The Two types of 529 Plans in Michigan
One of the most common questions I get asked is, "where should I save for my kid’s college?" Most clients start out by opening a savings account or CD for their child while they sift through the information to figure out where exactly they should put these funds. Leaving these funds in the bank can be appropriate for someone’s particular situation, however; a lot of individuals want the potential to earn more than what their bank is paying. That leads them down the path of selecting a 529 plan. Let’s walk through what a 529 plan is and what types of 529 plans are available in Michigan.
1. Prepaid Tuition - The Michigan Education Trust (MET) Plan
The Michigan Education Trust is a prepaid tuition plan. The plan allows you to purchase tuition credits to public universities and use them later to pay for college. You can select varying amounts of credit to pay for, from one credit hour all the way up to 150 credit hours (5 years). There are 3 different levels of tuition you can pay for.
1. The full benefits plan allows you to purchase tuition to any public college in Michigan. This is the most expensive option but insures your child’s college is funded at any public school in Michigan. It does not matter whether they chose University of Michigan, Saginaw Valley, or Michigan State, the credits are covered by your MET purchase.
2. The limited benefits allows up to 105% of the weighted average of tuition for all Michigan public universities. If a child goes to a school that is above average in tuition, the credit will be prorated leaving some credit still needing to be paid for outside of the MET. If they go to a school that is average or below, all the credits paid for will be covered by the MET.
3. The community college plan pays for tuition at a community college in Michigan. The community college must be in your district. If you go outside of your district, the MET will not cover the difference in cost for in district vs. out of district tuition. This is the least expensive of the MET options.
A very important item to note with these plans is the fact they deal with PUBLIC UNIVERSITIES IN MICHIGAN. If a child goes to a private college or out of state, the MET plans may not cover the full costs and might be subject to a refund policy. Some notable colleges that are private and would be subject to the refund policies are:
For a complete list of private colleges click here
The MET plan has some tremendous benefits. It allows you to lock in what you pay for college without having to be concerned about the stock market. You pay ahead of time and lock in tuition rates to hedge against rising costs. Also, the full amount you contribute to the MET plan is deductible on your state tax return as well. This is the only plan in Michigan that allows you to deduct the full contribution and is not limited to $10,000 per year.
The MET is also the least flexible of the plans. The most obvious issue arises if your child decides to go to a private college or a college out of state. If that happens, you may no longer have the cost of college paid for. You may also find yourself in a situation where you pay for the full benefits plan, and your child wants to go to a school that is much cheaper in tuition. If that is the case, you may have ended up paying much more for college than you needed to. To get the best benefits from the MET contracts, it makes the most sense to start the purchase when your child is very young. However, when you start the process early, you have the least amount of information on where your child will be going to school. This could cause you to find yourself in a situation where your child goes to a college that is not compatible with the MET. Essentially, to get the best benefit from the MET, it is very helpful to know what college your child is going to in order to make the right purchase. Below is the MET’s official explanation video on how their plans work:
2. 529 Savings Plan
A 529 plan is an education savings vehicle that offers both tax advantages and financial aid benefits. You make contributions and investment selections very similar to starting an IRA or a 401k. The tax advantages in Michigan can include a deduction on your state income tax return and tax-free distributions. The tax-free distributions are contingent on using the funds for a qualified education expense. These qualified education expenses can be at both private and public colleges and do not require the institution to be located in Michigan. If they are not made for a qualified education expense, the earnings are taxed and assessed a 10% penalty. The definition of qualified education expenses is broader than most people realize. Always consult with your tax preparer when questions arise on the expenses. The following is a list of expenses that count as a qualified education expense:
· Tuition and Fees
· School Supplies
· Internet Access
· Room and Board (This can include off campus apartment expenses, click here for more details)
One common concern that people have is "what if my child gets a scholarship?" The first thing you should do is celebrate that your child is getting their college paid for. After that is over, we can look at the ramifications of not having to use the 529 plan to pay for college. If the scholarship only covers tuition and fees, you can deduct the other college expenses incurred. If everything is covered by the school, you can take funds in the amount of your award without having to pay a penalty. You will have to pay taxes on the earnings when you take it out as a withdrawal, however; you do NOT have to pay taxes on your contributions. In summary, you do not get penalized for your child getting a scholarship; you can only lose the ability to take tax-free withdrawals on your earnings.
The other concern most people have when it comes to saving into a 529 plan is: "is this going to penalize my child on their Free Application for Federal Student Aid (FAFSA)?" The answer is a little more complicated then a simple yes or no. 529 plans owned by the student or one of the parents are considered a parental asset for FAFSA purposes. What this means is that the maximum amount that can be counted for FAFSA is 5.64% of the account value. When savings plans are in the name of the child, like a savings account or CD, 20% of those assets can be counted towards their FAFSA. There is no additional penalty in having assets saved for college when it comes to FAFSA.
Here are 3 different types of 529 savings plans available to residents of Michigan:
· Non-Michigan Sponsored 529 Plans
A non-Michigan sponsored 529 plan is a savings plan for college that is not sponsored by the state of Michigan. These plans give you the most flexibility in selecting your investment provider. You can open these at your local bank, through a financial advisor, or on your own at a place like a TD Ameritrade, Vanguard, Charles Schwab, or any large brokerage firm. This allows you to be very flexible in picking your allocation and how you want the funds invested. One note of caution when selecting a non-Michigan sponsored plan and using a financial advisor is being aware of the fees associated with the account. Some financial advisors will select a 529 plan that can charge a sales charge on all contributions. For example, the American Funds College Target Date Series Funds charges based on the following contributions amounts:
You want to have a conversation with your financial advisor to make sure paying up to 4.25% on your contributions is the right plan to be in. Another factor when using non-Michigan sponsored 529 plans is you are not allowed to deduct your contributions on your State of Michigan Income Taxes. The state deduction only applies to state sponsored plans. If you select something like the American Funds Target Date Funds as your 529 plan, you may end up paying 4.25% in sales charges and losing out on another 4.25% in state tax deductions for a total of 8.50%. You will want to take those lost benefits into consideration when deciding what plan is right. It is important to understand the costs of using the plan as well as how it compares in both fees and performance to the state sponsored plans.
· Michigan Advisor 529 Plan
The Michigan Advisor 529 Plan is a state sponsored 529 plan and eligible for a deduction on your State Tax Return. The Michigan 529 advisor plan used TIAA Cref as the program manager responsible for investment, record keeping, asset allocation, and performance reporting of the plan. With this plan, your investment options are limited to those offered by the plan. They do offer age-based investments, risk-based investments, multi fund investments, and individual funds. For the risk-based and age-based investments, investors might pay up to 4.25% in sales charges. If individual funds are selected, that initial sales charge drops to 2.50%. The age-based options are set to be auto managed by TIAA Cref. These portfolios automatically become more conservative the older your child gets.
One item that should be discussed with your advisor, when selecting which portfolio is appropriate, is how this fee structure is set up. From an advisor’s perspective, working on commission, the most advantageous fund to select is the age-based options. They generate the highest amount of commission for the advisor that is offering the MI529 Advisor Plan and are auto managed by TIAA Cref. If your advisor selects individual funds, they have to come up with their own allocation, manage and rebalance it over time, and are getting less in commission. The age-based features might be the most appropriate investment given your goals and objectives, but it is important to understand the fees and performance in comparison to the other state sponsored plans as well as non-state sponsored plans. Remember, you get the state tax deduction of 4.25%, but you could also be paying 4.25% in sales charges that negate the tax savings.
· The Michigan Education Savings Plan
The last of the 529 savings plans in Michigan is the Michigan Education Savings Plan or MESP. The MESP is a state sponsored plan that is also eligible for contributions to be deducted on your State of Michigan Tax Return. The MESP offers investment choices that include age-based, risk based, multi-fund investments and individual fund investments. The MESP uses TIAA-Cref as its program manager to help select investments, allocations, reporting, and record keeping. This is the same TIAA-Cref as the MIAdvisor529 Plan. There are some differences in the portfolios between the plans which makes it important to compare performance. The MESP does not charges any type of sales charges for the investments. This is because the program is offered directly through the state. It is designed to be a very low fee savings vehicle. One common reason advisors give for using plans other than the MESP is the other options allow them to manage your investments and advisors are able to keep track of your accounts. There are a couple of issues with that statement, which make it a little misleading.
1. If the plan they ultimately help you select is an aged or risk-based fund, they are not doing the managing anyway. The investment company like TIAA-Cref does the managing.
2. You can allow your financial advisor to get copies of the MESP statements simply by filling out this form. This will allow your advisor to keep track of your account to see if changes need to be made.
When it comes to selecting what 529 savings plan is right for you, make sure you compare all options. Evaluate the fees, benefits, and performance of both state sponsored plans and non-state sponsored plans. When working with an advisor, ask them why they selected the 529 that they did and ask why they didn’t choose the alternatives. Get all the information you need to help start saving for your kids college.
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