a beneficiary's account with up to $100,000 but can deduct only a maximum of $5,000 in contributions each year. Additionally, the entire amount of a nonqualified distribution (i.e., a distribution not used to pay for higher education costs) in a future year is recaptured into New York taxable income. This means that the individual who contributes $200,000 for two children in year one but revokes the accounts in year two has to recognize their full value in New York income against having taken only $5,000 as a deduction in the prior year.

Another aspect of the New York program that may be of concern to some is that account ownership cannot be transferred unless the donor becomes incompetent or dies. A grandparent interested in opening an account for a grandchild might want to transfer the responsibilities of account ownership to the child's parent in a future year. This does not appear possible without devising a tax-free rollover transfer involving a switch of beneficiaries.

Furthermore, upon the donor's death, account ownership is passed by will or the state laws of intestacy. This can create significant uncertainty if specific provisions concerning the transfer of account ownership are not contained in the donor's will. It is hoped that New York will change its laws to allow the donor to designate a successor owner on the account application, as most other states do.

A number of negative comments have been directed at New York's College Savings Plan concerning the relatively low investment return achieved in the first year by program manager TIAA-CREF. TIAA-CREF admittedly takes a conservative approach in its age-based asset allocation models, and investment performance has suffered through much of 1999 in comparison to states with a more aggressive approach. (A state law restricting the equities weighting has also hampered performance, although the restriction will loosen over time.) Long-term results should be what counts, however, in judging TIAA-CREF's ability to help program participants invest for college.

A larger concern should be the possibility that New York politicians will have a knee-jerk reaction to investment performance and attempt to substitute their judgment for that of the professionals at TIAA-CREF. Section 529 offers tremendous tax benefits for the college saver, who should be sure to consider these plans. However, it is important to understand all the features of a particular state's program before investing in one. Many states have section 529 plans open to nonresidents. The Exhibit lists the states that offer them, grouped by program manager. Note that plan features may vary considerably among states sharing the same program manager. For a complete rundown, visit http://www.savingforcollege.com. *