529 College Savings Plans: State-by-State Tax Benefit Comparison

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When choosing a 529 college savings plan, you’ll often have to weigh any in-state benefits with the superior investment options from an out-of-state plan. Every state seems to have their own unique combination of tax deductions and/or matching grants. Morningstar ran an analysis comparing the home-state tax benefits for a hypothetical family saving for college.

We selected a hypothetical family of four that earns $50,000, or close to the national median household income. In our scenario, the family has two children and contributes $100 per month to each child’s 529 account, for a total contribution level of $2,400 per year. We looked at the state tax benefits as of October 2014 and calculated the dollar value for each plan.

Here is a chart of their results (click for original image):

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Keep in mind that tax benefits can change, as can the quality and cost of each state’s 529 plan. An expensive plan can switch administrators and transform into a cheap plan the next year. A cheap plan usually stays that way, although it might get a little more expensive. Some states let you grab the tax deduction and then immediately roll over the assets to any outside plan; other states “recapture” the tax deduction if do you that.

Charts: Average New Car Price vs. Average Student Loan Debt 1990-2014

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When I was a senior in high school, I still remember my parents offering me a new luxury car instead of tuition assistance. Although I’m pretty sure it was only a test, it did serve to remind me of the cost of tuition and not to waste it. Seeing the average student debt of graduates is now over $30k, I wanted to see how the price of a new car and student debt tracked. These are the best charts that I could fine.

The green line in the first chart tracks the average cost of a new vehicle as rising from ~$15,000 to ~$27,000, within the time period of 1990 to present. I don’t believe the green line is inflation-adjusted. You can see it runs from roughly $15,000 to roughly $27,000. (Source: Atlantic)

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The second chart below tracks the average student debt upon graduation over basically the same timeframe, 1990 to present. The non-inflation-adjusted value has risen gone from ~$9,000 to ~$33,000. (Source: WSJ)

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It is hard to equate the two values because student debt is just the amount left over after the parent (usually) pays as much as they can while the student is in school. However, this USA Today article suggests that since 2010 parents on average have been paying less.

Five years ago, only half of families reported using grants and scholarships to pay for college. This year, two-thirds of families did, the study shows. [...] Meanwhile, parents are contributing less of their income and savings toward college costs, covering 27% of college costs compared with 37% in 2010, the study shows.

At the same time, other reports show that for parents with top 20% incomes, education spending has nearly doubled as a share of their total budget.

Average student debt is definitely growing faster than new car price. But in terms of total size, it is still comparable to the cost of a new car. People finance new cars all the time. Does that make student loans less scary? I don’t know, because financing a new car has always scared me a lot too.

Even after taking the tuition assistance from my parents, I still came out of college with roughly $30,000 in student debt myself, above-average at the time. I like to think that I got better value of my degree than a new car. :)

College Tuition Hasn’t Risen As Much As You Think

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gradcapThe new fall semester is underway, which means more college articles! Morgan Housel of Fool.com recently talked about how the increasing cost of college is exaggerated (emphasis mine):

According to the College Board, the annual sticker price of attending a private four-year college increased from $17,040 in 1992 to $29,060 in 2012, adjusted for overall inflation. But grants and scholarships more than doubled during that period. On net, the median annual cost of attending private college went from $10,010 in 1992 to $13,380 in 2012, meaning the amount students actually paid grew half as fast as the sticker price suggests.

Ditto for public four-year schools. The sticker price of tuition was $3,810 in 1992, and $8,660 by 2012, adjusted for overall inflation. That’s a gain of 4.2% per year. But the actual amount students paid went from $1,920 to $2,910, or an annualized gain of 2%. Adjusted for grants, the inflation-adjusted cost of two-year college has actually declined over the last 20 years.

Why would schools balloon the sticker price but make it up with scholarships? A lot of it is marketing. If I say, “Billy, tuition is $20,000 a year,” it sounds high. If I say, “Billy, tuition is $40,000 a year, but we’ll give you a scholarship to bring it down to $20,000,” it’s an offer he can’t refuse. There’s also a rich student, Jimmy, whose parents will pay $40,000 without batting an eye. Jimmy is actually making Billy’s scholarship possible.

By those numbers, the cost of 4-year public college grew at 2% annually above inflation over that 20 year period, while the cost of 4-year private college grew at 1.5% annually above inflation.

The average student debt is roughly $30,000, about the price of the average new car. As Jim of the FreeBy50 blog points out, only a tiny 0.3% of graduates end up with over $100,000 of student loan debt. Any media piece about a struggling student with a six-figure student loan is an outlier.

Now, I’m not saying there aren’t problems. For one, the wages of new graduates are stagnant. But the sky is not falling.

Increasingly, parents should look at listed tuition prices like the sticker price of a car. It’s just a starting point for negotiations. Colleges, especially private colleges, can easily adjust what they actually charge per student based on two variables:

  • Their financial situation, using need-based aid.
  • Their desirability as an applicant, using merit-based aid.

Universities have all sorts of financial aid tricks to adjust actual out-of-pocket costs… various grants and scholarship funds that they can draw from, work-study guarantees, comped room & board, and so on. You can even negotiate your aid package with them further after getting your acceptance letter.

In fact, the industry term is tuition discount rate, which measures the upfront tuition discount given directly from private universities, thus excluding outside scholarships, tax breaks, or subsidies. The NACUBO tuition discount rate for 2013 was 45% and had risen every year for the previous 7 years.

If Billy is a somewhat borderline applicant and his parents have a high income, he’ll may get accepted but must pay full sticker price. If Billy is a very strong applicant, he may get accepted with a partial or full scholarship regardless of income.

This is why parent shouldn’t automatically just tell their kid to go to a state public school. If your child finds the right fit, they could go to private school for close to or less than the cost of public. Many households with modest income and financial assets will be offered substantial grants. Of course, you have to be ready to say “no” if your kid gets in without any aid, meaning the total cost is more than a house (my personal fear!).

Effect of Student Loan Debt on Homeownership Rate

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Multiple sources are suggesting that increasing student loan debt levels will have a significant impact on future housing prices because people will delay their home purchases (or put them off entirely). Although that seems like a reasonable assumption, I haven’t actually seen any hard data on it.

In a recent Vanguard research paper titled No bubble to burst: U.S. student debt is not housing [pdf], they took data from the Federal Reserve’s 2010 Survey of Consumer Finances and U.S. Census Bureau and found that:

Although financing a bachelor’s degree with student debt decreases the likelihood of a typical 30-year-old college graduate purchasing a home by –1.7%, obtaining that degree also increases the likelihood of purchasing a home by 10.8%, relative to not attending college at all.

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In the end, the conclusion seems to still be consistent with other findings. Getting that college degree is still “worth it” financially, even with the accompanying debt, at least on average. Your income is higher, you’re less likely to be unemployed, and you are more likely to own a home.

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I suppose the primary thing to avoid is to not be above average on the debt. If you have to take on $120,000+ of debt just to get a 4-year degree, you’re probably going to the wrong school anyway. If the school really wanted you, they’d offer you a better aid package with grants and/or tuition waivers.

Tennessee Offers Free 2-Year College Tuition for All High School Graduates

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collegeTennessee lawmakers recently approved a program that would cover tuition and fees at two-year colleges for any high school graduate. The “Tennessee Promise plan” is the first of its kind in the U.S., although reportedly Florida, Mississippi, and Oregon are considering similar plans. It will be interesting to see if it succeeds in making higher education more affordable.

Participants will have to maintain a 2.0 grade point average, attend mandatory meetings, work with a mentor, and perform community service. The program is also “last money in” after other scholarships and grants. I hope that they will also make sure that any credits earned will transfer over to 4-year universities and that the courses are rigorous enough that the students don’t arrive at a significant disadvantage. If successful, this could essentially halve the cost of a in-state Bachelor’s degree, as most students will be able to live at home for the first 2 years as well.

I went to a well-respected public university, and while there got to know several community college transfer students as both an undergrad and graduate student instructor. As a whole, I found them to be much more hard-working and excited about their studies. I don’t have hard numbers but I’d be willing to bet that the junior transfers actually got better grades than those of us who entered as freshman. (Obviously those who got accepted as transfers were a selected group, not representative of all community college students. They also tend to be older, which can help with maturity.)

Free community college may also reduce the significant number of people who enroll at a 4-year university, rack up student loan debt, and don’t finish. According to this Slate article, 20% of those who enroll full-time at a 4-year program don’t finish within 6 years. Community colleges can also have low completion rates, but it is especially awful to have no degree and a big pile of debt.

Also related: We know student loan debt is growing, but now delinquency rates are increasing as well.

Daycare Costs vs. In-State College Tuition

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There are many articles about rising college tuitions and how to best save for college. But according a recent study, in 31 states the annual cost of day care for an infant exceeds the average cost of in-state tuition and fees at public colleges. From this WaPo article:

We accept that it typically takes 18 years to sock away a sizeable-enough college nest egg. Considering that child care is an equivalent, if not greater, expense and that the average maternal age at first child birth is 26, this suggests that we should similarly start putting money away for day-care expenses when we’re roughly 8 years old.

Here’s the state-by-state breakdown:

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Can You Ace This 3-Question Financial Literacy Quiz? – Only 1/3 of Americans Surveyed Did

There is a lot of policy talk about increasing financial literacy in order to improve people’s decision-making. The Conversable Economist blog discusses a paper that digs into this subject, called “The Economic Importance of Financial Literacy” (found via Counterparties). In order to measure current levels of financial knowledge, a very short survey was conducted on a nationally representative group of Americans age 50+ to. Only 34% of respondents answered all three questions below correctly:

Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow:

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Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After 1 year, would you be able to buy:

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Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”

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The first question measures numeracy or the capacity to do a simple calculation related to compounding of interest rates. The second question measures understanding of inflation, again in the context of a simple financial decision. The third question is a joint test of knowledge about ‘stocks’ and ‘stock mutual funds’ and of risk diversification, since the answer to this question depends on knowing what a stock is and that a mutual fund is composed of many stocks.

If you’ve been following this subject, sadly this isn’t be a surprise. Many similar tests confirm that the level of financial literacy in the U.S. is low. There is a lot of debate about the best way to solve this problem, from high school classes to adult education programs. Nothing has been found to be all that great (so far).

My take is that we should continue working on financial education as there is a lot of room for improvement, but also consider that many poor financial decisions can’t be solved by learning some definitions. The root cause is often a lack of non-academic skills like self-control, ability to delay gratification, and persistence. Most people know that they should spend less and save for the future. They just don’t necessarily do it.

College Tuition Growth Rate vs. Stock / Bond Investment Performance

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Inside this Morningstar article discussing the choice between a prepaid 529 plan or a 529 college-savings account, there was an updated chart comparing the 10-year growth rates of tuition at 4-year public and private universities, the S&P 500 index, and the Barclays US Aggregate Bond index. A blended 60% stock and 40% bond portfolio would have returned 6.34% annualized.

There used to be some great prepaid 529 options out there, but they have been gradually going away. Only a few states even offer a prepaid plan anymore (Alaska, Florida, Illinois, Maryland, Michigan, Massachusetts, Mississippi, Nevada, Pennsylvania, Texas, Virginia, and Washington). I’m not familiar enough to recommend any one in particular, but I do know people who still invest in both the Washington and Texas plans. You should look for one that provides at least some investment return if the student ends up going to an out-of-state school.

For many of us the traditional stock/bond route will have to do, which we see would only have just about kept up with tuition inflation over the least 10 years. I still can’t see tuition compounding away at 8% annually for the next 20 years, but I will probably make my 529 contributions under the assumption that a 60/40 stock/bond portfolio will only keep up with tuition over the long-term (as opposed to contributing less and hoping stock performance will cover the gap).

Consistently Top-Rated 529 Plans: Morningstar Gold and Silver Ratings 2010-2013

Investment research firm Morningstar rates 529 plans in their annual “529 College Savings Plans Research Paper and Industry Survey”. They recently announced their top plans from the 2013 survey, although it appears the full study and state-specific analyst reports are only available in their paid Premium section. Below, I have listed all of the top-rated plans from each of the 2010-2013 survey years, including which plans were consistently top-rated all four years.

Morningstar now uses a Gold/Silver/Bronze rating scale for the top plans and Neutral/Negative for the rest. (In 2010 and 2011, they employed the same methodology but used Top, Above Average, Average, Below Average, and Bottom. Top is now broken up into Gold and Silver, and Above Average is now Bronze.) The criteria include five P’s:

  • People. Who’s behind the plans? Who are the investment consultants picking the underlying investments? Who are the mutual fund managers?
  • Process. Are the asset-allocation glide paths and funds chosen for the age-based options based on solid research? Whether active or passive, how is it implemented?
  • Parent. How is the quality of the program manager (often an asset-management company or board of trustees which has a main role in the investment choices and pricing)? Also refers to state officials and their policies.
  • Performance. Has the plan delivered strong risk-adjusted performance, both during the recent volatility and in the long-term? Is it judged likely to continue?
  • Price. Includes factors like asset-weighted expense ratios and in-state tax benefits.

Consistently Top-Rated Plans 2010-2013

  • T. Rowe Price College Savings Plan, Alaska
  • Maryland College Investment Plan
  • Vanguard 529 College Savings Plan, Nevada
  • CollegeAdvantage 529 Savings Plan, Ohio
  • CollegeAmerica Plan, Virginia (Advisor-sold)

Gold and Silver-Rated Plans 2013 (source)

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Fidelity 529 College Savings Plan Index Portfolios & Fee Reducton

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Fidelity Investments recently made a 40% reduction on the management fees for their direct-sold 529 Index Portfolios, with total expense ratios now ranging from 0.19-0.29%, down from 0.25-0.35%. Fidelity runs 529 plans based in New Hampshire, Massachusetts, Delaware, and Arizona. From the press release:

The index portfolio fee reduction applies to all Fidelity-managed direct-sold plans including The UNIQUE College Investing Plan, Fidelity’s nationally distributed plan, offered by the State of New Hampshire; the Massachusetts’ U.Fund® College Investing Plan; the Delaware College Investment Plan; and the Fidelity Arizona College Savings Plan. Total fees for the 529 Index Portfolios, including underlying mutual fund expenses, now range from 0.19 percent to 0.29 percent of assets, down from 0.25 percent to 0.35 percent. Unlike several competitor plans, all Fidelity direct-sold 529 college savings plans continue to have no annual account fees, low-balance fees, or fees to receive paper statements.

This should also serve as a reminder that Fidelity does offer low-cost index options in addition to their (inferior in my opinion) higher-cost actively-managed portfolios. The choices can be confusing – for example their “Portfolio 2030 (Fidelity Funds)” has a total expense ratio of 1.01%, whereas their “Portfolio 2030 (Fidelity Index)” has a total expense ratio of just 0.25%. You can change your investment option by sending in a form, usually limited to once a year unless you change beneficiaries.

Here is a screenshot of all the Index portfolio options and fee breakdown.

I think people are getting more aware of the impact of fees on performance, and this move makes Fidelity’s plans more competitive with other top 529 plans. See rankings by Morningstar and SavingforCollege.com.

There are also Fidelity-branded credit cards that credit 1.5% cash back (Visa) and 2% cash back (American Express) towards any Fidelity account. I choose to have mine directed to a 529 account, specifically their New Hampshire UNIQUE plan which they advertise as their national plan (you can live in any state, but your state’s plan may have better tax perks). I have also opened plans from Utah (lowest costs, flexible options) and Ohio (inflation-protected bonds as investment option) for my new kiddo and deposited her birthday gifts there.

Free Online Finance and Retirement Planning Course from Stanford

Stanford University is offering a free open online course “Finance of Retirement & Pensions” taught by Joshua Rauh, Professor of Finance, running 10/14-12/13. Here’s the course description and a video:

In this eight-week course, you will learn the financial concepts behind sound retirement plan investment and pension fund management. Course participants will become more informed decision makers about their own portfolios, and be equipped to evaluate economic policy discussions that surround public pensions. The course begins with the principles of financial economics, such as the distribution of outcomes when investing in stocks, bonds, or annuities. These serve as the building blocks for an understanding of different retirement strategies that can help you improve your asset allocation. Finally, the course applies these principles to government programs and policies.

This MOOC looks a bit more focused, a bit more advanced, and also more interactive than the previous Coursera personal finance course I signed up for.

There is no actual course credit earned, but there is a competition at the end of the class where the top 5 teams with the best ideas for pension reform will get to present them at the Stanford Graduate School of Business, all expenses paid! Via NY Times.

Stat of the Day: Tuition Discount Rate

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Right now, freshmen are moving into dorms all around the country and parents are scrambling to pay the bills. I’ve written about how many students don’t pay sticker price on college tuition, but I recently ran across another statistic that tracks the phenomenon. It’s called the tuition discount rate. The version compiled by the National Association of College & University Business Officers (NACUBO) uses this definition:

Tuition Discount Rate: Institutional grant dollars as a share of gross tuition and fee revenue for first-time, full-time freshmen [...] gathered from 400 private, nonprofit four-year colleges and universities

Basically, this measures the upfront tuition discount given directly from private universities, thus excluding outside scholarships, tax breaks, or subsidies. The NACUBO tuition discount rate for 2012 was 45% and has risen every year for the last six years. From digging around their website, from 1990 to 2002 the average tuition discount rate increased from 26.7 percent to 39.4 percent. Then things stabilized somewhat until it started rising again in 2007. In rough numbers, over the last 15 years the discount rate doubled from 25% to 50%.

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