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Financing a college education in a struggling economy
Written by Chuck Stanley   
Monday, 23 February 2009 16:58
New Jersey’s budget woes and continuing recession mean more trouble for higher education and for the students and families who bear the brunt of rising tuitions and costs. State budget cuts have effectively put public higher education in New Jersey on the ropes for going on two decades.

The federal situation has been just as punishing: almost a decade of reductions in direct federal aid in the form of Pell grants, higher interest rates for federal loans, more reliance on private borrowing at even higher rates, and now the all-too-obvious problems for credit markets.

chuck_stanley
Chuck Stanley

The federal fiscal stimulus package will fund more direct student aid, and cut federal loan rates. In addition, Governor Corzine’s Administration has worked to improve the availability of State Tuition Aid Grants and other supports for students in need. But that good news won't change the fact that real costs at New Jersey colleges and universities are expected to rise at well above the inflation rate for some time.

All the more reason students and families should do all they can now to prepare for higher education costs on their own. As with most things, appropriate planning can make the difference.

For many families, 529 plans are prudent and effective means to save for future college costs. A 529 Plan is an education savings plan operated by a state or educational institution. 529 plans offer unsurpassed income tax breaks. Although contributions are not deductible on your federal tax return, your investment grows tax-deferred, and distributions to pay for the beneficiary's qualified college costs come out federally tax-free.

New Jersey is somewhat unique in that either the account owner or account beneficiary must be a state resident in order to open a 529 account here. Most state plans allow out-of-state residents to participate in their 529 plans, and New Jersey might want to reconsider its 529 parochialism given the fact that we lose more of our high school seniors to schools in other states than any other.

Since most other states do allow out of state residents to participate in their 529 plans, the question for most families becomes, which 529 plan best suits my needs? It can be a difficult question to answer as these plans evolve constantly and tracking rule changes and requirements can be complicated.

From my perspective there are several important factors – aside from the tax benefits mentioned above – that you should focus on when selecting a 529 plan.

Initially, you should determine if there is any immediate state tax benefit associated with the plan. Many states offer tax breaks for 529 plans, like an upfront deduction for your contributions or income exemption on withdrawals. Unfortunately, New Jersey is not one of them.

As with all investment, you should also understand the various investment vehicles offered through the plans you’re reviewing. Plans that provide the flexibility of both age-based portfolios and individual investment options allow you to choose between hands-on and hands-off approaches.

An age-based portfolio should provide a diversified group of investment options that automatically changes its portfolio objective from capital appreciation to capital preservation as the beneficiary approaches college. Age-based portfolios are best for clients who prefer not to review the performance of the plan and won’t commit to an annual review by a financial professional.

For those clients who are committed to an annual review of their financial plan, the assembly of a well-diversified portfolio of individual funds is recommended. An annual review allows your advisor to rebalance your portfolio as the beneficiary ages, as well as make adjustments due to changes in market conditions.

Consider the fees associated with the investment options in the plan, and/or fees that the plan itself imposes on the accounts. The internal fees of the investment options will directly impact the investment performance of the account. Small differences in fees – even one half of one percent – can make a significant difference in your account balance over time.

You can reduce fee exposure by utilizing passively managed investment options within the plan. Passively managed options typically have much lower fees because they are designed to match the composition and performance of established indexes, like the S&P 500, for example. Since low levels of trading are associated with a passive index vehicle, costs are invariably lower.

The NJBEST plan features an age-based allocation investment plan, an objective based investment allocation plan and two individual portfolios.

NJBEST’s age based allocation plan consists of nine actively managed Franklin Templeton Mutual funds, including a money market fund.

While I am personally a fairly aggressive investor, I would be concerned with their age-based plan’s aggressive asset allocation, with the Beneficiary having a 50% equity exposure only two years before entering college.

The NJBEST objective based investment allocation plan consists of four distinct objectives, constructed from twelve actively managed mutual funds, including nine of the funds from the age based allocation plan.

The funds in both the age-based and objective based portfolios are actively managed. Not surprisingly, the fees are higher than the passively managed funds available in some other state plans. The fees, while not egregiously high, over a longer time horizon, act as a headwind to your account appreciation. I also wish the portfolios provided a higher degree of diversification, providing exposure to widely accepted alternative asset classes.

NJBEST also features two individual investment portfolios, neither of which we recommend as a standalone option. One we find too conservative for beneficiaries with long investment time horizons, and the other by itself offers insufficient diversification.

One fairly unique feature of New Jersey’s plan is the monetary scholarship that is awarded to the plan beneficiary if certain guidelines are met. The guidelines are not difficult to meet, but state funding of the scholarships is contingent on legislative appropriations, which may be of reasonable concern given the fact and history of our state budget.

Chuck Stanley, is a Fee-Only financial planner with Main Street Financial Solutions, LLC in Pennington, NJ. He can be reached at 609-730-9222 or This e-mail address is being protected from spambots. You need JavaScript enabled to view it .

 

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