In our last entry we gave a brief example of the complexity of the structure and choices of 529 plans. In this post we will explain the often misunderstood advantage provided by states in the form of tax deductions.
 
529 plans are a well-known vehicle for saving for a child’s higher education. Although established by the federal government, they are administered by the states, with the assistance of an assortment of financial institutions. Some plans are seen as better than others, but they all allow savings to grow free of capital gains taxes until the plan ceiling is reached (the lowest limit being $235k – not an issue for most families).
 
529 plans are also known for offering state tax advantages. Most states offer a state income tax deduction as an incentive to save. The deduction amounts vary, but one detail remains the same: the deduction fails to incentivize saving across all income groups. We believe strongly in the need to create incentives to save, especially for one’s child, but we think it’s worth asking the question: Are tax deductions really the most effective means of promoting college savings across all income groups?

 
 

First, a few things…

Deduction vs. Credit

A deduction is a reduction in your taxable income.

A credit is a reduction in the taxes you owe.

Of the many states that have created an income tax incentive for 529 savings, the vast majority offer deductions (a few offer credits). These deductions create an increased incentive to save for your child’s education, but not every family can save enough to take advantage of the full deduction. And in states with progressive income taxes, families with higher incomes pay higher state taxes which translates into a greater benefit for those families.

Here’s an example to illustrate the point:

Let’s say there are two families living in New York: the Johnsons and the Smiths. Each family has one child for whom they’re saving.

The Johnsons are successful professionals with a household income of $600,000. They save the maximum allowed per couple in NY for a 529 plan: $10,000.

The Smiths are teachers with a combined household income of $100,000. They are able to save $2,000 as a couple each year.

First, we need to determine each family’s highest state tax rate (since this deduction is subtracted off the top).

Johnsons’ highest state tax rate = 8.97%
Smiths’ highest state tax rate = 6.85%

Saving $10,000 each year, the Johnsons are seeing a tax savings of $897. At a savings level of $2,000 each year, the Smiths are seeing a tax savings of $137.

 

 

Annual Household Income

Annual 529 Plan Contribution

Tax Rate

Savings

Johnsons $600,000 $10,000 8.97% $897.00
Smiths 100,000 2,000 6.85% 137.00
NY Median Income ‘09 54,554 1,000 6.85%   68.50

In this scenario, the state of New York is awarding an additional $760 to the higher-income family, the family that probably doesn’t need any financial incentive to save for their children. (Notice also the Johnsons will receive a tax benefit thirteen times the size of the tax savings offered to the family at the median household income level in this example.)

Some states have higher deductions and some lower (almost all state tax tables are different).  Pennsylvania provides the highest per couple annual 529 deduction at $26,000. Some states don’t have an annual, but a total deduction per plan. South Carolina having the highest at $318,000 (with a top state tax rate of 7%, some South Carolina families would be rewarded with an extra $22,600).

It’s fair to say that 529 plans were created to encourage saving for a child’s higher education for all families, but the current system does not deliver effective incentives across the board. This is something that’s been recognized by the policy experts at the New America Foundation. In a recent column, Reid Cramer and William Elliot III note:

In the U.S., 529 College Savings Plans have proven to be popular vehicles as earnings on deposits are tax-free. Unfortunately, to date they have had a limited reach among many households with modest incomes. That’s largely because the strength of the incentive to save is based on how much a family earns. If the family has a small tax bill or gets a refund, the incentive is particularly weak.


We couldn’t agree more. The goal of any incentive should be to encourage all families to save. Providing small matching amounts through a program like the UK CTF program or via targeted tax credits would provide a better and more equitable foundation for college savings. Couple a more universal incentive with an ultra-simple savings product like the soon-to-be-unveiled TrustEgg account, and we could start creating an asset-building environment that’s much more optimal for all Americans.

 

 

 

We here at TrustEgg think a lot about 529 plans. And while we have a couple of in-depth posts analyzing 529s on deck, two recent news stories about the uncertainty of 529 plans caught our eye.

There are two basic types of 529 plans: college savings plans and pre-paid tuition plans. College savings plans are simply contributions on behalf of a child invested in some type of savings vehicle, often a mutual fund. Pre-paid tuition plans involve purchasing “units” of tuition at a participating college or university at a certain set price (higher than current tuition), and then using these units to pay for tuition years later when the child enrolls, no matter how much tuition has increased by that time.

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The first story is from Kansas, where the governor’s proposed tax plan would eliminate state income tax deductions from the state’s 529 college savings plans. State income tax deductions are one of the major financial incentives for using 529 college savings plans, and ending them could seriously decrease the amount of contributions currently being made by the 60,000 Kansas families using the in-state college savings plans.

The second story involves Illinois‘s pre-paid tuition plans, where the state is currently $560 million short of its projected obligations to pay tuition for 54,000 current and future students. A combination of the economic downturn and unexpected rises in tuition costs have contributed to this shortfall, and the program is currently closed to new investors while the state decides how to address the problem (meanwhile, closing to new investors would seem to exacerbate the problem). While Illinois does not guarantee the pre-paid investments, they have yet to miss a payment, and it remains to be seen how many students, if any, will eventually be affected.

529 plans can provide attractive financial incentives for those families with the savvy to discover them, but it’s becoming increasingly clear that some of these incentives exist only at the whim of state governments, many of which are severely tightening their short-term budgets, to the detriment of long-term programs like 529s. We’ll be back soon with more on 529 plans, and why we think it’s clear the time has come for a new choice in saving for a child’s future.

It’s that time of year again – that time when we run out at the last minute to buy unnecessary plastic junk for the little ones in our lives. Instead of going down that well-worn path this year, consider designating a few bucks for your child’s future educational or life needs. We’ve previously run down some of the pros and cons of the differing savings vehicles currently on offer, like 529s and Coverdell ESAs. We encourage you to choose the one that best fits your situation or simply open a savings account in the child’s name.

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As we’ve said in the past, the most important step is the first one: start saving today for your child’s tomorrow. We’ll have a great product for you to choose for the 2012 holiday season, but don’t wait for us. Start now – you’ll thank yourself later.

Wishing You and Your Family the Happiest of Holidays!

Team TrustEgg

TrustEgg co-founder Gabe Krambs recently sat down for an interview with Jay Gould of Foundville. Check out some clips of the interview below:

What is TrustEgg?

How the TrustEgg Idea was “Born”

How are Parents Saving before TrustEgg?

TrustEgg Makes It Easy for Everyone to Save for a Child



 

We’ve been writing about our views on the financial services industry, and decided we should get another point of view. We reached out to CEO and Founder of KibooLisa Halpern – with a few questions.

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  • Every start-up has a story or reason for leaving their usually secure 9-5 jobs for the uncertainty of a new venture. What was your reason/story?

Both my parents are entrepreneurs. When I was a little kid, my mother started a nail salon with two of her friends. My father is a serial entrepreneur with lots of ideas, some very successful and some flops. I grew up living a life of highs and lows. One of the reasons I became a lawyer is because I wanted a steady paycheck. After practicing law for 8 years, I couldn’t fight it anymore.

I have come to realize that being an entrepreneur is part of my DNA, and not a choice that I had. The idea of Kiboo came from my experiences practicing tax and estate planning, as well as interacting with my nieces and nephews. I saw on a daily basis parents and grandparents struggling to teach their kids and grandkids about money. There was (and still is) a growing divide between young people and banking. Kiboo was created to fill the gap.

  • How do you think your company will disrupt or even replace the current financial options?

Kiboo is all about engaging our customers around their money and the things they care about. We are the front-end user experience. We are not a bank and don’t ever plan to be. Essentially we commoditize the FDIC bucket, take out the noise, and put all our special sauce around it so that banking becomes relevant and personalized to the customer. Kiboo makes your money a fluid engagement that is a constant interaction, rather than a static place you go to view a balance or pay a bill.

Another differentiator for us is that we are geared toward young people. All of our content and communication is focused on the experiences, wants, and needs of a young person (and their parents). This is different from the one-size-fits-all of traditional banks. Early on, we decided that there is no way to be everything for everyone and we can have the most impact starting with young people.

  • When people talk about banks, most visualize the building or branch they go to make deposits and other non-ATM transactions. What do you think the branch network of the future will look like? Will there be any?

I don’t see physical banking locations going away any time soon. However, I do see a shift in the venue away from the retail bank branch where you only walk in for one reason and a move toward a location that serves multiple purposes. Today, we see the transition with the growing number of ATMs located in retail stores. I live in New York City, where you can’t walk a city block without seeing a big bright and shiny bank branch. More and more of these branches are closing and being replaced with tricked-out super-drugstores (equipped with a bank branded/full service ATM).

  • Other than the fact that your company exists mostly online, what differentiates you from current financial institutions?

Kiboo does more than provide a place to view your money and pay bills. Among our differentiators, it’s about having a voice when it comes to giving to social causes.

Another differentiator: Kiboo is about sharing goals that you want to achieve with your friends and family.

And another, Kiboo is about interacting with your money and making communications meaningful and personal. For example, we will tell you “Jeff, you are bringing in more money than you are spending. Nice job.” Not only does this tell you something useful that isn’t apparent just by looking at your bank statement, it’s also positive reinforcement. And who couldn’t use a little more of that?

The more we learn about the customer, the more we drive personal and relevant communications that in turn drive smarter money decisions.

  • What is the one thing, product, or service that you believe is most lacking or out of date, which you intend to change?

If I had to choose one thing lacking which Kiboo intends to change (in a big way), it would be customer engagement. In this area, Kiboo is at an advantage because we are built from the ground up starting with the customer user experience. The root cause of the loss of customer engagement at traditional financial institutions stems from old legacy systems and a heavily regulated industry that has resulted in a cookie cutter, one-size-fits-all banking.

  • Finally, and most importantly, what do you think of our logo? 

Your logo is awesome.

 

Can’t argue with that.

We would like to thank Lisa, and Kiboo, for taking the time to answer a few questions and share their views. Companies like Kiboo are helping to begin a very exciting new chapter in the financial services industry. 

 

Team TrustEgg

 

 

Last week, we were in New York City for a conference on innovation in finance called Finovate. It was great to witness firsthand some of the exciting changes coming to the finance industry, and to hear all of the great new ideas and products that are available. There were a ton of great companies present – too many to mention in one blog post (see the ‘Best in Show’ for more standouts) – but there was one company that really got our attention at TrustEgg: FamZoo.

Most people would agree that every family wants to teach the proper financial habits to their kids, but they can be very difficult skills for parents to teach, and a very tedious lesson for children to learn. FamZoo attacks that problem head on, creating a website that makes financial education simple and intuitive.

Famzoo1

At FamZoo, Mom and Dad are basically the bank (nothing new there) but FamZoo creates a way to track everything from allowances to ‘loans’, allowing kids and parents to keep tabs on account balances and loan repayment progress. It’s a fun and interactive way for parents to ‘Prepare kids for the wild’. This is a great leap from the days of a weekly allowance (that is if your parents loved you) and a consumer education class in high school. 

We’re pretty sure the ‘Bank of Mom & Dad’ isn’t FDIC insured, but it definitely seems like a great place for children to start their financial lives.

TrustEgg gives FamZoo, and their entire team, two thumbs up. Financial literacy is such an important part of our lives, and FamZoo has created a great way to get kids involved and excited about learning responsible financial habits. We strongly encourage anyone with children (or just an interest in financial education) to check them out.

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Kiboo and BankSimple are two other outstanding financial startups that caught our eye. Along with Famzoo, these companies are helping to create a new space in the financial world that is just as focused on creating value for customers as they are on creating shareholder value. As children get older, companies like these two will be great alternatives to current banking options.

 

A New York Times article that details the concept of “creating shared value” has garnered a lot of commentary in recent days. The framework was created by Michael Porter and Mark Kramer, a Harvard Business School professor and the Founder and Managing Director of FSG Social Impact Consultants, respectively. Porter and Kramer are well-known figures in the business and venture philanthropy worlds, creating a reputation for demanding more value from businesses, charities, and governments.

 In their words, “The concept of shared value can be deļ¬ned as policies and operating practices that enhance the competitiveness of a company while simultaneously advancing the economic and social conditions in the communities in which it operates. Shared value creation focuses on identifying and expanding the connections between societal and economic progress.”

Their work has grabbed our attention, because it seems to synthesize much of what we had already thought about the failings of the financial services industry and our motivations for launching TrustEgg.

We’ve left behind our former lives to take a risk starting a company that aims to address a major socio-economic concern: the wealth gap. The big banks provide a number of useful products and services to millions of Americans, but none of them was founded to remedy a recognizable social problem. Contrary to the rest of the financial services industry, we are absolutely committed to “creating shared value” by starting a new business that makes money, provides well-paying jobs, and contributes to our community’s tax base. And, in addition to that, a business that offers low and middle-income families a simple and easy way to build assets for their children.

There are think tanks and consulting firms that are speculating about the value of reaching out to underserved financial services customers, and we are encouraged by these realizations. But for us, serving middle and working class Americans isn’t an afterthought – it’s our reason for being. We’re excited about launching a savings product that is of high quality and unrivaled simplicity, and will be of true economic and societal benefit. We hope you are, too.

 

Simplify, simplify. – H. D. Thoreau

One “simplify” would have sufficed. – Ralph Waldo Emerson, in response

We’re not sure if we’re channeling our inner Oprah, but let’s talk about another book. Let My People Go Surfing, by Yvon Chouinard, the founder and owner of Patagonia (the apparel company, not the region), is a book we believe is a must-read for any entrepreneur, especially if that entrepreneur is looking to re-invent or transform an industry, which is precisely what we’re doing with TrustEgg.

The book details the long roads (and mountain paths) Chouinard and his partners traveled to create the best product for their customers and the best company for their employees.  Performance at Patagonia isn’t measured by dividends and stock price. Instead, success is gauged by meeting high standards: for the clothing they produce, the relationships they develop, and the environment they inhabit.

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With regard to their products, Chouinard and his staff have created an innovative checklist that seeks to objectively measure quality. This list isn’t specific to clothing and can be applied to a great variety of products and industries. Two items on his checklist that stood out for us at TrustEgg were simplicity and functionality.

As a preface to these criteria, Chouinard recounts a conversation he had with his chief designer who, at one point, challenged Chouinard by saying they didn’t make the best clothing in the world and if they did, they’d go out of business. When asked why, she replied, “Because the best shirt in the world is Italian, it’s made from handwoven fabric, with hand-sewn buttons and buttonholes, and impeccably finished. And it costs three hundred dollars. Our customers wouldn’t pay that.” (p. 87) Chouinard tells this story to illustrate the point that when the Italian shirt is looked at through the lenses of simplicity and functionality, it turns out to be far from the best product for the vast majority of consumers.

From TrustEgg’s perspective, the same principle applies. Most people don’t need and won’t benefit from financial products designed for a hedge fund manager and his kids. In reality, these financial products are just too expensive and complex for the average family.

TrustEgg will be able to provide people the ability to save for a child’s future with the greatest ease at a minimal cost. There will always be products that are more complicated or expensive, or, at the other end of the spectrum, options that are cheap and provide very little value. But TrustEgg is different. We’re committed to creating a highly functional and simple product that will re-define what quality means for financial services. TrustEgg is a company that will adhere to these principles: Make it simple, inexpensive, and available to everyone.

The Government wants more people to be able to have the running start that owning financial assets brings. It wants more young people to reach age eighteen with a financial asset that will provide them with financial opportunities and security – for example, by helping them pay for lifelong learning, or by providing them with money in a savings account that they can call on when starting a family, buying a house, or in times of special need.” Page 1, (Savings and Assets for All).

This is how Tony Blair, Gordon Brown and the rest of the then-ruling Labour Party introduced the Child Trust Fund (CTF) and affiliated legislation in 2001. It was a ground-breaking policy innovation at the time, and it is an idea from which we have drawn inspiration and insight. Unlike a Coverdell ESA or a 529 savings plan, the CTF was created to be a no-strings-attached savings account for every child born in the UK after September 2002. Similar to future TrustEgg customers, CTF account holders at the age of 18 will be free to use the money accumulated in their account for any purpose without the fees and negative tax implications associated with education-specific accounts here in the U.S.

Additionally, in the case of the CTF, the British government originally committed itself to building the financial assets of all children by depositing at least 250 pounds into every newborn’s account (500 pounds was deposited for children of more modest means). The new coalition government has ended its monetary commitment and changed the name of the program to the Junior Individual Savings Account, but the core of the idea remains.
Ultimately, this is the system we seek to create with TrustEgg, a simple and universally accessible savings program that will radically improve the savings environment for children and their families. It’s an ambitious goal, no doubt, but we believe every child deserves an equal opportunity to achieve financial freedom and success, and we’ve developed a financial product to do just that. Stay tuned.

 

A Coverdell ESA is a savings account for children that allows deposits to grow tax-free, and can be used on qualified education expenses. Unlike a 529 College Savings Plan, money held in a Coverdell account can be spent on education expenses from kindergarten through graduate school. Deposits to a Coverdell ESA also grow tax free and incur no penalty, so long as the money is spent on education-related items. 

However, eligibility is income-restricted, and contributions to the account are limited to $2,000 per year. In addition, although there are no restrictions on the number of Coverdell ESAs a beneficiary can have – parents, grandparents, friends and family can all open an account for the same person – if the $2,000 per year ceiling is reached there are tax consequences for the child when a withdrawal is made.

To complicate matters further, most firms require minimums to open an account, which needs to be actively managed by the guardian. Fees associated with active management can add up, and there is still no guarantee that the ESA contributor understands the intricacies of investing in an equity-based savings account.

Like we’ve said before, there are real benefits to some of these designated education savings vehicles, but these benefits often come with complicated caveats.

In our minds, saving for a child’s future should be easy, and it shouldn’t involve constant monitoring, guessing and second-guessing. Opening an account to save for a child’s future is the most important step you can take, and with TrustEgg that’s all you will have to do.

The Coverdell ESA is an Education Savings Account, not so commonly referred to as Internal Revenue Code (26 U.S.C. § 530). These accounts were previously known as Education IRAs, but were renamed in 2001 to honor the late Senator Paul Coverdell.

 

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