State Tuition Programs: Golden State Scholarshare College Savings Trust

By Anil Deora

A growing number of states are sponsoring tuition savings programs (also known as "529 plans" based on the Internal Revenue Code section that created qualified state tuition programs) that offer tax-deferred growth of earnings and the flexibility to use the savings to pay for a wide range of qualified higher education costs at eligible schools anywhere in the country.

Qualified state tuition programs are one of the hottest ways to save for higher education costs. These state-sponsored investment programs provide a tax-favored approach for saving for education. Federal and state taxes on earnings are deferred until the money is withdrawn for qualified education expenses -- instead of being taxed on a year-to-year basis.

Qualified withdrawals are treated as the student's income, and federal taxes are paid at the student's rate. Most states don't impose any taxes on qualified withdrawals. However, there are taxes and a federally-imposed penalty (generally 10 percent) on withdrawals used for purposes other than qualified education costs.

The Golden State ScholarShare College Savings Trust:

The Golden State ScholarShare College Savings Trust was launched on October 4, 1999, and is designed to offer an opportunity to invest and save for college or other higher education expenses on a tax-advantaged basis.

The Program, features both federal and state tax-deferred growth on earnings in ScholarShare Accounts, which can result in tens of thousands of additional dollars in savings. When the savings are eventually used to pay college costs, taxes will be paid at the beneficiary's (student's) income tax rate, which will likely be lower than that of the Account owner.

Under the Golden State ScholarShare Trust, you open an Account on behalf of a designated beneficiary. The money you contribute to the Account is placed in a trust, which will invest in special investment portfolios designed to meet the needs of differently aged beneficiaries. The portfolios combine stocks, bonds and money market instruments. For younger beneficiaries, allocations are weighted more heavily toward equities, and as beneficiaries become older, allocations are weighted more heavily toward bonds and money market instruments.

Earnings in a Golden State ScholarShare Account will grow on both a federal and state tax-deferred basis until your beneficiary is ready to go to college. Then, the funds in the Account can be used to pay for qualified higher education expenses at eligible schools in California or anywhere in the country.

You can open a ScholarShare Account for any beneficiary (even someone who is not a relative) for as little as $15. Contributions can be made in any number of easy ways. And all earnings on those contributions grow tax-deferred on both federal and state levels until they're used for qualified higher education expenses. Then they're taxed at the designated beneficiary's tax rate.

Some advantages of contributing to a Golden State ScholarShare Account include:

There are no income limits: Unlike the Education IRA, anyone at any income level can contribute to ScholarShare. Earnings on the contributions are tax-deferred: You don't pay taxes on the earnings from your contributions until the money is withdrawn. With other types of vehicles, like savings accounts or mutual funds, you have to pay tax on earnings every year. When money from the ScholarShare Account is withdrawn to pay for qualified higher education expenses, the taxes are based on the beneficiary's tax rate, which is usually much lower than yours. Low minimum contribution amount and easy automatic payments: Unlike investments that require an initial contribution of hundreds or thousands of dollars, ScholarShare allows you to open an Account with as little as $15 per Account per pay period when you use payroll deduction. Minimum Contribution: You can open a ScholarShare Account with a regular minimum contribution of $15 per pay period through payroll deduction at participating employers. If you open an Account using a check, money order, electronic funds transfer, or automatic withdrawals from your bank account, your initial and subsequent contributions can be as low as $25. Maximum Contribution: Each designated beneficiary in the ScholarShare Trust has a maximum contribution limit that applies to all Accounts opened for him or her. Maximum contribution limits are based on the beneficiary's age, and the estimated costs for the highest-cost California higher education institution for the year that the beneficiary would normally enroll.

In setting these contribution limits, the ScholarShare Trust will: (1) determine the year in which people the same age as the beneficiary would normally attend college; (2) estimate the present value of college costs for four years at the most expensive institution in the State of California; (3) using the difference in projected earnings and projected inflation in college costs, calculate the maximum investment in today's dollars that can be allowed so that the Account does not exceed the projected future cost of attending college. The investment limits will be reviewed and recalculated each year to reflect the most recent data for college costs and investment yields. (Because the calculations are based on estimates, no assurance can be given that the amount held in an Account(s) for any beneficiary, even if the maximum contribution limit is met, will be sufficient to pay the qualified higher education expenses of the beneficiary.) Educational Institution: Payment from a Golden State ScholarShare Account can be made to virtually any eligible educational institution in the country.

Expenses Covered: The program is designed to pay for qualified higher education expenses, including tuition, fees, supplies, certain room and board costs, books, and equipment required for enrollment or attendance at an eligible undergraduate, graduate, or professional institution of higher education, or at an approved vocational/technical school. Cost: You pay no application fees, no sales charges and no annual fees for your ScholarShare Account. An asset-based fee of 0.70% is paid from the overall investment portfolio of the Trust to cover the fee of the Program Manager, and a fee of up to 0.10% is paid to cover the cost of Trust administrative services and oversight.

Beneficiary: Any adult or emancipated minor can open a Golden State ScholarShare Account on behalf of any designated beneficiary. The Account owner may designate anyone he or she chooses as the beneficiary, including himself or herself. And multiple Accounts can be set up for the same beneficiary by different people, as long as the beneficiary's maximum contribution limit is not exceeded.

There are no restrictions based on age, relationship to the Account owner, or state residency of either the Account owner or the beneficiary. The tax benefits are not contingent on the beneficiary being a dependent of the Account owner. Each Account can have only one designated beneficiary. You must establish a separate Account for each of your children or other beneficiaries

There are no restrictions on when an Account can be opened. Of course, the earlier the Account is opened, the more time there will be to make contributions before the funds are needed. However, when an Account is first opened, there is a twelve-month waiting period before funds can be distributed for higher education expenses without a 10% penalty on the earnings portion of the distribution. ScholarShare Account and eligibility for financial aid: Your eligibility for aid will depend on your family's financial circumstances at the time your child enrolls in a post-secondary institution. Approximately 6% of a parent's assets and 35% of a student's assets are considered in the formula for determining financial aid eligibility. Funds in qualified state tuition programs, like ScholarShare, may be considered to be an asset of the Account owner.

Tax Treatment of withdrawals for qualified higher education expenses:

Income earned on contributions to Accounts will be subject to federal and state income tax at the beneficiary's tax rate when withdrawn for payment of the beneficiary's qualified higher education expenses. The student or the student's parent may claim a Hope Scholarship Credit or Lifetime Learning Credit for tuition and related college expenses covered by a qualified state tuition program, provided the other eligibility requirements for the credits are met. However, if contributions are made to both Education IRA and ScholarShare in the same year and for the same beneficiary, the amounts contributed to the Education IRA will be subject to a federal excise tax. Caution: Neither contributions nor investment returns in your Account are guaranteed. Investment results may vary based on market performance. Your options, if the beneficiary you designate on the Account decides not go to college or does not finish college:

* A "member of the family" (as defined for tax purposes) of the current beneficiary can be designated as the new beneficiary.

* Funds may be left in the Account for the current beneficiary in the event he or she returns to school. (However, the Account must be closed no later than 10 years after the beneficiary turns 35; and if the beneficiary is age 35 or older when designated, there is a time limit of ten years for the funds to be used before the Account must be closed and all funds disbursed.)

* Funds may also be withdrawn for purposes other than the payment of qualified higher education expenses (i.e., a nonqualified distribution), but then the earnings portion of the withdrawal will be subject to federal and state income tax at your (not the beneficiary's) tax rate and will be subject to a 10% penalty as well. If the distribution is made due to the death, disability of, or scholarship award to the beneficiary, federal and state income tax would be owed, but the 10% penalty would not be levied.

If you move to another state, you can still maintain a ScholarShare Account balance. Also, you can keep contributing money to the Account and continue to enjoy the federal tax benefits. The tax consequences in your new state of residence may differ from the tax consequences in California. Annual and quarterly statements will be provided to Account owners reflecting activity in their Accounts.

Since the Golden State ScholarShare College Savings Trust has only been launched a few days ago, this article is only a summary and does not provide all material information. For more information, contact Toll Free 1-(877)-SAV 4 EDU (728-4338), 5am-6pm PT, or visit http://www.scholarshare.com. State Tuition Programs in Other States: In addition to California, some other states such as Arizona, Colorado, Connecticut, Delaware, Indiana, Iowa, Kentucky, Massachusetts, Minnesota, Missouri, Montana, New Hampshire, New York, Rhode Island, Tennessee, Utah and Vermont, also offer qualified state tuition savings programs. Unlike California, some states also give you a state income tax deduction for what you contribute to the program. It may therefore benefit you and your beneficiary to see which state's plan would serve your needs better.

Disclaimer: Most of the time the general rule is stated, but there may be exceptions or certain conditions to be met before the general rule can be applied. The information in this article SHOULD NOT be acted upon without first checking with a professional to determine its applicability to your situation.

(c) Copyright Anil Deora 1999.

Anil Deora, B.Sc., B.L., MBA is a Management Consultant and Registered TaxPreparer based in the Bay area. He can be reached at Tel: (408)-865-0700. email: deora@rightskills.com. Please see this and other articles at www.indzine.com/adeora/taxes