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ABCs of 529 Plans

LPL Financial located at NYCB 

ABCs of 529 Plans

If you’re already saving for college, you’ve probably heard about 529 plans. 529 plans are revolutionizing the way parents and grandparents save for college, similar to the way 401(k) plans revolutionized retirement savings. Americans are pouring billions of dollars into 529 plans, and contributions are expected to increase dramatically in the coming decade. Where did these plans come from, and what makes them so attractive?

The history of 529 plans

Congress created Section 529 plans in 1996 in a piece of legislation that had little to do with saving for college--the Small Business Job Protection Act. The law on 529 plans was later refined in 1997 by the Taxpayer Relief Act, in 2001 by the Economic Growth and Tax Relief Reconciliation Act, and in 2006 by the Pension Protection Act. In this short period, 529 plans have emerged as one of the top ways to save for college.

Section 529 plans are officially known as qualified tuition programs under federal law. The reason “529 plan” is commonly used is because 529 is the section of the Internal Revenue Code that governs their operation.

What exactly is a 529 plan?

A 529 plan is a college savings vehicle that has federal tax advantages. There are two types of 529 plans: college savings plans and prepaid tuition plans. Though college savings plans and prepaid tuition plans share the same federal tax advantages, there are important differences between them.

College savings plans

College savings plans let you save money for college in an individual investment account. These plans are run by the states, which typically designate an experienced financial institution to manage their plan. To open an account, you fill out an application, choose a beneficiary, and start contributing money. However, you can’t hand pick your own investments as you would with a Coverdell ESA, custodial account, or trust. Instead, you typically choose one or more portfolios offered by the plan--the underlying investments of which are exclusively chosen and managed by the plan’s professional money manager. After this, you simply decide when, and how much, to contribute.

With early college savings plans, plan managers commonly invested your money based only on the age of your beneficiary (known as an age-based portfolio). Under this model, when a child is young, most of the portfolio’s assets are allocated to aggressive investments. Then, as a child grows, the portfolio’s assets are gradually and automatically shifted to less volatile investments to preserve principal. The idea is to take advantage of the stock market’s potential for high returns when a child is still many years away from college, while recognizing the need to lessen the risk of these investments in later years.

Though the age-based portfolio model is certainly logical (indeed, many parents were already trying to invest this way on their own), offering only this type of portfolio made college savings plans seem a bit inflexible. After all, with other college savings options like Coverdell ESAs, custodial accounts, mutual funds, and trusts, you can invest in practically anything (thereby taking into account your risk tolerance), and you have complete freedom to sell an investment that’s performing poorly (though in some cases the proceeds must still be used for education purposes, or for the child’s benefit in general).

Now, college savings plans are older and wiser. Today, more plans offer a wide array of portfolio choices. So, in addition to choosing an age-based portfolio, you may also be able to direct your 529 plan contributions to one or more “static portfolios,” where the asset allocation in each portfolio remains the same over time. These static portfolios usually range from aggressive to conservative, so you can match your risk tolerance. But keep in mind that college savings plans don’t guarantee your return. If the portfolio doesn’t perform as well as you expected, you may lose money.

When it’s time for college, the beneficiary of your account can use the funds at any college in this country and abroad (as long as the school is accredited by the U.S. Department of Education).

Prepaid tuition plans

Prepaid tuition plans let you save money for college, too. But prepaid tuition plans work differently than college savings plans. Prepaid tuition plans may be sponsored by states (on behalf of public colleges) or by private colleges.

A prepaid tuition plan lets you prepay tuition expenses now for use in the future. The plan’s money manager pools your contributions with those from other investors into one general fund. The fund assets are then invested to meet the plan’s future obligations (some plans may guarantee you a minimum rate of return). At a minimum, the plan hopes to earn an annual return at least equal to the annual rate of college inflation for the most expensive college in the plan.

The most common type of prepaid tuition plan is a contract plan. With a contract plan, in exchange for your up-front cash payment (or series of payments), the plan promises to cover a predetermined amount of future tuition expenses at a particular college in the plan. For example, if your up-front cash payment buys you three years’ worth of tuition expenses at College ABC today, the plan might promise to cover two and a half years of tuition expenses in the future when your beneficiary goes to college. Plans have different criteria for determining how much they’ll pay out in the future. And if your beneficiary attends a school that isn’t in the prepaid plan, you’ll typically receive a lesser amount according to a predetermined formula.

The other type of prepaid tuition plan is a unit plan. Here, you purchase units or credits that represent a percentage (typically 1 percent) of the average yearly tuition costs at the plan’s participating colleges. Instead of having a predetermined value, these units or credits fluctuate in value each year according to the average tuition increases for that year. You then redeem your units or credits in the future to pay tuition costs; many plans also let you use them for room and board, books, and other supplies.

A final note to keep in mind: Make sure you understand what will happen if a plan’s investment returns can’t keep pace with tuition increases at the colleges participating in the plan. Will your tuition guarantee be in jeopardy? Will your future purchases be limited or more expensive?

What’s so special about 529 plans?

Section 529 plans--both college savings plans and prepaid tuition plans--offer a combination of features that have made them attractive to college investors:

Federal and state tax-deferred growth: The money you contribute to a 529 plan grows tax deferred each year.​ Federal tax-free earnings if the money is used for college: If you withdraw money to pay for college (known under federal law as a qualified withdrawal), the earnings are not subject to federal income tax, similar to the treatment of Coverdell ESA earnings.

Favorable federal gift tax treatment: Contributions to a 529 plan are considered completed, present-interest gifts for gift tax purposes. This means that contributions qualify for the $14,000 annual gift tax exclusion. And with a special election, you can contribute a lump sum of $70,000 to a 529 plan, treat the gift as if it were made over a five-year period, and completely avoid gift tax.

Favorable federal estate tax treatment: Your plan contributions aren’t considered part of your estate for federal tax purposes. You still retain control of the account as the account owner but you don’t pay a federal estate tax on the value of the account. But if you spread today’s gift over five years and you die within the five years, a portion of the gift will be included in your estate.

State tax advantages: States can also add their own tax advantages to 529 plans. For example, some states exempt qualified withdrawals from income tax or offer an annual tax deduction for your contributions. A few states even provide matching scholarships or matching contributions.

Availability: Section 529 plans are open to anyone, regardless of income level. And you don’t need to be a parent to set up an account. By contrast, your income must be below a certain level if you want to contribute to a Coverdell ESA or qualify for tax-exempt interest on U.S. education savings bonds (Series EE bonds, which may also be called Patriot bonds, and Series I bonds).

High contribution limits: The total amount you can contribute to a 529 plan is generally high. Most plans have limits of $300,000 and up. Coupled with the tax-deferred growth of your principal and the income tax-free treatment of qualified withdrawals, it’s easy to see how valuable your money can be in a 529 plan.

Professional money management: For college investors who are too busy, too inexperienced, or too reluctant to choose their own investments, 529 plans offer professional money management.

College savings plan variety: In many cases, you’re not limited to the college savings plan in your own state. You can shop around for the plan with the best money manager, performance record, investment options, fees, state tax benefits, and customer service. (You can’t generally shop around with prepaid tuition plans, though.)

Rollovers: You can take an existing 529 plan account (college savings plan or prepaid tuition plan) and roll it over to a new 529 plan once every 12 months without paying a penalty. This lets you leave a plan that’s performing poorly and join a plan with a better track record or more investment options (assuming the new plan allows nonresidents to join).

Simplicity: It’s relatively easy to open a 529 account, and most plans offer automatic payroll deduction or electronic funds transfer from your bank account to make saving for college even easier.

Innovation: Section 529 plans are a creature of federal law, but the states are the ones that interpret and execute them. As Congress periodically revises the law on 529 plans, states will continue to refine and enhance their plans (and their tax laws) in order to make them as attractive as possible to college investors from all over the country.

What are the drawbacks of 529 plans?

No college savings option is perfect, and 529 plans aren’t, either. Here are some of the drawbacks:

Investment options: 529 plans offer little control over your specific investments. With a college savings plan, you may be able to choose among a variety of investment portfolios when you open your account, but you can’t direct the portfolio’s underlying investments. With a prepaid tuition plan, you don’t pick anything--the plan’s money manager is responsible for investing your contributions.

Investment guarantees: College savings plans don’t guarantee your investment return. You can lose some or all of the money you have contributed. And even though prepaid tuition plans typically guarantee your investment return, some plans sometimes announce modifications to the benefits they’ll pay out due to projected actuarial deficits.

Investment flexibility: If you’re unhappy with your portfolio’s investment performance in your college savings plan, you typically can direct future contributions to a new portfolio (assuming your plan allows it), but it may be more difficult to redirect your existing contributions. Some plans may allow you to make changes to your existing investment portfolio once per calendar year or upon a change in the beneficiary. But in either case, it depends on the rules of the plan. However, you do have one option that’s allowed by federal law and not subject to plan rules. You can do a “same beneficiary” rollover (a rollover without a change of beneficiary) to another 529 plan (a college savings plan or a prepaid tuition plan) once every 12 months, without penalty. This gives you the opportunity to shop around for the investment options you prefer.

Nonqualified withdrawals: If you want to use the money in your 529 plan for something other than college, it’ll cost you. With a college savings plan, you’ll pay a 10 percent federal penalty on the earnings part of any withdrawal that is not used for college expenses (a state penalty may also apply). You’ll pay income taxes on the earnings, too. With a prepaid tuition plan, you must either cancel your contract to get a refund or take whatever predetermined amount the plan will give you for a nonqualified withdrawal (some plans may make you forfeit your earnings entirely; others may give you a nominal amount of interest).

Fees and expenses: There are typically fees and expenses associated with 529 plans. College savings plans may charge an annual maintenance fee, administrative fees, and an investment fee based on a percentage of your account’s total value. Prepaid tuition plans may charge an enrollment fee and various administrative fees.

Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about 529 plans is available in the issuer’s official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.

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The Divisions of New York Community Bank

Queens County Savings Bank​

Established on April 14, 1859 in the village of Flushing, Queens County Savings Bank was the first savings bank chartered by the State of New York in the New York City borough of Queens. Until then, local residents would need to travel to Manhattan to do their banking; the opening of the borough’s first local bank was accordingly met with elation and relief.

While the bank expanded here and there over the course of the next 14 decades, its greatest growth occurred in just the last 15 years. In anticipation of expanding its franchise through the first of several mergers, the Bank changed its name to New York Community Bank on November 21, 2000. By the end of that year, NYCB had grown from 14 to 86 branches; today, it has more than 220 branches in five states.

In deference to its heritage as a Queens-based institution, the Community Bank operates each of its 31 branches in the county under its original name, Queens County Savings Bank.

Roslyn Savings Bank

Established in 1875, The Roslyn Savings Bank was the first financial institution headquartered in Nassau County, one of two counties--with Suffolk--that constitute Long Island, New York. Its founders wanted to build a bank that would provide the Island’s residents with a safe place for their savings, as well as the financial assistance they’d need to build or purchase homes.

A member of the NYCB Family of Bank since October 31, 2003, Roslyn Savings Bank today serves the Island’s businesses and consumers through 41 conveniently placed branch offices.

Richmond County Savings Bank

A member of the NYCB Family of Banks since July 31, 2001, Richmond County Savings Bank is the third oldest of our divisions, with roots that go back to October 30, 1886. It was then that the bank was established to serve those who lived and worked on Staten Island, and it was less than one year later that it made its first mortgage loan.

Today, nearly every street on the Island has at least one home that was financed by Richmond County Savings Bank.

Originally located in the Odd Fellows Building at the corner of Richmond Terrace and Broadway, the Bank today has 20 convenient banking locations in all.

Roosevelt Savings Bank

Roosevelt Savings Bank was established in 1895 on the corner of Gates Avenue and Broadway in Brooklyn under the name “Eastern District Savings Bank.” In 1920, the bank changed its name to honor the memory of the nation’s 26th president, Theodore Roosevelt.

In February 1999, Roosevelt Savings Bank merged with and into Roslyn Bancorp, which merged with and into New York Community Bancorp, Inc. in October 2003.  Today, Roosevelt Savings Bank serves its customers through seven branches in Brooklyn as a member of the NYCB Family of Banks.

Atlantic Bank

Atlantic Bank was established in the mid-1920s and was acquired by New York Community Bancorp, Inc. on April 28, 2006. We have 11 full-service branches in Manhattan, Queens, Brooklyn, Westchester, and Nassau County, and offer a comprehensive menu of financial services for small and mid-size businesses, commercial real estate investors, consumers, and their families.

Because Atlantic Bank is part of the New York Community Family of Banks, our customers can also bank at any of our 237 branches in the Metro New York, New Jersey, Ohio, Florida, and Arizona.

We are committed to providing our customers exceptional service and convenience, and a full-service menu of products and services to meet your business and personal needs. With free 24-hour access to a network of 233 ATM locations, we make it easy for you to bank with us.

Garden State Community Bank

Garden State Community Bank has been a member of the NYCB Family of Banks since March 2008, when we combined all the branches of four smaller New Jersey-based divisions--First Savings Bank of New Jersey, Ironbound Bank, Penn Federal Savings Bank, and Synergy Bank—into a single division with a highly relatable name.

While Penn Federal Savings Bank and Synergy Bank were directly acquired in 2007, First Savings Bank of New Jersey and Ironbound Bank were acquired in 1999 by Richmond County Financial Corp., which subsequently merged with NYCB.

By combining the strengths of these four local banks with the strengths of our institution, we established a Garden State community bank that offers more products and services, and more convenient locations, than any one of these banks provided on its own.

Today, we serve our customers through 41 branches in Essex, Hudson, Mercer, Middlesex, Monmouth, Ocean, and Union Counties, most of which first opened their doors nearly 14 decades ago.

Ohio Savings Bank

Ohio Savings Bank is one of the more recent additions to a respected banking family that has been serving customers and communities for more than 156 years.

Established in 1889 as the Ohio Savings Home Loan and Building Co., the bank’s initial expansion was limited to Ohio until it opened its first Florida branch in 1989. Eleven years later, it expanded again, this time to Arizona. And seven years later, it changed its name to AmTrust Bank.

On December 4, 2009, AmTrust Bank became the newest member of our banking family, the first of our divisions to serve customers in non-contiguous states. Four months later, we elected to pay tribute to its forebear, by operating our 28 branches in Ohio under a more suitable name: Ohio Savings Bank.

AmTrust Bank

AmTrust Bank is one of the more recent additions to a respected banking family that has been serving customers and communities for more than 156 years.

The first branch of AmTrust Bank opened its doors in the late 1980s, when Ohio Savings Bank opened the first of its branches in south coastal Florida under the “AmTrust Bank” name. Eleven years later, it expanded again--this time to Arizona--and on December 4, 2009, it joined the NYCB Family of Banks. With our acquisition of Desert Hills Bank less than four months later, we further expanded our franchise in the Grand Canyon State.

AmTrust Bank serves its customers through 40 convenient branches: 14 in central Arizona and 26 in Florida.

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