SPEAKERS CONTENTS INSERTS
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INVESTING FOR THE FUTURE:
529 STATE TUITION SAVING PLANS
Wednesday, June 2, 2004
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance
and Government Sponsored Enterprises,
Committee on Financial Services,
The subcommittee met, pursuant to call, at 10:06 a.m., in Room 2128, Rayburn House Office Building, Hon. Richard H. Baker [chairman of the subcommittee] Presiding.
Present: Representatives Baker, Gillmor, Oxley (ex officio), Biggert, Capito, Kennedy, Tiberi, Brown-Waite, Kanjorski, Hooley, Sherman, Meeks, Inslee, Moore, Lucas of Kentucky, Crowley, Clay, McCarthy, Baca, Emanuel, and Scott.
Chairman BAKER. I would like to ask our meeting to come to order and welcome our witnesses to the table this morning.
This morning, the committee meets to examine the manner in which special State education enhancement programs function for the benefit of prospective college students and moms and dads, typically characterized as Section 529 plans. All States, with the exception of Washington and the District of Columbia, have established some 529 plan and make it available to their constituents.
While the SEC does not have direct supervisory responsibility for the conduct of the 529 plans, they do, under Federal securities law, exercise jurisdiction with regard to fraud and other misconduct as well as having direct responsibility to regulate the broker dealers and the municipal security dealers that sell interest in 529 plans. So there is a Federal nexus for some examination of the manner in which these plans are operated.
Page 2 PREV PAGE TOP OF DOC In the past several years, the committee has engaged in market-sector by market-sector review of current regulatory structure and determined the adequacy of current disclosure regimes, the transparency, suitability, the method by which the average consumer may judge whether a particular investment is appropriate for their needs.
Chairman Oxley has recently written the SEC with his own list of questions relative to the 529 plan disclosure requirements that raise several interesting points. One of the obvious and apparent conclusions that I have reached is, there is not, at least today, a national standard of conduct for a State 529 plan to provide comparability between States. If one is enrolled in a plan in State A and then subsequently moves to State B, there may be tax consequences to the individual that are not clearly understood or perhaps properly disclosed today. Whether or not the offering materials are substantially different in content and presentation from marketing materials, whether there is sufficiency in clear disclosure of fee schedules, many of these issues sound like repeats of the same questions on other subjects in months past. And so the committee's review of these matters is certainly understandable and appropriate given our market sector responsibilities.
I will say that, today, I feel we have invited individuals to give the committee insight into the manner by which 529 plans function that have already exhibited high standards of professional conduct and perhaps can give us insight into where the industry may be moving.
And I wanted to conclude my remarks simply with an observation. It may be that an enhanced self-regulatory model may work well here as well and that, by States conducting their own review and examination, could come to standards for comparability on a national scale that could perhaps result in recognition of some system that an individual 529 plan might receive a nationally recognized merit award or status or recognition, thereby indicating to a State who refuses to adopt the model code that there are certain elements of that State's plan which are perhaps aberrant or not sufficient to warrant such recognition.
Page 3 PREV PAGE TOP OF DOC I would much prefer to see a self-regulatory model at this point than having the Federal Government intercede into another area where their participation may not be necessarily welcome in the first place.
To that end, I certainly appreciate those who are participating in the hearing this morning. It is the beginning of our process of understanding, and we certainly will reach no conclusions before a thorough exchange of ideas has been provided to all stakeholders. With that, I yield such time as the gentleman may consume to Mr. Kanjorski.
Mr. KANJORSKI. Thank you, Mr. Chairman.
Mr. Chairman, in Pennsylvania, we take pride in reminding others of many wise observations of Benjamin Franklin. As I prepared for today's hearing, I was accordingly reminded of one of his more insightful reflections, ''An investment in knowledge always pays the best interest.'' this statement is as true today as it was more than 200 years ago in part because of Section 529 tuition savings plans.
During the last decade, the cost of attending a university has increased 40 percent while the typical household income has increased just 12 percent. Additionally, the average cost of attending a 4-year university now stands at $34,000 for State institutions and at $90,000 for private colleges. Moreover, the price tag for a higher education is expected to continue to grow in the future, likely continuing to outstrip any gains in families' earnings.
Because Democrats and Republicans alike recognize that an investment in higher education continues to produce appreciable returns for individuals in society, we have worked cooperatively in recent years to help families cover this necessary financial expense. In 1996, for example, we joined together to create 529 plans. As a result, families today can use this instrument to set aside money for higher education purposes that grows free of any Federal tax.
Section 529 plans have grown greatly in popularity since their inception in the late 1990s, and they are now one of the most common ways to save for a college education. Total assets in 529 plans which stood at $2.6 billion at the end of 2000 rose to $8.5 billion at the close of 2001. They also doubled in value in 2003, reaching $35 billion and covering more than 4 million accounts by the year's end.
Page 4 PREV PAGE TOP OF DOC In addition, the experts at the Federal Research Corporation now predict that American families will invest $300 billion in 529 plans by 2010. The tremendous expansion of the tuition savings plans industry has now produced some predictable growing pains. Although we created 529 plans in the Federal Tax Code of 1996, we did not simultaneously implement a comprehensive regulatory regime to cover this financial product. As a result, some have begun to raise concerns about the need to improve the oversight of this sector of our financial system.
For the purposes of our securities laws, the States generally have oversight responsibilities for Section 529 plans. One problem that has received substantial attention in recent months with respect to the 529 plans concerns the disclosures that investors currently receive about the performance of these financial products. As we will hear later this morning, many States have begun to take action on their own to protect investors, including working to develop a model disclosure regime.
National authorities in recent months have also begun to examine 529 plans which remain subject to Federal antifraud rules and broker dealer sales practice requirements. Earlier this year, the Securities and Exchange Commission announced the creation of a task force to study the fee disclosure regime and sale of 529 plans. Additionally, we have learned that the National Association of Security Dealers is now investigating whether some brokers in selling out-of-State 529 plans ultimately exposed their clients to lower investment returns and higher State taxes.
From my perspective, it is very important to study these issues and for State and Federal regulators to take coordinated action to protect families who invest in 529 plans. Greater standardization in disclosing fees and expenses will facilitate direct comparisons in performance between the various 529 plans across State lines. I am therefore pleased that the College Savings Plans Network has begun the work needed to implement a comprehensive disclosure system that will provide a greater comparability of 529 plans for investors and help to ensure that we have access to the same quality of information as mutual fund investors.
Page 5 PREV PAGE TOP OF DOC As we proceed today, I hope they will also examine the interplay between 529 plans and the proposal by the Bush Administration to create life savings accounts. As currently conceived, LSAs will permit individuals to save money tax-free for any purpose, including higher education. A recent study by the Senate Finance Committee determined that, because LSAs would be more flexible than 529 accounts, they could compete with tax-favored savings programs for education, particularly among persons with limited disposable income. We should therefore explore today whether the increased flexibility of LSAs might undermine a family's well-intentioned efforts to save for a child's higher education.
In sum, Mr. Chairman, I commend you for convening today's hearings on 529 plans. We should conduct oversight of this growing segment of our financial marketplace in order to determine how we can make the present regulatory structure stronger. The observations of today's witnesses about these matters will help me in forming my opinions on these issues.
Thank you Mr. Chairman.
[The prepared statement of Hon. Paul E. Kanjorski can be found on page 45 in the appendix.]
Chairman BAKER. I thank the gentleman.
Mr. OXLEY. Thank you, Mr. Chairman. Obviously, welcome to our panel. I see some familiar faces out there.
We all know that there are few things in life more essential than a good education. Helping parents save and invest for their children's higher education is a vital public policy initiative, particularly in this environment of runaway tuition costs.
Success of the 529 tuition savings plans is good news, but it is not surprising. These programs offer all families, regardless of income, the opportunity to obtain tax-free growth and distribution on money they save and invest for college costs. There is now more than $35 billion invested in the 529 plans across the country. And some have predicted that total assets will balloon to some $300 billion by the end of this decade.
Page 6 PREV PAGE TOP OF DOC Given the increasingly important role that 529 plans play in enabling parents to save for their children's education, I have become concerned about certain aspects of some of these plans. For example, why are there such disparities in fees and the disclosure of those fees? Have the fees charged by these State-sponsored plans become so exorbitant that they actually outstrip the tax benefit that Congress has attempted to provide? Have the States established adequate procedures to monitor the performance and operation of the investment managers they hire to run their plans? Are they offering documents clear and concise?
These are some of the concerns that prompted me to write to SEC Chairman Bill Donaldson in February of this year. In his response to me, Chairman Donaldson said that ''the current State of affairs with respect to 529 plans is complicated and likely difficult for parents to understand,'' end quote. He also announced the creation of the chairman's task force on college savings plans. I am pleased by the commission's energetic response, and I understand that the task force has made considerable progress, and I look forward to hearing from them in the near future.
We have assembled an all-star lineup here today. I particularly would like to welcome Diana Cantor, the chairman of the College Savings Plans Network, and Jacqueline Williams, Executive Director of the Ohio Tuition Trust Authority. I know that they have put in long hours over the past few weeks to improve the disclosure regime of 529 plans. And I look forward to their testimony and that of the rest panel.
Mr. Chairman, again we look forward to the hearing, and I yield back.
[The prepared statement of Hon. Michael G. Oxley can be found on page 40 in the appendix.]
Chairman BAKER. I thank the gentleman for his participation and his statement.
Are there any members wishing to make additional open statements at this time?
Page 7 PREV PAGE TOP OF DOC Mr. Scott.
Mr. SCOTT. Thank you very much, Mr. Chairman. This is indeed a very important hearing and has some very important ramifications for my State of Georgia. And I certainly want to thank you Mr. Chairman and also Ranking Member Kanjorski for holding this hearing today regarding State-sponsored 529 college tuition savings plans. I believe that it is very important for this committee to examine the legitimacy and disclosure fees that some 529 plans are using.
And while this hearing will focus on many of the problems that have been identified with some State savings plans, my State of Georgia has a strong record of managing its plan. Since 2002, the Georgia higher education savings plan has offered a wide variety of investment options, managed by TIAA-CREF, an industry-recognized leader in providing investment services in the education and research communities. In just 2 short years of existence, the Georgia higher education savings plan has over 42,000 participants who have invested more than $165 million to pay for college education.
Contributions to the Georgia higher education savings plan can be made for as little as $25 per beneficiary, per investment option or as little as $15 for contributions made through payroll deduction
s. Up to $2,000 can be deducted per beneficiary for taxpayers who meet filing status and income requirements.
Georgia's plan has made savings for college more affordable with one of the lowest fees among 529 plans across the country. Participants pay no application fee, no sales charge and no annual account maintenance fee. An annual management fee, which is deduced from fund assets, is used to cover the cost of investment management fees and expenses as well as administrative services. The annual all-inclusive fee is only 0.85 percent of assets.
While Georgia has a 529 plan that maintains low and reasonable fees, other States have not managed their plans quite as well. And I look forward to hearing from this distinguished panel of witnesses today to discuss efforts to improve the management of 529 plans.
Page 8 PREV PAGE TOP OF DOC Among the issues that I will be looking for information on are whether the 529 plan administrators exercise sufficient oversight of the intermediaries they employ to sell interest in their plans, whether the disclosures given to investors are sufficient to permit informed investment decisions, and whether greater standardization in fee disclosure to facilitate comparability is achievable and whether the fees charged by some 529 plans negate the expected tax benefits from the investment.
Thank you for coming, and this is a very distinguished panel. And I look forward to hearing your comments.
Thank you, Mr. Chairman.
Chairman BAKER. I thank the gentleman.
Are there further opening statements?
If there are no further opening statements, I would like to move at this time to our first witness, Ms. Diane Cantor, chairman of the Executive Board, College Savings Plans Network.
And I wish to commend you for your good work in this area and also, on a personal aside, seeming to be a continuing positive influence in Mr. Eric Cantor's conduct. So I welcome you here this morning.
STATEMENT OF DIANA CANTOR, CHAIRMAN, EXECUTIVE BOARD, COLLEGE SAVINGS PLANS NETWORK
Ms. CANTOR. Thank you, Mr. Chairman. Thank you Member Kanjorski and distinguished members of the committee. My name is Diana Cantor. I am the executive director of the Virginia college savings plan and chairman of the College Savings Plans Network, an affiliate of the National Association of State Treasurers that has represented State 529 college savings and prepaid tuition plans since 1991. I thank you Mr. Chairman for the opportunity to address your committee.
Page 9 PREV PAGE TOP OF DOC The cost of attending college, whether public or private, continues to rise steadily. In order to send their children to college, American families increasingly rely upon debt to meet the rising cost of a higher education. Despite the cost, the value of a higher education is undeniable.
The best answer to rising college costs is to encourage families to save in advance. The States began creating prepaid tuition and savings plans more than a decade ago to help families cope with spiraling tuition costs. The theory has worked. Give families a tax advantage, disciplined, safe way to save for college expenses, and they will use it.
There are two types of Section 529 plans, prepaid and savings. Prepaid plans are similar to a defined benefit pension plan where the family is purchasing a defined amount of future tuition years of credit. Savings trusts are more analogous to defined contribution plans. Families can save in a variety of investment options, including equity and fixed-income mutual funds, actively managed accounts, money market, and stable value funds.
Families participating in 529 plans are specifically saving for college where otherwise they may not set aside money for that purpose. The programs, through their marketing efforts, draw attention to the need to save for college early and help many families across the country take that all-important step of beginning to save.
State college savings programs have achieved phenomenal success. With the enactment of the Economic Growth and Tax Relief Reconciliation Act, the number of children participating in our programs has skyrocketed. Every State in the Nation plus the District of Columbia now has at least one Section 529 savings option designed to meet the particular circumstances and policy goals of their States. States are able to offer their participants an opportunity to invest in funds and actively managed accounts that may otherwise be unavailable to them due to high minimum investment requirements. Savings plans typically do not have age or residency requirements as is common with prepaid tuition plans, so investors are free to choose any plan across the country that best meets their needs.
Page 10 PREV PAGE TOP OF DOC Today, with assets topping $40 billion in savings plans and $10 billion in prepaid tuition plans nationally, these plans are receiving increased attention. The Securities and Exchange Commission, in response to an inquiry from Chairman Oxley, recently announced the creation of a Section 529 task force to review among other things disclosure and fee issues. Questions have been raised as to why our programs may look different from State to State.
Our feelings as State administrators are that the unique features of our plans provide their prime attraction, the ability of each State to craft a program that best suits its citizens' needs and further that State's higher education policy.
Over a year ago, the College Savings Plans Network undertook an effort to create voluntary disclosure principles. These principles were adopted in draft form just last week at our network's annual meeting. The goal of the principles is to provide a framework for disclosure so that an investor can easily understand his or her own State plan as well as compare Section 529 plans on an apples-to-apples basis. They contain recommendations on information that should be prominently stated, such as the need to consider State tax treatment and other types of benefits and the availability of other 529 programs offered by that State.
The principles also contain tables and charts which provide clear, concise and consistent descriptions of fees, expenses and investment performance. Fees will continue to vary among these plans as fees differ among all types of non-529 investment options. Consumers do not expect to pay the same fees for a completely passive large cap index fund as they do for an actively managed international equity fund. Nor do they expect to pay the same for a direct-sold investment as they would for an advisor-sold product. But the intent of our disclosure guidelines is to make comparing the same types of plans much easier.
State oversight of their 529 plans provides an additional layer of accountability and protection for participants in these plans. States, such as Ohio, Louisiana, and Wisconsin, have already reacted to the current environment by expanding investment options, adding low-cost funds, and lowering fees. As creatures of State law, Section 529 plans are subject to multiple levels of oversight that help protect the programs' participants. Each State is governed by its own administrative procedure laws, procurement laws, ethics and conflict-of-interest statutes and freedom of information or Government in the Sunshine acts.
Page 11 PREV PAGE TOP OF DOC The plans are all administered by State boards, authorities or trusts. By statute or regulation, the operating authorities are required to follow prudent personal standards in selecting and retaining funds or managers. All of the programs are subject to financial audit and reporting requirements.
Promoting greater access to higher education and encouraging savings over debt is sound public policy. The existing State college savings programs promote these goals and reduce the need for financial aid and student loans.
Mr. Chairman, these programs are working. These plans have already provided benefits to more than 400,000 students nationwide and another 6 million children are waiting to use their accounts. In closing, Mr. Chairman, Section 529 plans are flourishing, and families are using these plans in record numbers to save for their children's future.
Congress' mission in creating 529 plans is being accomplished. We, along with our partners in the financial services industry, will work together to continue to improve these plans and to serve America's families and our most important customers, America's children.
Thank you again, Mr. Chairman, Ranking Member Kanjorski, distinguished Members of the committee, for your support of State college savings programs and the millions of families across America who participate in them. We look forward to continuing to work with your committee to continue to provide the best college savings options available through Section 529 plans. Thank you.
[The prepared statement of Diana Cantor can be found on page 78 in the appendix.]
Chairman BAKER. I thank you for your statement.
For the purposes of our next introduction I would yield such time as the gentleman may consume to the gentleman from Ohio, Mr. Tiberi.
Mr. TIBERI. Thank you, Mr. Chairman.
Page 12 PREV PAGE TOP OF DOC It is a pleasure to introduce another central Ohioan, Jacqueline Williams, who is the executive director of the Ohio Tuition Trust Authority. Jackie was appointed executive director of the Ohio Tuition Trust Authority in June of 1999. She has held leadership positions in both the public and private sector. She is president of the Columbus Board of Health, serves on the Columbus Cancer Clinic Board. She earned both her master's and her bachelor's degree at Miami University in Oxford, Ohio, one of the alma maters for our chairman to the left here.
On a personal note, Mr. Chairman, I had the opportunity during my last term of the General Assembly to work with Ms. Williams, and she was respected by members on both sides of the aisle.
And it is a real pleasure to work with you and thank you for being here to offer your expert testimony, Ms. Williams.
STATEMENT OF JACQUELINE WILLIAMS, EXECUTIVE DIRECTOR, OHIO TUITION TRUST AUTHORITY
Ms. WILLIAMS. Thank you very much. Thank you for the wonderful introduction.
Mr. Chairman, Ranking Member Kanjorski, and members of the committee, this is a real pleasure to speak to you today regarding 529 plans and to share one State's history and philosophy regarding these plans.
My name is Jackie Williams, and I am the executive director of the Ohio Tuition Trust Authority and a member of the Executive Committee of the College Savings Plans Network. The Ohio Tuition Trust Authority is an independent, self-supporting State agency which is governed by an 11-member board representing business, higher education, and elected officials.
Ohio was one of the first States to offer a qualified tuition program, and in 1989, the General Assembly in Ohio created the trust authority to help with the following objectives: Make higher education more affordable and accessible to Ohio citizens, to assist State universities by providing a stable financial base, to protect Ohio citizens from rising tuition costs, to encourage savings, and to promote secondary and post-secondary academic excellence.
Page 13 PREV PAGE TOP OF DOC Since 1989, almost 25,000 students have attended college using over $232 million invested in Ohio's plan. But according to the recently completed report of Ohio's Governor's Commission on higher education and the economy, only 11 States have smaller portions of their populations who have earned baccalaureate degrees. The report states that Ohio's economic growth and prosperity is inextricably linked to increasing participation by Ohioans in higher education.
We offered initially a unit-based prepaid tuition plan called the Guaranteed Savings Fund, and our State provided a tax exemption on earnings as an incentive for families to save. In 1994, the Ohio General Assembly supported and the voters of Ohio approved a constitutional amendment to provide the State's full financial backing for that prepaid plan in the event the fund could not meet future obligations. So clearly, this was a very high priority for our State.
In 1996, when Congress established qualified State tuition programs and added Section 529 to the Internal Revenue Code, Ohio's program fell under the guidelines established for such programs. And in 1999, the tuition trust proposed legislative changes to the agency's statute to take advantage of these Federal changes. The Ohio General Assembly unanimously supported the decision to offer more diverse choices for investments and also expanded the tax incentive by providing a $2,000 State tax deduction on contributions to the program.
We undertook an extensive competitive bid process to select and hire a firm to provide investment management, marketing and administrative services. Our due diligence included on-site examinations of bidders by our staff, a review of fees and performance by our outside consultants, and oral presentations by finalists. And in 2000, we hired Putnam Investments to manage the savings program.
The firm was selected for a variety of reasons, but one of the most important things was their commitment to educate and sell options to consumers through an extensive network of financial advisers. This was a deliberate choice on the part of our board because they wanted to extend the access of these programs to the public. Our staff, while one of the larger ones in the 529 industry was never intended to grow large enough to address the more than 11 million people in the State of Ohio.
Page 14 PREV PAGE TOP OF DOC Our plan is sold through financial advisors and directly through the tuition trust. The advisor-sold component offers 17 market-based options, and those same options are available directly through the trust authority at a lower cost for Ohio residents. Over the past 4 years, we have experienced significant growth in our program. In our State alone, over $1.1 billion has been invested through CollegeAdvantage on behalf of 186,000 beneficiaries. And the average account value, despite the fact that most of these programs will allow people to save significant amounts for private or public education, graduate school et cetera, the average account value is $7,500.
However, we continue to refine and enhance our program, and in the spring of 2003, we conducted market research of Ohio citizens who had relatives under age 18 to whom they felt some obligation to help save for college. Among respondents who were saving, bank accounts were the most popular vehicle. And while 9 percent were using CollegeAdvantage to save, 28 percent were using taxable instruments. And fully half of all respondents, despite the fact that they had children or grandchildren, were not saving at all.
The other point that came out was that fully two-thirds of the people responding considered themselves to be do-it-yourself investors and wanted very clear, easy-to-understand savings options. To meet the needs uncovered through research, we took a two-step approach. And in January of this year, we issued an RFP to index fund managers for a low-cost index provider. Through a competitive selection process, we hired the Vanguard Group in March. And in May we added 15 Vanguard investment options to CollegeAdvantage.
We will soon issue an RFP to Ohio banking institutions for a 529 savings account and at least one-time deposit product. The goal would be to distribute these products through the bank's distribution channels including branch locations, on-line bank centers, call centers, workplace programs and other access points, because our job is to make sure that our citizens have full access to these programs. We offer flexible contribution methods through electronic funds transfer, payroll deduction, on-line contributions, no enrollment fee, and minimum contributions of $15. We also have made college more affordable by having some of the lowest fees in the industry, and while total expense ratios will definitely vary with the type of investment option, the lowest all-inclusive fee available through our program, is 35 basis points.
Page 15 PREV PAGE TOP OF DOC So we have done a considerable amount to standardize the information that is available over the past several months to people in our program, and we believe that we are now leading the industry in terms of some of the recent enhancements we have made to our disclosure materials. We are working to increase access to higher education in our State by offering a diverse range of investment choices, low fees, affordable minimum contributions, online access, easy contribution options, and State tax advantages. These features make Ohio's program unique and tailored to the needs of Ohio families.
While disclosure information should be standardized across the 529 industry, each State must be able to shape and define its own plan to meet the unique needs of its citizens. Our success is essential if the governor's goal of increasing participation in post-secondary education by 30 percent or 180,000 students by 2015 is to be reached. Each day, we work with families one at a time to support their aspirations to achieve a better future for their children.
Thank you again for the opportunity, Mr. Chairman. We look forward to working with you and Members of your committee. And we would be pleased to answer any questions when it is appropriate. Thank you.
[The prepared statement of Jacqueline Williams can be found on page 156 in the appendix.]
Chairman BAKER. Thank you very much.
I would like to now welcome Mr. Marc Lackritz, president of the Securities Industry Association, back to the committee.
STATEMENT OF MARC E. LACKRITZ, PRESIDENT, SECURITIES INDUSTRY ASSOCIATION
Mr. LACKRITZ. Thank you, Mr. Chairman, and thank you for the opportunity to testify today about Section 529 plans, how important they are to financing higher education costs and how we might work together to improve them.
Page 16 PREV PAGE TOP OF DOC My name is Marc Lackritz. I am president of the Securities Industry Association. Our member firms are deeply committed, Mr. Chairman, to reviving a national culture of saving, particularly among young people. We have worked very hard to educate and encourage both students and parents to invest regularly in a product with marginal risk to help foster a renewed sense of personal responsibility. One such product, the Section 529 plans, offers some of the best benefits for savings for college.
Our members are actively involved in all phases of the management and marketing of 529 plans because these plans have easier eligibility and contribution requirements than certain other investment options, thereby making them accessible to far more families and people. The enhanced Federal tax benefit provided by Congress in the tax legislation of 2001 instantly increased the popularity of Section 529 plans: 63 percent of these accounts were open in 2001 or later, and participation in account balances will continue to rise as individuals become more aware of the tax benefits of the plan.
Indeed, if a family contributed $2,000 annually to a 529 account for 18 straight years and assuming an 8 percent rate of return, they would have saved nearly $75,000 for college, enough for most 4-year public institutions across the country. The favored tax treatment of 529 plans not only enhances returns but also helps to assure that the funds will be there when they are needed for college by discouraging withdrawal for other purposes.
Without the involvement of the States, 529 savings plans would not exist. States approve the method of distribution both in-State and nationally, and broker dealers that distribute 529 plans must work with the States to negotiate selling agreements and produce marketing and other program literature. Tax treatment of 529 plans is subject to both Federal and State law. And the Securities and Exchange Commission and the Municipal Securities Rulemaking Board oversee the broker dealers and investment advisors who distribute the plans.
Mr. Chairman, we believe there are five different ways to improve on Section 529 plans. First, make the tax-free treatment of distributions permanent. The short-term success in expanding 529 plans from enhanced Federal tax advantages enacted in 2001 could be undermined by the uncertainty that the tax incentive will not be made permanent. If Congress does not extend the provision for tax-free withdrawals on 529 plans, then, after 2010, earnings in the account will be taxed at the recipient's rate as they are withdrawn. We would urge Congress to make the tax-free treatment of distributions permanent as soon as possible to ensure certainty to participants that the tax benefit will exist when they make their withdrawals.
Page 17 PREV PAGE TOP OF DOC Secondly, create tax parity among the States. Creating tax parity among all 50 States would significantly increase participation and lower cost for investors. Currently, more than 50 percent of the State plans have different tax rates and policies in place. Families and their financial advisors face a complex challenge to determine the value of particular State's tax benefit when placed in the proper context of other investment considerations. SIA and our member firms are actively working at the State level to achieve tax parity across the board. We have had some success, although current State fiscal constraints are hampering broader progress.
Third, we need to improve disclosure. We also believe that clear, more complete and more understandable disclosure of fee and investment-related information would help investors make relevant, consistent comparisons among different types of plans. Currently, marketing material for mutual funds purchased through a broker dealer must comply with NASD advertising rules, and since about 75 percent of 529 plans are sold through brokers, investment-related disclosure in advertising is fairly consistent across 529 plans.
However, fees are not disclosed in the uniform way in program materials with some programs including costs, such as annual maintenance fees, while others do not. We believe that all fees should be transparent and should be included in investment performance information. We have worked with the States as they develop the draft guidelines that will standardize both the kind of information disclosed as well as its location.
Similarly, we support improved disclosures of potential home-State tax benefits. Under the MSRB guidelines, broker-dealers must provide disclosure to clients of any potential home-State tax benefit. However, the location of that notice in the program description is not standard among plans. We believe this information should appear on the first page of the program description to help both investors and their financial advisors. That statement, however, should also indicate that tax treatment is only one of many features that should be weighed by investors in selecting a 529 plan.
Page 18 PREV PAGE TOP OF DOC Fourth, ensure suitability. Under our securities laws, broker-dealers must ensure that products that they sell to their clients are suitable for them. The variety of different 529 plans as well as other education savings vehicles can make choosing the right one a difficult and confusing exercise for investors. Registered representatives and financial advisors help investors make the right investment decisions by encouraging their clients to consider a variety of factors when reviewing college savings plan options.
And fifth, improve investor education. Investors continue to state that they lack the knowledge about investing and that they want the securities industry's help in educating them. We have recently updated our free guide to understanding 529 plans to include a list of questions a 529 investor should consider before investing in a particular plan. In addition, our investor education website, pathtoinvesting.org, includes information on 529 plans as well as opportunities to invest in a hypothetical account.
In conclusion, Mr. Chairman, SIA is committed to ensuring that 529 plans remain among the best possible products available to save for higher education. We have met with members of the 529 task force established by Chairman Donaldson, and we will continue our outreach efforts to promote a greater awareness and understanding of 529 plans. We look forward, Mr. Chairman, to working with you, the regulatory agencies and State officials to make permanent the Federal provision for tax-free withdrawals on 529 plans, achieve tax parity among the States, improve disclosures, and provide ongoing education on 529 plans and other appropriate investments. Together, we will expand the opportunities for all families to save for their children's education, the most important investment in our future. Thank you very much.
[The prepared statement of Marc E. Lackritz can be found on page 89 in the appendix.]
Chairman BAKER. Thank you, sir.
Our next witness is Mr. Michael A. Olivas, who holds the William B. Bates Distinguished Chair in Law and who appears today as the director of the Institute for Higher Education of Law and Governance from the University of Houston Law Center.
Page 19 PREV PAGE TOP OF DOC Welcome, sir.
STATEMENT OF MICHAEL A. OLIVAS, WILLIAM B. BATES DISTINGUISHED CHAIR IN LAW AND DIRECTOR, INSTITUTE FOR HIGHER EDUCATION LAW AND GOVERNANCE, UNIVERSITY OF HOUSTON LAW CENTER
Mr. OLIVAS. Thank you Chairman Baker, members of the committee and the subcommittee. I appreciate the opportunity to present testimony this morning and to share some of my research on prepaid plans and college savings plans which I have been studying since they began. I will spare you the details. These are available in fine bookstores everywhere and soon to be a major motion picture.
I would like to draw your attention to a number of the issues raised by a colleague, Joseph Hurley, whose annual book, the Best Way to Save for College, rates these various State plans. For example, he lists them according to eligibility or who is able to open an account, an issue that is not as easy as it seems on the surface: The time or age limitation on the beneficiary or the eventual user; age-based investment options; static investment options; the underlying investments; fees and expenses on a variety of bases; the broker distribution fees; contributions both the maximum and the minimum; account changes, such as beneficiary changes, transfers in ownership and other kinds of things like this, including the ability to transfer to a sibling or a relative; full faith and credit, whether actual or political full faith and credit; State income-tax deductibility exemptions from creditors; whether or not these are subject to involuntary transfer alienation clauses; and reciprocity with a variety of other State plans.
As students and these plans become more portable, these issues are going to continue to vex both enrollment managers, higher educators generally as well as parents and the children. Of course, these very many options reflect the maturity of investment markets and make the various plans extremely popular with parents and other investors, especially those plans that offer enhanced portability and the collateral State tax benefits as program choices.
Page 20 PREV PAGE TOP OF DOC Of course, these investors have many choices among investment funds, especially in the State savings plans. A number of States offer multiple plans. It was mentioned this morning that one State offers at least 17 at last count. As attractive as these choices are, an observer cannot help but question whether a State program really requires as many investment choices for contract purchasers, each with a different and often unclear fee structure, investment mix and track record. The marginal advantages may not be evident in any annual review while the State's supervisory role is made much more complicated by the extremely complex bid and review process, especially in States with intricate procurement and investment regulations.
This lack of transparency is the clear disadvantage held up to the mirror of enhanced investor choice. In my judgment, we may be verging on a system where there are too many choices for most investors and the system's complexity renders comparable choice shopping too complicated for most investors, particularly for those who participate because they are risk-averse in the first place and do not feel comfortable simply investing in traditional instruments, beating the markets or having bank accounts.
There is almost too much dynamism in these plans as the various States compete with other State plans to offer more plans and more complex options so as to attract more contract purchasers. A system can have too many choices and can intimidate or paralyze unsophisticated buyers especially in markets that are planned to be churning markets.
This system complexity can be a barrier to market entry for some persons. Yet another issue is that the range of investment options may have unintended consequences. Diverse plan options may encourage purchasers to place all their eggs in one basket. I have been concerned about the rise of single mutual funds as State options both with and without brokers in a number of State plans.
My concern is that people in traditional marketplaces might choose mutual funds due to their broadly based mix of stocks or bonds, in some instances, when individual contract purchaser needs may be poorly suited to such vehicles. Whenever information, such as how to best allocate and invest in State programs, is at a premium, the persons least likely to participate or prosper are the less well-educated, the very group at whom these programs are aimed, the poor, immigrants and minorities, especially linguistic minorities.
Page 21 PREV PAGE TOP OF DOC Thus, system complexity in State prepaid and saving plans programs, even in States with low barriers to entry and monthly payment options such as those in Georgia, attract and reward the most advantaged and knowledgeable participants much like the college application process itself, which so clearly serves the interests of advantaged and wealthier students. If information and investor savvy are needed for these dynamic investments, State prepaid and savings plans will widen the gap between the wealthy and the poor, majority and minority, street-smart and average persons.
Finally, I note that my earlier concerns about the viability of these programs have largely been met by the emergence of legislation and favorable tax treatment, including legal developments. After all, there are a number of us in the 1980s that were wondering how we were going to pay off the funeral of these plans before they received tax treatment favorable by this legislature.
However, as in any other public program, it is clear that the wealthy have more options, and the poor cannot afford to avail themselves of various tax vehicles or savings programs, although they value higher education for their children every bit as much as do the wealthy.
I urge you to facilitate truly comparable disclosure requirements, full and open participation data which we do not have at present, usable program investment performance and comprehensive eligibility and enrollment information.
Because of unique State conditions and political considerations, each State has fashioned its own plan or plans, and maybe, we should just rejoice in the thousand flowers that are blooming. But I fear that the program complexity has made this generous and useful universe off-putting to many parents and would-be contributors. I urge, at the very least, standardization and uniformity with regard to fee disclosures, which we do not have. And it is not clear to me that those governed can govern themselves in this regard. That is, it is not clear to me that the States are in a position to gather this information and report. I believe that this would be very troubling, and I think we have a number of categorical precedent's for this that this committee is aware of as no other.
Page 22 PREV PAGE TOP OF DOC I have attached a copy of the various State plans taken from a recent article, also available in fine book stores everywhere. I hope that this will be a useful starting point and will be useful to readers, and if I may answer any questions or elaborate upon these views, I would be certainly pleased to do so. Thank you for this opportunity to share my research and my thoughts with you.
[The prepared statement of Michael A. Olivas can be found on page 133 in the appendix.]
Chairman BAKER. Thank you very much, sir. We appreciate your attendance.
Our next witness is Mr. Daniel McNeela, senior analyst, Morningstar, Inc.
STATEMENT OF DANIEL MCNEELA, SENIOR ANALYST, MORNINGSTAR, INC.
Mr. MCNEELA. Thank you for the opportunity to appear before this distinguished committee. My name is Dan McNeela, and I am a senior analyst with Morningstar, Inc., an independent investment research firm that provides data and analysis on mutual funds and other investments.
More than a year ago, we began to cover 529 plans which, as our research has shown, have much to offer. Now, I lead a team of four analysts that reviews all 529 plans in existence. Our analysis shows that a well-chosen 529 plan is an attractive investment vehicle. To inform their decisions, we write commentaries that detail the benefits afforded to 529 investors. Such advantages include considerable investment flexibility, tax advantages, high contribution limits, and diversification.
That said, my testimony today focuses on the shortcomings of 529 plans. Several areas are in need of substantial improvement. All too often high costs, poor disclosure and unreasonably complex structure greatly diminish their potential value. Some of our greatest concerns relate to the myriad costs investors pay to participate in a 529 plan. Investors face enrollment fees, account maintenance fees, administrative fees, management fees and, in many cases, broker fees. Some of those costs are dollar-based while others vary depending on the amount invested in the plan.
Page 23 PREV PAGE TOP OF DOC Calculating the specific fees associated with a particular investment option can be a major undertaking. Most plans are set up as funds of mutual funds whereby a single investment option represents a basket of underlying funds. To arrive at the total expenses of a single investment option, investors must first prorate the costs of the underlying funds depending on their weighting in the portfolio and add the costs of all those funds together. Any associated administrative fees and broker fees, if applicable, must be added to arrive at a total. Even at that point, dollar-based fees are left unaccounted.
That process is frustrating enough for individual investors, but most 529 plans exacerbate this problem by burying this important cost information in the back of a 100-page-long program disclosure document. At its worst, the complexity of the cost structure and the reluctance to make the information easily accessible amount to deceit on the part of 529 providers.
The simplest solution is to require plans to prominently feature cost information on websites and in their literature. Costs should be presented both at the base level, so investors can see what they are paying for, and in aggregate, to summarize the plan's expenses. In situations where costs vary depending on the chosen investment option, a total cost for each investment option should be clearly outlined. In effect, this summary expense data would serve the same purpose as that of expense ratios for mutual funds.
Finally, 529 plans should heed the call that mutual funds are hearing for better cost disclosure by providing cost estimates in dollar terms as well as percentage terms. A projection of a total cost based on a $10,000 investment would serve investors by making comparisons between competing plans much easier.
Clear disclosure of costs in both percentage terms should help alleviate the other major problem of 529 plans. In short, too many plans are prohibitively expensive. One reason plans are so expensive is that several large groups are in line to collect fees. With States, fund companies, brokers, and third-party administrators all putting their fingers in the pie, it is no wonder that investors can end up with a knuckle sandwich. Anyone who says that costs don't matter is most likely a recipient of those fees. Plan costs come out of investors' pockets on a dollar-for-dollar basis.
Page 24 PREV PAGE TOP OF DOC Although the debate between low cost index funds and more expensive actively managed options is worthwhile, overcharging for lavish advertising campaigns and bloated administrative expenses is reckless and unfair. A recent review of 529 plans turned up several with investment options whose costs approach or exceed 2 percent of assets for Class A shares. This figure does not include front-end sales costs, which can be as much as 5.75 percent of assets, or any dollar-based fees.
Collectively, these expenses significantly diminish potential gains. If long-term returns before fees average 6 percent annually, expenses could consume more than a third of investors' potential gains. The difference between paying 1 percent or 2 percent in annual asset-based fees may seem minuscule to uninformed investors, but presenting those costs in dollars and cents and projecting them over a multi-year period will shed light on this issue. In the aggregate, we can see how meaningful the potential differences become. With $47 billion currently in 529 plans, a 1 percent asset-based fee costs 529 investors $470 million annually. At a 2 percent fee level, annual costs to 529 investors rise to $940 million.
Although fees and their transparency are important issues, 529 plans also have a responsibility to disclose how fees are used. This concern focuses on administrative fees which vary greatly among plans. Tennessee's plan, for example, is cheaper than average overall because it uses low-cost index funds and lacks a broker sold option. Its cost structure is also simple because it charges a flat 95 basis points regardless of the investment option. But Tennessee's administrative costs are unreasonably high. The plan's disclosure documents do not explain why it costs nearly 50 percent more than nearly identical plans offered by Michigan and Missouri. Tennessee charges as much as 0.88 percent in administrative fees without accounting for that how that money is being used.
By comparison, Utah reports that it has been able to cover its operating costs by charging a mere 0.25 percent in administrative fees. States that offer 529 plans need to be accountable for fees. Citizens have a right to know how their money is used.
Page 25 PREV PAGE TOP OF DOC The first step towards achieving that goal is improved disclosure. We believe that States should tell investors how much money they collect and where that money ends up. Are fees paying for splashy advertising campaigns or defraying the costs of other projects? To date, States haven't felt compelled to provide answers.
In a similar vein, residents receive little information regarding how their States' selected fund company partners. States should be forthcoming about the selection process and criteria used. They should fully explain the terms of the deal, including any benefits the States will receive and how their choice serves citizens.
The final area in need of improved disclosure is the evaluation of performance. Investors currently receive information regarding the performance of the various investment options for both short-term and long-term periods, but to grasp how well their plan is performing, investors need to see the performance of relevant benchmarks alongside the plan's returns. These benchmarks should reflect the asset classes in which the investment options are invested.
Because many of the investment options include both stocks and bonds, blended benchmarks which combine returns from different asset classes are most appropriate. It is important that this comparison relates to the actual performance of investment options net of all asset-based fees. If this is done properly, plans saddled with poorly performing funds and high cost structures will have few places to hide.
As a supplement to those numbers, plans should provide investors with a written commentary explaining why the investment options did better or worse than their benchmark. This analysis, which need not be lengthy or complicated, would markedly demonstrate accountability. Thank you for your time.
[The prepared statement of Daniel McNeela can be found on page 129 in the appendix.]
Page 26 PREV PAGE TOP OF DOC Chairman BAKER. Thank you very much, sir.
Our next witness is Mr. Mercer Bullard, who appears here today as president and founder of Fund Democracy, Inc., also an assistant professor of law at the University of Mississippi.
STATEMENT OF MERCER E. BULLARD, PRESIDENT AND FOUNDER, FUND DEMOCRACY, INC., AND ASSISTANT PROFESSOR OF LAW, UNIVERSITY OF MISSISSIPPI SCHOOL OF LAW
Mr. BULLARD. Thank you, Chairman Baker and Members of the subcommittee. And thank you also for the opportunity to appear before you to discuss 529 State tuition savings plans. It is an honor and a privilege to appear before the subcommittee today.
I will focus my remarks on the issue of fee disclosure by 529 plansand that is 529 savings plans, not prepaid plansand begin with the aspects where there does not appear to be much disagreement. There seems to be little disagreement, for example, that 529 fee disclosure is inadequate. 529 plan fees are hard to find. They are hard to understand, and they are not standardized so as to permit easy comparison across different plans.
The transparent disclosure of fees is critical to the efficient operation of any market, and the 529 plan industry is no exception. Unless and until 529 plan fee disclosure is reformed, plan participants will pay higher fees than they otherwise would pay.
It would not be surprising if there were also general agreement about general minimum standards for 529 plan fee disclosure. 529 plans are in many respects similar to mutual funds, and 529 plan assets are primarily invested in mutual funds. Therefore, mutual fund rules are likely to provide at least a reference point if not a baseline for 529 plan fee disclosure.
This brings us to areas of potential disagreement. For example, as the subcommittee is very aware, there is substantial disagreement by the adequacy of mutual fund fee disclosure. The SEC has admitted that current mutual fund fee disclosure requirements are inadequate and has proposed rules to address some but not all of the most glaring deficiencies. I hope that these problems will at least be fixed for 529 plans if not for mutual funds, and I have described in my written submission the minimum standards that I believe 529 plans should be held to.
Page 27 PREV PAGE TOP OF DOC In fact, I believe that fee disclosure requirements for 529 plans should exceed those applicable to mutual funds for two primary reasons. First, Congress enacted 529 plans for a specific purpose, to promote investment in higher education, and Congress is financing this policy with foregone tax dollars. Every additional dollar spent on 529 plan fees is $1 less that can be spent on higher education. Congress has a heightened interest in promoting competition and thereby lowering 529 plan fees.
A second reason 529 plan disclosure rules must go further than mutual fund rules is that 529 plans are subject to special constraints that further impede the operation of competitive market forces and necessitate more aggressive fee disclosure requirements. These additional anticompetitive constraints arise from the exclusive sponsorship of 529 plans by governmental entities. 529 plans issue municipal securities, which generally exempt the plans and their issuers from the rules that apply to similar investment products.
This means that participants in 529 plans are deprived of the benefits not only of fee disclosure rules but also a number of other rules that, in the private sector, have the effect of promoting competition or otherwise limiting fees. For example, mutual fund sales charges are subject to set limits; 529 plan sales charges are not. Mutual fund shareholders generally have the right to have their contributions invested and redeemed immediately at the fund's per share net asset value; 529 plan participants do not have these rights. Fund share holders have the right to vote on key fee increases; 529 plan participants do not. Fund shareholders can recover excessive fees in court; 529 plan participants cannot. Each of these mutual fund rules directly or indirectly limits fund fees, but these rules do not apply to 529 plans.
Furthermore, the State sponsorship of 529 plans creates conflicts of interests that generally are not present in the private sector, and these conflicts of interest may result in higher fees. States may set fees or hire managers based on political considerations rather than the effect on participants' interests. In one case, a State treasurer purportedly used 529 plan assets to run ads about the plan that prominently featured the treasurer, who was running for reelection. States, as a group, have a monopoly over the Federal tax benefits provided by 529 plans. And each State individually has a monopoly over that State's tax benefits. These monopolies further reduce price competition and increase costs.
Page 28 PREV PAGE TOP OF DOC State sponsorship of 529 plans means that there are 50 different sets of rules, thereby increasing costs for providers which they pass on to participants in the form of higher fees. Establishing one set of rules would reduce costs.
The absence of nondisclosure rules that promote competition and limit fees, States' conflicts of interest, the State's monopoly over plan tax benefits, the added compliance costs of 50 different sets of rules all argue for more aggressive fee disclosure requirements than in other contexts.
This is not to say that, if such rules are not adopted, all 529 plans would charge excessive fees. There are States that offer low-cost plans with reasonably clear although not standardized fee disclosure such as we have heard Georgia's plan described as well as Virginia's and Ohio's in today's hearing, and they are likely to continue doing so with or without new rules.
But this is not true of all States, and tailoring fee disclosure to the Vanguards of the 529 plan industry makes no more sense in the 529 plan context than it would in the private sector.
529 plan fee disclosure must be designed with a view to the sponsors, the States, for which mutual fund-like disclosure rules will not be enough to make them sufficiently accountable to market forces and insure that 529 plans serve their congressional purpose.
Another subject about which there may be some disagreement is who should promulgate and enforce rules for 529 plan fee disclosure. I believe that the SEC has unparalleled expertise and experience in developing fee disclosure rules. It also has the objectivity and independence, as noted by Professor Olivas, which the States lack that is necessary to interpret and enforce these rules. I would recommend that Congress authorize the Commission to enforce and enforce fee disclosure rules for 529 plans.
Also I want to specifically address the idea that Chairman Baker raised about an SRO and note that we just heard, for example, Ms. Williams talk about the standardization, and it is important, but immediately caveated that with the statement that Ohio must be able to shape and define its own plan to meet its own needs. And I think that we must wonder, when we hear that statement, whether for some States, perhaps not Ohio, that is going to mean that they will want to go their own way regardless of what standard arrangements that Ms. Cantor may reach.
Page 29 PREV PAGE TOP OF DOC Another thing to think about is in the creation of this SRO you have created a brand new regulatory entity that doesn't currently exist. We already have banks and the IRS regulating IRAs. We have the Department of Labor regulating employee benefit plans. We have got the SEC regulating variable annuities. And query whether you want to have a new regulator with a whole new set of rules, one that is now answerable to possibly 50 different interpretations of those rules to administer this new securities product.
And another thing to think about is this issue will not stop with the disclosure of fees. It will go on to disclosure of performance and performance and standards, as Mr. McNeela just mentioned. It will go on to the issue of whether there should be limits on loads, as soon as some broker dealer exceeds the NASD loads on the ground as permitted under MSRB interpretations that they are providing additional services. There will be further debates about what substantive investments are made in 529 plans. What is going to happen the first time that a State decides to invest in companies in-state in order to help that State's economy? What is going to happen when the first state offers an Internet fund, the equivalent of an Internet fund in 2006 and somebody sees 40 percent of the investments that they made for their kids' education go down the tubes in 1 year as we know can happen? These are the things that are going to have to be dealt with sequentially by a new SRO. And the irony of this is of course that we have been here before. With the National Securities Markets Improvements Act it was precisely the inability of the states to standardize disclosure requirements that they were applying to mutual funds that caused Congress to enforce that standardization.
And I believe that that has been a great boon for the industry. It is simply inconsistent with the concept of Federalism that we would could expect States to get together and rigorously enforce standards that would apply to all of them or, in fact, none of you would need to be here. The States could simply do that on their own.
So as you can see, I have a bit of skepticism generally about State actors and the private sector, and particularly as Professor Olivas mentioned, having those State actors in the private sector regulate themselves.
Page 30 PREV PAGE TOP OF DOC So in conclusion, despite the inadequate state of the 529 plan fee disclosure, this product is still relatively in its infancy and regulators have a real opportunity to get it right from the start. We know how good fee disclosure promotes competition, reduces fees and creates wealth. And in this case that additional wealth creation will go to the worthy cause of higher education. I would be happy to help with the answers to any questions if you have them.
Chairman BAKER. Thank you, sir.
[The prepared statement of Mercer E. Bullard can be found on page 47 in the appendix.]
Chairman BAKER. Ms. Cantor, I would start with just the obvious, since the product is relatively new, there are still many parents learning about it and the dramatic growth we see over the past 3 years, perhaps is just a very modest indicator of what the future may hold with regard to national participation. That, in itself, would make congressional interest even more sensitive to appropriate management standards of disclosure and transparency. Given the fact that the network recently adopted a draft of principles, what would be your expectation as to a final accord being formally adopted that would be able to be reviewed by the public and Members of Congress as well? Is there a time line? Or what is your expectation?
Ms. CANTOR. Thank you for that question, Mr. Chairman. Regarding the process that we would like to continue with the guidelines that we promulgated and adopted last week, which, by the way, were a joint partnership effort between the public and the private sectors, our next step, as we promised the SEC task force, is to sit down with them under Chairman Oxley's direction to have them review with us the guidelines, get their input, work with your staff here on financial services who have a copy of the guidelines. It is a work in progress.
There are still States and their counsels who are making comments and making suggestions. We welcome all opportunities for input. We are hopeful that in the next several weeks over the summer months we will be able to work with our partners and with the regulators to provide a comprehensive set of guidelines that we look to provide to the members of Congress.
Page 31 PREV PAGE TOP OF DOC Chairman BAKER. With regard to similar efforts in other related matters, in the insurance world, we have 50-plus different regulatory structures, with varying degrees of enforcement authorities within the various States. And we have been working with the NAIC and others to try to reach some national standard to allow for more uniform sales practices and enforcement capabilities. And that has gone on for some number of years. And we are really, although having made some modest progress, we are not very close to the goal which many members of the committee would support.
And that is the reason for suggesting that if you reached accord on a model standard of disclosure, as for example, and had perhaps a product or two in response to Mr. Olivas' concerns about having too many choices for the confused average consumer, if you had a standard national product that all States would offer that could be compared A to B to C, and if the State complied with all of the model requirements which your network would adopt in consultation with the SEC, that could then lead the State to earn a nationally recognized standard of conduct, for example.
I really view that almost as the minimal sort of step that could be taken to avert where we don't want to go, and that is ultimately some Federal intervention to set a model up. I really like the idea that innovative people come up with products that meet consumer needs. In some States, there are much higher per capita income than others. Smart people are going to go wherever they can to make money for their children. And we can't keep people from investing where they think best for their own future.
So merely the fact you offer more products is not a bad thing. But having some measure of comparability so people understand what they are buying when they are not the sophisticated investor, I think, is the general concern. Because this is the roadway out for many young people to become those sophisticated investors, and we certainly want to make sure that average working families can make clear choices based on comparability. Given the fact we don't really have a firm time line, could we expect something within a year or two as to a final product? Without boxing yourself in unreasonably, how long a clock would one expect the Congress to wait while the self-regulatory process works?
Page 32 PREV PAGE TOP OF DOC Ms. CANTOR. I would be hopeful that by the end of this calendar year we would be able to have something well withinby the end of 2004 should not be an issue to present something to Congress. And again, you know, asking the support of your staff to work with us along the way would be most helpful in moving forward some ideas that would be, you know, optimal in your opinion.
The one thing that I always do want to mention, and I always use especially the example of your own plan in the State of Louisiana, where your State has crafted a program specifically for Louisiana residents that they feel, you know, best suits the citizens there, which is an amazing type of matching program into the 529 plans where certain States that have put in incredible benefits for their own citizens based upon their own needs. We have to make sure that we encompass the individuality of some of those plans into a structure that would be a model guide line.
And so that is what we are working to do. We will seek the input of every single State administrator in the country to make sure that we understand the complexities of their programs. We have been able to get the guidelines put together in a relatively short amount of time. So I am hopeful with the support of the SEC task force, and again with your staff, we will be able to move pretty quickly.
Chairman BAKER. I think the last piece of that and my time's expired, is the idea of a single product that could be offered everywhere so you could have clear concise comparability on a very limiteda very safe, an S&P index kind of not actively managed fund, so someone could pick that up and look at Mississippi or Louisiana or Texas and say, well, my State's doing pretty well or I am okay with this little extra charge because ofI think it is a little daunting when you sit down and try to go through 12, 13 plans and really figure out what that means to you 15 years hence. Particularly, when, if it is a basket of underlying mutual funds where you really don't know the managerial costs associated with that mutual fund nor how to calculate it for those 12 or 15 funds. But I appreciate that. And let me move on.
Page 33 PREV PAGE TOP OF DOC Mr. Baca, did you have questions?
Mr. BACA. Yes. Thank you very much, Mr. Chairman. And thank you panelists for being here and discussing the 529 plans. My particular question is who knows about the 529 plans. This is part of the problem that we have right now I know that there are 22 States and the District of Columbia that provide State tax deductions to residents who invest in 529s. What are the 22 States and why aren't other States participating?
Ms. CANTOR. Is that question for me, sir?
Mr. BACA. Any one of you can answer that.
Ms. CANTOR. I think the issue of who is providing a State tax advantage goes back to the creation of these plans at every State legislature, and so there are several States, as you know, around the country who don't have a State income tax structure, which is why you don't see, you know, Florida and Texas for example offering any State tax advantage. That is where you start to see some of the disparity in 529 plans which, if you go back to the beginning, are mutual fund securities. So at the base level, these are like municipal securities that the States are issuing with their partners in the financial services industry. And that is where you find some of the different State tax treatment. As far as who knows about these plans, you know, it is a huge effort on behalf of the States to work with their partners to perhaps make marketing decisions that may not be made just in the private sector.
It is a goal I know of the States of Ohio and Virginia, in particular, to reach those middle income and lower income families who get lost in the shuffle, not, you know, poor enough for financial aid, if you will, but nowhere near being able to meet the cost of higher education. We conduct marketing campaigns that maybe traditionally would not be a great marketing decision. They are questions that Ms. Williams and I face every day from our State legislators when we testify during our legislative session some of the first questions we get are how are you reaching all Virginia families and all Ohio families.
Page 34 PREV PAGE TOP OF DOC So we make extreme efforts to make sure that we are reaching all families in our States, and I know the other States around the country are doing the same in these partnerships that are truly unique. But the differences between the State tax legislations typically come from the creations of these plans and the amendments that legislatures are able to do. And as was mentioned, I think, by one of the panelists that sometimes State budget issues, today is truly the reason why you are finding, you know, hesitancies or the lack of any type of State tax additional benefit added on to these plans. I believe in the future you will see more and more of that as our economy continues to recover.
Mr. BACA. So what you are saying is that each State has to create its own plan. As we look at standardization, there are certain States that are not participating and in order for them to do that they have to develop their own plans, correct?
Ms. WILLIAMS. Well, every State
Mr. BACA. Or approval from the State legislators.
Ms. WILLIAMS. Yes. These are statutorily based typically because they need to be sponsored by States. They can also be sponsored by higher education institutions, but they generally have been created by statute and every State now offers 529 plans. Only 22 states choose to offer a tax deduction in combination with their plan. So that is the difference. Some States choose to offer a tax deduction and others do not. And I think it is very seriously connected with what the particular goals of that State are.
In Ohio, we have a goal to significantly increase the number of people who are actually attending colleges in our State. We have traditionally been a manufacturing economy and now we have a significant need to increase the number of people who are going to attend college in our State. And our State has felt that it was important to associate tax benefits with these kinds of savings, so I think that is the variability that does occur between different States.
Page 35 PREV PAGE TOP OF DOC Mr. BACA. I see that as very important, especially as I see the State of California increasing its tuition fees. Many of these students cannot even go to a State college or university. They will be going to our community colleges, so I see the need for these kind of plans and others. But what percentage of those in the plans are Hispanics? What kind of marketing tools do we have reaching out to Hispanics? We represent 16 percent of the total population of the United States, 42 million people right now, 700 billion in purchasing power.
So when you look at having access to community and to State colleges and universities, what is currently in plan in terms of marketing? Do you have any statistics or data that shows what percentage of people participating in the plan are Hispanics, Blacks, or Native Americans?
Ms. WILLIAMS. I can try to answer that. Although we try to collect those kinds of statistics, typically that information is discretionary, as is income. So what we typically find out is that people don't generally report that kind of information to us since it is voluntary. In the case of Ohio, we have a staff of 35 people and we have five marketing reps who arewho actually work out of their homes and live in various regions of the State. And their job, despite the fact that our product is sold through financial advisors, is to market the product through public events such as baby festivals and ethnic fairs. We also send a newsletter out to every elementary school student in our entire State which they take home to their families. We
Mr. BACA. So are you saying then that in reality, maybe we are not even targeting Hispanics since that information isn't even provided?
Ms. WILLIAMS. I don't think that is true. I know that we target every
Mr. BACA. It is up to the plans to target Hispanics, to make them aware that this is even available for them. I would have loved to have participated in these plans. I have a child that is going to go to a university next year.
Page 36 PREV PAGE TOP OF DOC Ms. WILLIAMS. Well, I can only speak for our State, and I know that we have an extensive effort to target every single ethnic group in our entire State. We work through churches and
Mr. BACA. But you don't have a percentage so we don't really know what percentage are actually targeted.
Ms. WILLIAMS. Unfortunately I don't have a statistic.
Mr. BACA. So then we need to make sure that as we look at the work in progress and the model that is going to be used that we develop a good marketing plan that reaches out to our communities, to make sure that they are also eligible to participate or want to participate.
Ms. CANTOR. Congressman Baca also, California for instance has a Spanish Web site that contains the information.
Mr. BACA. Yeah. But not everybody has a computer in California. That is nice.
Ms. CANTOR. Right. I do know also that several States, I know in our home State here in Virginia, we issue our materials that go to every student in the State is available in Spanish. If anyone calls our lines at the State agency, we have Spanish speaking employees who deal with the Hispanic population. We have targeted marketing campaigns every year to reach the Hispanic minority community and the African American community and the Asian community. So it is a big push on behalf of the States that contain, you know, ethnic populations thatI know it is a huge push in Texas. The commercials are in Spanish. And I think that there has been greater and greater success in reaching communities by speaking a language that everybody can understand. I know the National Association of State Treasurers has Spanish educational Web sites also available that you can access at the public libraries, and I do know about the
Page 37 PREV PAGE TOP OF DOC Mr. BACA. But you have got to be aware that these plans exist, because if not, then they can't access them. Miguel, it seems like you wanted to say something.
Mr. OLIVAS. Well, only that I am a native Spanish speaker and let me just tell you my confusion is not ameliorated by reading these things in Spanish, nor would it be if I were a Vietnamese speaker. Let me tell you the problem is not necessarily translating these materials into Spanish or other languages. Native English speakers cannot make sense of many of these materials, let me just say. If you try, if you ever bought for your daughter a telephone plan, a portable telephone and then multiply that times 10 and try and find out how she is going to use it for 18 years, and put down a lump sum or try and invest; are approximating that kind of complexity.
And I am not certain that the answer is simply publishing it in more languages, although I think that the States, to their credit, have actually marketed these things very well. To me the question isn't that we are not marketing these things well enough. The question is how much information all users have, whether bilingual or whether native English speakers or native Spanish speakers or Hmong speakers. The question isn't whether one can go to a Web site that is bilingual.
The question, in my view, is whether or not you can make sense of that and whether or not you have confidence that the program is still going to be there. And I would have expected some convergence of these plans. Because some of these plans are actually being enacted at various States by national players who draft these plans and simply in some instances have turn keys in some of these States.
In an article I wrote on my native State of New Mexico, it is pretty clear to me that there is not much New Mexican-ness to that plan, which is done by a program that doesn't exist in New Mexico, except in this form. It is headquartered outside of New Mexico and it simply rents space in New Mexico to enable its plan to be enacted there.
Page 38 PREV PAGE TOP OF DOC [speaking Spanish.]
Chairman BAKER. Mr. Baca, I need to move on to Mr. Tiberi, if I may. We will come back with another round.
Mr. TIBERI. Thank you, Mr. Chairman. I was hoping we could maybe get an Italian plan in Ohio. Ms. Williams, the Ohio plan which was established in 1989 before I went to the legislature is a fabulous plan. As a participant now, as a father, I want to compliment the leadership that you have provided. I wish that we would have had a plan sooner, so I could have taken advantage of it as a college student. In your written testimony, you mention that in Ohio, we have recently gone through an overhaul of materials, since we are talking about marketing, that is put in place to try to simplify fee disclosure. Can you describe to us what fees are disclosed and where the fees are disclosed in this marketing material.
Ms. WILLIAMS. Sure, I will be glad to, Congressman. We completely overhauled our entire offering materials and we have a one-page document now in our offering statement which shows all the over 30 options that we offer, exactly what the program fees and expenses are. It shows the fee that our agency collects in order to help administer the funds. It also shows the underlying fund fee and the total annual expense ratio. So we have laid it out on one page. We have also taken great pains to create a new document that is a risk tolerance questionnaire that we have made available to an individual who is walking through the product.
And it is a series of a few questions that help that individual to identify what kind of saver they are, what kind of risk tolerance they take. And then consequently, they can look at the list of our products and determine what products might be in their own best interest.
So this is the start of a process to be much more clear and consumer friendly, in order to enable people to be able to make the best possible decisions for their families.
Page 39 PREV PAGE TOP OF DOC Mr. TIBERI. For participants in Ohio, in addition to the tax benefits that you spoke of in your testimony, what other benefits are there for participants from an Ohio perspective?
Ms. WILLIAMS. Well, we work with Ohio employers, for example. We work with almost 2000 Ohio employers to allow people to contribute through the workplace. We actually go on-site. We market, we talk to people at their place of employment. We have no annual fee for Ohio residents for this plan. There is no enrollment fee for this program at all. We try to make this program available and accessible everywhere. We do targeted radio advertising. We do print advertising because we want every single child in our State who aspires to go to college to have some ability to save through this program. And while we know it won't cover the cost for most people, we think it is important that there are some resources available since the cost of college has at our public universities in Ohio has gone up 50 percent in 4 years.
Mr. TIBERI. From your perspective, since 1999, when you became the administrator of the Ohio program, what has been the most common complaint from participants/investors?
Ms. WILLIAMS. It varies as our program has changed. You know, we have heard complaints about fees, we have heard complaints about accessibility. The biggest complaint was we had a 1-year moratorium on new contributions to our prepaid plan, which ends the end of this year. And the biggest complaint has been that that program is no longer available. And the reason being we simply could not keep up with the costs of rising tuition at our State universities. So it was a very difficult decision for us to make.
But that has been the biggest complaint in the entire time that I have been there. But we listen very carefully to our customers. We offer an 800 number. We communicate with them by the Web. And we really take into consideration their needs and desires and try to craft our plan in order to meet those.
Page 40 PREV PAGE TOP OF DOC Mr. TIBERI. Thank you. One last question for Ms. Cantor. What do you think from where you sit nationally, of dollar cost disclosures percentage cost disclosures and how does the college savings plan work draft deal with those two issues?
Ms. CANTOR. I think those are part of the guidelines that you will see. I think they are important. It enables, you know, families to sit down at their kitchen table and understand the types of dollars that will be coming out of whatever they are earning. So those are definitely a part of what we are looking at in the tables that will be disclosed in the future, and so I am hopeful that that will aid the transparency and the disclosure across the country of what will be taking place.
Mr. TIBERI. And most administrators agree with that, from your knowledge?
Ms. CANTOR. I think that the commitment of our industry and all the stakeholders to participate in the process has been unanimous. Nobody wants to be the one plan that stands out and is covered in the financial press as the worst program because the beauty about the plans is not only do the States have the sensitivity politically and otherwise to react quickly to the concerns of our constituencies, but we are also very sensitive to the attention that is paid to this and the reputation. The last thing you want is your State legislature or your governor to ask you why you are the only State that doesn't suit a model or doesn't have a qualification status or you know a gold standard or something. So I think we are very sensitive to that. It is not probably in the terms of private competition but more of our ability as State administrators to hold up our plans as models across the country so that we make our constituents happy.
Mr. TIBERI. Thank you.
Chairman BAKER. Thank the gentleman.
Page 41 PREV PAGE TOP OF DOC Mr. MEEKS. Thank you, Mr. Chairman. And let me justI will just throw out a couple of questions and just anyone can answer. Hopefully, and I apologize if they were asked already. But you know, having a 4-year old daughter myself, I am doing some of this college planning and so I want to make sure, and let me just ask, are there 529 plans whose fees are so high that they would negate the tax benefits of investing in the plan? That will be my first question.
Mr. LACKRITZ. Congressman Meeks, maybe I can address that. I know in the letter that Chairman Donaldson sent back to Chairman Oxley in response to the concerns about 529 plans, he raised the possibility that there could be fees that would be so high that they would, in fact, eliminate the tax benefit that would inure as a result of the plan. In reality, I think that is highly unlikely for a number of different reasons. But it is important from the standpoint that the fee structurethe different fees that advisors charge or that broker dealers charge when they sell these plans provide for a number of different services, levels of services that the plans provide. The key, I think, is to make sure that the disclosure is clear, that we increase competition by getting State tax parity across the board and encouraging more competition here and make sure the disclosure is fair open and let the marketplace and competition drive fees down so that they are as low as possible for everybody involved.
Mr. MEEKS. Okay. Well, and I know the plans, you know you talk about the fees, and you are shaking your head no. No, I thought you were shaking your head no.
Mr. OLIVAS. It was an inadvertent twitch.
Mr. MEEKS. Oh, okay. Since 529 plans became law in 1996, do we have affirmative evidence I would say that they have truly been effective in helping parents save money for their children's college education, or is it still too early, we don't have enough of a test.
Page 42 PREV PAGE TOP OF DOC Mr. OLIVAS. Well, there is some scholarship, and I recommend it as a cure to insomnia for the most part. Economists have begun to turn their attention to this, and I think that there is no evidence yet that there has been substantial diversion into these plans by people who would not have otherwise done so. This is the hard part to measure. Many of the people who participate in my estimation are people who already had the proclivity to do so and are seeking instead of putting money into a coupon bond or some other investment vehicle, are trying these particularly whether there used to be full faith and credit for the prepaid plans that would guarantee no matter how much the cost went up it would be covered. But that, of course, is just a small number of States.
And as was suggested earlier, as indicated earlier, Ohio and others have put those on hold. Of course, they will still pay off to the participants, but they aren't taking any newcomers. And so you had to be first there. Well, I simply ask who was always going to be first? It was going to be the most advantaged, the wealthiest and, in many cases, people who instead of putting money into other investments simply took this route. And so while I think that there is not definitive scholarship, I believe that this is intuitively obvious in the participation rates.
Mr. BULLARD. If I could add to that. To answer both your questions, it really goes to the way to think about 529 plans. If you think about them as an alternative to investing in a taxable account, then the question of whether the fees could erode the tax benefits is really a question of whether you would pay more in the 529 plan than you would otherwise pay in a taxable account.
And in my testimony, I have suggested some reasons why that might be the case. But more importantly, I think that is the way to look at it. And simply the fact that there are high cost 529 plans doesn't mean that they are destroying the tax benefit. They are simply reflecting the fact that we have high cost taxable account options. And we are also reflecting the fact that there are people who live in that marketing channel, and whether they buy the 529 plan or buy in the taxable account, they are going to pay high expenses. And that is not so much a 529 plan issue as an issue generally about the fees that people pay and decisions they make about using intermediaries for the most part.
Page 43 PREV PAGE TOP OF DOC Mr. MEEKS. So I guess the word is still out then, or the decision is still out as to whether or notbut obviously people who are lower income, whether they benefit from the these 529s because they don't have the disposable income to invest in these 529s in the first place, and then whether or not there are benefits to them, you know, as it results to the deductions in the respective States. Yes, ma'am.
Ms. CANTOR. Congressman Meeks, I would invite all the panelists and anyone else to listen in on some of our phone calls that we get back at the State agency and the visits that we have from police officers and teachers and first time students who are attending college as the first member of their generation to go to college about the family by family contacts that we have of who we are reaching and helping. And what we really like to stress, and what we have seen across our State, and I am sure is replicated across the country is the powerful message that these plans are sending to American families, that a higher education is not only worth saving for, but in many instances for families it is worth budgeting for and worth sacrificing for.
We get dozens and dozens of requests to send certificates from grandparents who are putting in $20 a month so that their grandchildren know that they have a future ahead of them to go to community college, to work as hard as they can on their grades because their parents are putting away some money every month. So although some of the focus today has been on the fee structures and disclosures and mutual fund investors, we really work with the families on a day-to-day basis and those families who may not have seen investing as something they wanted to do, and possibly having the State involved gives the family some extra security, that they can call up the State office, they can call their State legislator, they can call the Governor's Office if they have a problem if they are not getting service that they should demand and require from our programs.
So I am hopeful that you know more and moreover time, I know we are reaching them you know today. I am hopeful and our goal is in our States to continue to reach more of the population that would not necessarily be saving today. And you will find much are our marketing materials directed to that end.
Page 44 PREV PAGE TOP OF DOC Chairman BAKER. The gentleman's time has expired. Thank the gentleman.
Mrs. BIGGERT. Thank you Mr. Chairman. This has been a very interesting hearing. I wish that I had known about this when I had three children in college at once, but it was before the time of this, so maybe my grandchildren will benefit from this.
Mr. Lackritz, you mentioned in your written testimony something about the Coverdell Education Savings Accounts. Are those competing at all with these 529s?
Mr. LACKRITZ. Well, Congresswoman Biggert, in a way they are competitive because they are a savings vehicle for higher education. But the restrictions, the income limitations and the restriction on contributions is such that they, you know they are limited in contribution and deduction to $2,000 a year, and there are income limitations on eligibility as well so they are far more restricted and as a result participation is not nearly as wide. 529 plans really, going back to Congressman Meeks' question, 529 plans are a terrific for federalism here.
The innovation, experimentation and pioneering work of the States, coupled with the active effort at the Federal level have produced a remarkably successful plan. I mean in 3 years, the penetration rate in 529 plans has gone up to, I think it is 8 percent now over 4 million households and over $40 billion invested in these plans. I would suggest, the awareness of saving for education has increased significantly because of these plans. So all of that is to say, I think the 529 plan, the Coverdell Savings Accounts, educational savings accounts are another vehicle but they are much more restricted.
Mrs. BIGGERT. So they probably are not used as much or is that just because theyof the education. Which leads me to my next question. Could you just discuss in more detail the investor education programs? This is one of your brochures, I think that
Page 45 PREV PAGE TOP OF DOC Mr. LACKRITZ. Well, I am glad you got it. I was going to hold it up for people in case they were interested. We have an extensive investor education Web site. It is called www.pathtoinvesting.org, and it has sort of best of class investment advice. There is no selling of products or services specifically on the site. It is designed to help people understand the basics of saving and investing for the future.
It also provides a site for individuals that are getting into the market for the first time to participate in a hypothetical investment exercise where they can take a hypothetical $100,000 and invest that and sort of see what happens before they actually risk any of their own money. In addition, we have a number of different publications. Your guide to understanding investing is our sort of flagship publication which is put out by the same people and authored by the same people as using your guide to understanding 529 plans.
Mrs. BIGGERT. What feedback have you gotten from investors about the programs or about the education program?
Mr. LACKRITZ. It is interesting. They seem to like the information we are providing and they want more. It is almost like a public good. I mean, whatever we produce, they like it and they want more. So we are continuing to put out more guides, more help in different areas for investors to help educate them as much as possible.
Mrs. BIGGERT. Do you think that the States should adopt their own investor education programs or just rely on yours?
Mr. LACKRITZ. I would defer to the States on that. I think that we have terrific material and I think given the fact that our firms are expert and have great expertise in the capital markets and in helping individual investors invest for the future I think these are terrific program materials. We would make them available to States if States wanted to use them.
Mrs. BIGGERT. Do many of the States use them or is it just
Page 46 PREV PAGE TOP OF DOC Mr. LACKRITZ. Not yet. What we try do is to link our investor education Web site as broadly as possible and as widely as possible, and we have got a number of links to otherfor example, the Treasury now has an investor education financial literacy office specifically devoted to this. We are getting linked to that. We are getting linked to the SECs investor education Web site. We get linked to other Web sites as well.
Mrs. BIGGERT. Thank you. Maybe this would be to Ms. Williams or to Ms. Cantor. Mr. McNeela proposed in his written testimony that only States that don't discriminate against out-of-State plans, in other words, States that don't penalize for withdrawals from out-of-State plans deserve to have their plans defined as a qualified tuition tax savings plan and only those plans then would presumably receive all of the Federal tax benefits. What do you think of this proposal?
Ms. CANTOR. I think we go back to the beginning as we usually do, to get a good answer. These, again, Congresswoman Biggert are municipal fund securities. They are no different from a taxation basis in general from municipal bonds that are issued by a State. If somebody lives in the Commonwealth of Virginia and owns an Illinois general obligation bond, they are going to pay Virginia taxes on the earnings of that security.
There may be some States that give an additional benefit and maybe conform to the Federal tax exemption, but I think it is the prerogative of the States. I think that the focus of our industry really needs to be on the permanency of our Federal tax exemption. I think that is the one chilling effect that we are seeing out there for families, because in the interest of full disclosure, which it seems we do on every page, we are constantly reminding our investors that our Federal tax exemption does expire unless it is extended or put into permanency by 2010. And before we blink, as we all know as parents, 2010 will be here. And so that is something that we hope to work very hard with all of you on to help that chilling effect that is going on.
We even hear some financial advisors that have national showcases to communicate saying, well, maybe you shouldn't put your money in a 529 plan because the Federal tax exemption will disappear and people think the program is going to disappear. Just to reiterate about our education initiatives, all the States have extensive, you know education initiatives. Not only do we partner internally with the State higher education authorities, the State Treasury Departments on all their financial literacy awareness activities, we also partner with the securities industry association and other member associations to offer those materials.
Page 47 PREV PAGE TOP OF DOC We have them available to us. SIA has made those books available to all the States. We bring them to the PTA meetings. We bring them to our church meetings and so we make sure that families who want general information use the best materials out there. We also are able to model a lot of our own materials on good ideas to communicate more effectively. So I am hopeful again as time goes on, this is still a new industry at some level. We may not be newborn, but we are certainly toddlers, you know, toddling around and trying to grow to the next step. We are going to do the best we can to there in a strong and a consistent way.
Mrs. BIGGERT. Thank you. Thank you, Mr. Chairman.
Chairman BAKER. Thank the gentlelady. Mr. Sherman.
Mr. SHERMAN. Yes, Mr. Chairman I am going to take up so much of the committees' time tomorrow that I am going to keep my comments to just 1 minute.
Chairman BAKER. Oh, thank you.
Mr. SHERMAN. And that is to echo what Ms. Cantor said and that is we ought to call on the Ways and Means committee to either make this a permanent program, or not. But the phony tax budgeting where they put in a program that they intend to have permanent, but then they put in the law that it is going to expire, and then they wait a couple of years then they extend it creates a circumstance where it costs the Federal Treasury every bit as much as if the program was permanent, but the effect on encouraging people, whether it is these 529s, or whether it is the research and development credit which I realize is outside this hearing, but they come up with things they want to encourage that are long term plans, then they provide a tax credit that is going to expire in a few years and then they extend it with the effect that they get all the costs and only some of the encouragement. And I will yield back.
Chairman BAKER. Do you want to yield to Mr. Baca or to yield back?
Mr. SHERMAN. Actually I will yield to Mr. Baca. I thought he would be next.
Page 48 PREV PAGE TOP OF DOC Mr. BACA. Thank you very much for yielding to me. And I want to continue with the questioning that I addressed before. And I do appreciate the fact that we are addressing this issue because I think it is very important. This administration is actually cutting back additional funding for education, especially higher ed, the PALS Program and other programs. The States are also cutting back funding for our higher education institutions, our State colleges and universities. Is there a disparity in terms of the returns between a moderate-income person who pays X amount of dollars, who buys into the 529, plan versus those with low incomes?
Mr. BULLARD. The return on the investments will be the same. It will be on a pro rata basis based on the amount of the account as I understand virtually all of the plans. But another way of looking at that question is with respect to fees and one of the interesting aspects of these plans is that when you have an asset based fee, what you really have is a structure whereby the larger accounts are in fact subsidizing the smaller accounts.
So with respect to mutual funds and other aspects of the plans where there is an asset based fee, for example, one percent of assets a $100,000 account is paying $1,000 a year. The $1,000 account is paying only $10 a year and the $100,000 account is in effect subsidizing the smaller account. So this has always been a characteristic of the mutual fund industry but is essentially a kind of progressive pricing structure.
Mr. BACA. Right. That is why Chairman Oxley, in his opening statement, was concerned with the disparity of the fees and I was just asking why. Mr. Olivas?
Mr. OLIVAS. Well, I think that he was actually talking about a different matter, and I think that was the extent to which fees erode either the corpus or the return. I do think that people who have prepaid options or who pay a small amount per month, which I encourage, and the reason that I have encouraged these plans over the years is because I do think that the psychological encouragement of people to invest in their children and their grandchildren's education is paramount, and I have been willing, in many instances, to let the wealthy be advantaged even more because I think that it pulled along smaller investors as well, and I think that that is extremely important.
Page 49 PREV PAGE TOP OF DOC But I think that your question is do poor people get back as much as wealthy people, and that is always going to depend upon their tax situation. These are structured frankly for wealthy people. Poor people don't have as much to put in and don't have as much to shelter. And they participate accordingly in higher education. I think that these are largely a refuge of the wealthy. I think that the data, no matter how they are cut and no matter how many picnics these are sold at, essentially the wealthy participate. I think that that is simply a costwe are always going to have the poor among us. I mean, to some extent, we are always going to have that disparity.
Mr. BACA. That is why I am very much concerned with the outreach that is going on. We talked about the Internet and you mentioned earlier that even bi-lingual information doesn't increase access. So we need to continue to develop further outreach in terms of our communities. You mention, the PTA and the churches, but there are a lot of other organizations as well. Are we tapping those organizations in terms of availability of information of the 529 plans, so that people within our communities can invest?
But we want to make sure that people have access and opportunity to go on and not be denied because they can't afford to go to a State college or university. That is why I also agree with you in reference to standardization. Disclosure needs to be increased as well. And I do agree with my colleagues. So we must market to Hispanics and other groups who want to go to college.
Hopefully we come up with some form of a plan that can standardize the 529 plans and provide more of an opportunity to reach out to our communities.
Chairman BAKER. The gentleman's time has expired. And I want to get the other two gentlemen in. I am informed we are going to have a series of votes here shortly afternoon. Mr. Clay, I think you wanted to
Mr. CLAY. Thank you Mr. Chairman. I will be brief. I am not sure which witness can answer it. But President Bush has proposed an alternative savings option, the Lifetime Savings Account. There are concerns that LSAs would be in competition with 529 college tuition plans because the LSAs could be used penalty free for uses other than education. Can LSAs be designed in a manner that could coexist with 529 plans without siphoning off their investors? We do not have enough investment dollars in this country and we need more programs to induce savings. Why make them competitive? And can this be done? And if somebody could attempt to answer.
Page 50 PREV PAGE TOP OF DOC Ms. WILLIAMS. Representative, in my view, they would be difficult to coexist. I do think that if LSAs were created that they would siphon off savings that have accrued to 529 plans. And I think specifically of States like Ohio, which have added tax benefits to these plans, and I think that it would be a critical issue, which we would have some difficulty with because if we are going to provide some kind of Federal and other State tax advantage, it needs to accrue to a higher purpose than allowing people potentially to use savings accounts potentially for higher purposes, but maybe to buy a new wardrobe or for other such purposes. So I think it would be detrimental to 529s.
Mr. CLAY. Yes, sir.
Mr. LACKRITZ. Yes, Congressman, I would justI would respectfully differ a bit from Ms. Williams' response. We think it is really important to increase the level of savings in this country overall. And we favor any kind of measures that would help to increase overall savings. We think that the Lifetime Savings Accounts are more of a fundamental tax reform frankly than they are a specific account designed specifically for a particular purpose.
They also would not enjoy State tax benefits in the same way that 529s are, so we would favor the creation of lifetime savings accounts. I think that would be a complement in many respects to what is being provided now by the 529s.
Mr. CLAY. So you think that the two plans could coexist?
Mr. LACKRITZ. Absolutely.
Mr. CLAY. Thank you. How do we evaluate 529 plans when there is not sufficient information because of lack of disclosures to compare plans? What do you suggest we do to get the proper transparency needed for investors to make the best choice of investment plans, or do we need more enforcement? Or are sufficient resources in place already?
Page 51 PREV PAGE TOP OF DOC Ms. WILLIAMS. I think that the voluntary disclosure principles which the college savings plans network developed is a huge and important step to take us in this direction. I think the States have a vested interest in ensuring that their State plan represents them favorably in terms of the information that is provided. It is, in no State's best interest, to provide information regarding a program that is confusing and difficult to understand.
So I thinkand knowing from our perspective we are expending significant resources, time, money and attention, to talk to the public in order to make sure that we are disclosing everything that we need to legally, that we are making it very, very clear, very easy to understand, and I know from talking to my colleagues, that that is their goal as well. It is to help people make these important decisions, not to create confusion.
Mr. BULLARD. Congressman, just toI would have to disagree. History tells us that voluntary standards will not work. These programs have been offered for more than a decade, and what Ms. Williams has to say about the States not, you know, being in their interest to provide good disclosure has been true for that entire 10, 12-year period, yet they have not provided that disclosure. Without a strong enforcement mechanism, without an experienced regulator who can independently establish those standards, I think it is simply unrealistic to believe that this program will work when we have seen this kind of approach fail in the context of State regulation year after year after year with respect to securities products.
Mr. CLAY. Thank you for your response. I yield back the balance of my time.
Chairman BAKER. I thank the gentleman. Mr. Emanuel.
Mr. EMANUEL. Thank you, Chairman Baker, and thank you for holding this hearing. As you know, college costs went up 11 percent last year and 14 percent this year alone. And the truth is the most important thing you can get in life besides the love of your parents is a college education, and none of us would be in this room if it wasn't for either one or both of those.
Page 52 PREV PAGE TOP OF DOC But the fact is, there is the deduction of college tuition that hasn't really gone up. It is 4,000. It expires in 2005 for tax deductions. The Hope Credit, which was originally for community colleges, is stuck at 1,500 with the average cost of community colleges are around $2,000, and the 529well, community college is still on average around the country is around $2,000, and the Hope Credit needs to go up. It is the vehicle of keeping people involved in the changing economy and giving them a ticket to upward mobility.
On the issue here, in the 529, and I obviously apologize for having left and I had to go to another hearing. Some members talked about bringing uniformity, conformity and standardization to both the fee structures as well as thesome of the plans, and I want to associate myself with those words and those ideas because I think they are important to give people. I mean, just as a parent, you know, whether you are comparing mutual funds, health saving plans, insurance policies, college savings plan for your kids. I mean, there iswe all know this. There is X amount of hours in the day and you can say whatever you want. And giving people choice, but when you have all that choice, as we are now witnessing some of our seniors, who have plenty of time to look at savings plans on discount cards that, choice leads often to confusion, chaos and it is manufactured. It is not intentional.
And I do agree that if those who wanted to, the States wanted to bring that kind of access and conformity they would have done it already. The market would have demanded it. And so they need sometimes adult supervision to help bring that process about. And let me ask you one thing. On the $4,000 tuition deduction for college, 3,000 this year, next year and the next 2 years goes up to 4. According to a Harvard study, only 4 percent, only a third of the folks who are eligible take it. Two-thirds do not take the college tuition deduction. It is right on the 1040 form. It is available. It is one line. And that is about as accessible as it can be.
What is the eligibility universe for the 529 plans? And what is the world, and the percentage that take it? So what is use versus eligibility on 529s? Anybody can take a shot.
Page 53 PREV PAGE TOP OF DOC Mr. LACKRITZ. At least the numbers that I was given indicate that first of all, anybody can invest in these things. I think the good news about the 529 plans is there are no income restrictions. There are no limitations. And as a result, they are universalit is about the closest thing to a universal program I think that there is. And the numbers I was given indicate that about 8 percent of families have taken advantage of this.
So there are over 4 million accounts, 529 accounts so far. But that is in literally the last 3 years, since the 2001 tax legislation which I think clarified it considerably and created the tax free withdrawal provision. So from the standpoint of how quickly it has increased, it has increased dramatically in only 3 years and on that growth rate it is going to continue to increase substantially.
Mr. OLIVAS. That speaks to the numerator. The denominator is that these are kids not yet in school. I mean, some of these are 6 months old and we won't be able to know until 18 years. And so the denominator is increasing exponentially as well. And so speaking about the participation rates in the numerator is only a very small part of this. 8 percent would astound me if that were somehow close to the denominator. I think that you have to understand that given all the grandparents out there and so forth, to get your arms around the universe of potential participants is simply impossible.
Mr. EMANUEL. Of the 8 percent is thatwas there a big growth right after the 2001 Tax Code, and then it has tapered off, or do you see another spike coming? And is there anything more in the details of who is participating. Is it people with much younger kids, people with kids in their teens as they start to focus on this?
Ms. CANTOR. The average age of a beneficiary in these plans across the country is about 8 years old, if that gives you some sense. Also attached to some of the testimony you will see charts on the growth in these plans. One thing I also want to clarify that one of the other panelists said is that for the most part, prepaid tuition plans were the only plans that were around 10, 12 years ago. Savings plans did not really exist and start to come into creation until the beginning of the year 2000.
Page 54 PREV PAGE TOP OF DOC So if you really look at you know the ability of an industry to take hold of itself and to manage the growth that it is experiencing these are still relatively brand new plans. The savings plans have not been around for 10 years. And I would say that the States are doing a fantastic job of overseeing their plans and making sure that we move forward.
Mr. OLIVAS. These are plans that the State shut down as soon as it got too expensive to maintain them. That is not a record to emulate in the savings side.
Mr. EMANUEL. Did you want to add
Mr. BULLARD. I agree with Professor Olivas. I mean, if the States want to stand on their record of performance, then that is the best argument for why we need SEC regulation.
Mr. EMANUEL. I have no further questions Mr. Chairman.
Chairman BAKER. Thank you Mr. Emanuel. I want to express my appreciation to each of you. As you can tell, members had to come and go, but there is significant and considerable interest in this matter and I suspect as the plans grow in size, congressional interest will only go in one direction. To that end, I am very optimistic and appreciative for the work done by the network and hope that leads us to some consensus set of standards that perhaps by early next year the committee can return to this subject and evaluate the progress made.
I would also say to our scholastic academic studious analysts from the right, represented in various fine book stores, that if there is a way to assemble data from 2001, 2002, 2003, years closed from a handful of States, with a $10,000 typical or let's go $2,000 a year for each of 3 years, make your point.
As to the lack of equality in fees, whatever concerns that you elicited this morning in your testimony to the committee, give us more substance as to past performance. Now, this is not an indication, as I realize past performance is not an indication of future earnings. But it will give usI probably have some of those pieces of mail in my box waiting on me. But the point is, is it gives us a snapshot of where the problems may really be and that would help the committee in its evaluation of the model reforms which the network now has under consideration, and perhaps over a continued discourse in this matter we can come to some conclusion that is in everyone's best interest.
Page 55 PREV PAGE TOP OF DOC Clearly facilitating opportunity for educational college is something every American should support, and I believe they do. But making sure the system is working in a fair manner and that individual average investors are understanding what their rates of return are is something that is very, very important if that program is to maintain long term viability.
So I appreciate all of your various perspectives. We look forward to working with you in the future. Our meeting stands adjourned.
[Whereupon, at 12:07 p.m., the subcommittee was adjourned.]