Education planning is often a component of the financial plans we develop for our clients. Residents of South Carolina should be aware of the advantages and shortcomings of our state’s 529 college saving program. It is often hard to find the information you need to make an informed choice when confronted by a prospectus that has as many supplements as original pages, so we offer this synopsis to help you understand the pros and cons of the Future Scholar program.
Paying for college can be a monumental task. Although inflation in higher education has moderated in recent years, the price of a four-year college education is still very high. To help parents meet this major expense, states have developed and offer 529 college saving plans with tax benefits that can at least ease the burden a bit. In South Carolina, the program goes by the name of Future Scholar. Like all 529 college savings plans, any US citizen can open an account regardless of income or family relationship and there can be multiple accounts for the same beneficiary so long as the combined contribution does not exceed $426,000.
The money from any 529 college savings plan can be used for tuition and fees, room and board, books, computers and other supplies required for attendance at an eligible institution. Eligible institutions include two and four-year colleges, graduate and professional programs, and certain vocation/technical schools.
Reasons to utilize a 529 college savings plan
No matter what your state of residence, there are some advantages to utilizing a 529 college savings plan that are common to all such plans.
Tax Free Growth
Your contributions grow tax free, and distributions used to pay expenses related to secondary education are tax free also. A common question is what happens if the money is withdrawn for reasons other than higher education? In that case you will pay taxes on any earnings and a 10% penalty on those earnings with your federal income tax return. However, keep in mind, you can change the beneficiaries of a 529 plan. So, if one child chooses not to go to college, you could name another child as the beneficiary and protect the tax benefits of the plan.
Estate Planning Tool
Although estate taxes no longer affect most Americans, a 529 plan can still be utilized to shift assets out of an estate for tax purposes. Using the gifting allowance, currently $14,000 per person per year, a couple could move up to $140,000 out of their estate by using the five-year contribution allowance common to all 529 college savings plans. If a contributor were to die before the five-year period has passed, some of the funds would be brought back into the decedent's estate.
A unique feature of all 529 plans is that, although the contributions are counted as a gift at the time they are made, the funds can still be reclaimed by the account owner at any time. This has some usefulness as a Medicaid planning tool for older donors.
Low Impact on Needs Based Financial Aid
Because the assets in a 529 plan are not in the student’s name, they are considered as assets available for the family contribution versus assets that the student has. Colleges expect student to use up to 20% of any assets in their name each year to pay for college, but the family contribution is just 5.64% of their “unprotected” assets.
No matter which state’s 529 plan you choose, the funds can be used to pay for college expenses at any college or university. Unlike prepaid tuition plans, with a 529 plan there is no in state requirement.
State Income Tax Advantages
For South Carolina residents, contributions to the Future Scholar 529 college savings plan could be deductible on their state income tax return. With most SC income taxed at a 5% or 7% rate, this could save you $50 to $70 per thousand dollars of taxable state income. If you itemize your federal income taxes, your net savings will be smaller because it results in a smaller federal deduction for state income tax payments.
The state income tax deduction is a valuable benefit. Even if you have not used the Future Scholar plan for your college saving vehicle, you can still use it as a pass-through account in the years when your student attends college and claim this tax benefit. This deduction for contributions to an account may be taken in any taxable year for contributions made during that year and up to April 15th of the succeeding year.
There is no requirement that the funds stay in the plan for any set period, so if your student is attending college in the fall you could still open and contribute to the plan, then immediately have the funds sent to the college or university, thereby capturing the tax savings and in effect getting a 5% to 7% discount on tuition, fees, and expenses. With the all in cost of attending college approaching $20,000 annually that would translate into savings of up to $1,400 each year.
Future Scholar Management
The SC 529 plan is managed by a group called Columbia/Threadneedle, which was born from the merger of Columbia Management Investment Distributors of the US and Threadneedle Investments of the UK. Columbia Management is owned by Ameriprise, a national broker/dealer and financial service firm.
There are two ways to invest in the Future Scholar program. If you are a South Carolina resident, you can open and fund your accounts online directly with Columbia/Threadneedle or you can invest through the broker or your choice. See the sections on fees and expenses to understand the differences.
Rating the Future Scholar Program
Each year Morningstar publishes a ranking of 529 college savings plans. The programs are put into gold, silver, and bronze categories with a couple of sub ratings for the bronze plans. The SC Future Scholar plan ranks a middle of the pack bronze for the direct option. The advisor sold options ranks lower under a Neutral Rated sub category. You can view the 2016 Morningstar rankings by clicking here.
The younger your beneficiary, the greater the value of lower fees and better fund selections. A strategy South Carolina residents can use to get the biggest bang for their buck is to initially contribute to the Future Scholar program to capture the state income tax savings. Later, they can execute a custodian to custodian transfer to a better 529 plan such as the gold rated Utah Educational Savings Plan. A custodian to custodian transfer is not a taxable event and it enables you to have your cake and eat it too so to speak.
No matter which 529 college saving plan you use the key to long term success is to start early and contribute often. Your financial planner should be able to give you an idea of how much you need to save each month or how large a lump sum you need to contribute to achieve your college funding goals. And the old adage still applies, “Fail to Plan and you Plan to Fail”.
How to Invest in the SC Future Scholar Program
Because you can only change the investments in a 529 plan twice per calendar year, many investors choose to select an age based or a risk based portfolio that is rebalanced by the plan administrator. In the South Carolina plan, you can select from the following asset allocation portfolios:
The age based portfolios are divided into Aggressive, Moderate, and Conservative tracks. With different asset allocation portfolios being used at different ages to achieve a glide path to college entrance date.
If you purchase share through a broker, there are some small differences in the allocation portfolios because they offer some actively managed fund choices not available to direct buyers.
If you are a South Carolina resident you can participate in the Future Scholar program directly online, without the need for a broker/dealer intermediary. This option offers lower expenses and fees. You can view the direct investment funds and expenses here.
Want to setup a SC Future Scholar plan yourself? You can click here to learn more and open an account.
Purchase Through a Broker
Often the SC Future Scholar plans are recommended and sold by registered representatives, or brokers. Here the pricing and expenses are higher and much harder to understand. The Future Scholar program offers funds with A, E, and Z share classes? Additionally, there are more mutual funds to select from and many of those choices are actively managed mutual funds.
It is a bit of a slog, so we’ve aggregated the fund expenses by share class based on a current (6-9-2017) program description. You can find the broker directed investment funds and expenses here. Or you can view the program description and prospectus here.
Fund Fees and Expenses Comparison
Broker Sold Fund Fees and Expenses
Legacy Capital Preservation Funds
Pricing Alternative A
Pricing Alternative AG
Pricing Alternative E
Pricing Alternative Z