Legislature(1997 - 1998)
02/24/1998 03:40 PM Senate STA
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* first hearing in first committee of referral
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= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
SB 322 - CHILDREN'S DIVIDEND FUND
SENATOR DUNCAN presented his bill which establishes an Alaska
Children's Dividend Trust. This Children's Trust permits children
between the ages of 0 - 18 to deposit their Permanent Fund
Dividends (PFD) in a tax-deferred trust account for college or
vocational education expenses. Children under the age of 18, or
their parents on their behalf, could participate in the program
through a check off on the dividend application form and would
receive quarterly balance statements. SENATOR DUNCAN said, later,
withdrawals would be allowed for post-secondary or vocational
education purposes. These withdrawals could be taken twice yearly
at which time taxes would become due. Expecting that the student
would be taxed at the 15 per cent rate, SENATOR DUNCAN demonstrated
that they might receive an overall benefit of approximately $14,700
in 18 years based on certain assumptions of fund growth. SENATOR
DUNCAN commented that this demonstrated the advantage of having
this tax deferred status.
CHAIRMAN GREEN asked why the age 18 was chosen when some children,
like her, graduate from high school at an earlier age. SENATOR
DUNCAN replied that age 18 is not necessarily the magic number and
agreed with CHAIRMAN GREEN that it might be changed to reflect
whenever a child graduated from high school.
SENATOR DUNCAN said at college age the child has an option to take
payments as a lump sum, or in different ways over the course of 1 -
7 years. Tax rates would vary according to how the distribution was
made, but overall there would be a benefit, according to SENATOR
DUNCAN. To qualify for this tax deferred status the fund would be
structured as a "Rabbi trust," like the state's deferred
compensation plan. SENATOR DUNCAN said there are no assurances that
this fund would in fact be given tax-deferred status by the
Internal Revenue Service (IRS). He said the fund would have to be
already in place and structured carefully before the IRS could make
that determination. SENATOR DUNCAN said it is his understanding
that at some point a tax attorney would need to be hired to advise
whether the fund is likely to be approved by the IRS. SENATOR
DUNCAN mentioned the bill also contains a provision for withdrawal
of the funds for non-educational purposes when a person reaches the
age of majority. He said funds could also be withdrawn for other
reasons, such as serious medical problems, before the age of
majority.
SENATOR WARD asked about the fiscal note, and if any consideration
had been given to the idea that the fund itself could pay the start
up costs. SENATOR DUNCAN replied that he would allow the Department
of Revenue to address that question. He did mention that the first
year there would be no participants in the program. SENATOR DUNCAN
does not agree with the cost in the fiscal note for the first year
but did point out that in subsequent years the fund pays for
itself. He said they could talk about the first year cost. He
mentioned that other tax attorney opinions had been much less
expensive, however, he did not know if they were equal in
complexity to this issue.
SENATOR WARD asked again about a mechanism to recoup whatever cost
is incurred and SENATOR DUNCAN said he believed it could be done if
it is a major concern.
CHAIRMAN GREEN recalled a ballot consideration she had proposed and
said the immediate reaction from the Division of the Permanent Fund
was fear of the IRS deciding that the structure of the Permanent
Fund itself was questionable. She said there was discussion that if
the fund was changed it may be in jeopardy and she had, at that
time, asked for further inquiries and never received any response.
CHAIRMAN GREEN said it appears to be a subject no one wants to get
into. SENATOR DUNCAN replied that this is a different matter, her
proposed constitutional amendment would have changed the purpose of
the dividend, and he does not see this bill having any impact at
all in that way, as it only provides a dispersement option to a
person receiving a dividend and does not change the Permanent Fund
Dividend program itself at all.
CHAIRMAN GREEN mentioned that the question will arise if it is
government's role to be the keeper of a trust on behalf of anyone.
SENATOR DUNCAN replied that the state already holds money in trust
in retirement funds and he believes it to be a legitimate
government role if they were to pass a law allowing it. SENATOR
DUNCAN said a trust could be managed by the Department of Revenue
or even a private firm, this trust is only set up as a government
trust in order to obtain tax-deferred status.
CHAIRMAN GREEN asked if a person deposited their dividend directly
into a limited private trust account if tax deferred status could
be achieved. SENATOR DUNCAN responded that he was not qualified to
answer that question but likely someone in the audience could.
CHAIRMAN GREEN noted that this bill has a fairly limited title and
wondered if SENATOR DUNCAN anticipated other groups rushing in
attempting to be covered. SENATOR DUNCAN replied that he hoped not,
if the bill is to achieve its goal of a tax deferred trust for
education of the children of the state, it must be kept narrow. He
said if other groups are added, it might endanger the ability to
get a favorable IRS ruling.
MR. BRIAN ANDREWS, along with MR. STEVE BRANTNER, came forward and
urged support for SB 322. MR. ANDREWS restated what the bill would
do and offered his opinion that if the fund was carefully
structured in the form of a Rabbi trust it would receive a
positive revenue ruling from the IRS. He explained that the tax
deferred status of such a trust is based upon positive IRS rulings
dealing with the doctrines of constructive receipt, economic
benefits and forfeitability. MR. ANDREWS said it should be noted
that the IRS has recently loosened up the provisions of the Rabbi
trust by now allowing for up-front funding and various forms of
disbursement. It should also be noted that the Taxpayer Relief Act
of 1997 also established an educational IRA account a person can
deposit after-tax dollars in but, when distributed, yields tax-free
proceeds for the purpose of higher education.
MR. ANDREWS stated that this fund would be self-funding and would
not affect general fund expenditures. He believes the popularity of
the fund would provide economies of scale that would make it cost
effective when compared to private individual accounts. His opinion
was that the relevant general fund expenditures would include
modifying the PFD application and the costs associated with
developing a legal opinion, which he is not sure could be generated
by the attorney general or legislative counsel. He mentioned costs
ranging from 10,000 - 100,000 dollars for this outside counsel, and
assumed a figure of 40,000 to 50,000 would be reasonable.
MR. ANDREWS calculated some possible pay-out scenarios of the
trust, saying overall, the benefits of the program far outweigh the
costs of a legal opinion, in his estimation. He also noted the
intangible benefit to Alaskans in which parents are able to
establish a savings program for higher education costs without
first having to handle the money. MR. ANDREWS concluded that the
committee should pass the bill.
CHAIRMAN GREEN asked what the reason was for retaining legal
counsel. MR. ANDREWS clarified that participants would not have to
pay tax or the deposits to the fund or its earnings. SENATOR DUNCAN
restated this and added that taxes would only be paid on any
withdrawal at the time of withdrawal, and the purpose of the
opinion is to ascertain that the trust meets the requirements of a
Rabbi trust and could be tax deferred. He remarked that it takes
the IRS to make that determination.
CHAIRMAN GREEN asked if this could not be accomplished by sending
a letter to the IRS and SENATOR DUNCAN replied that he had sent
them many letters.
SENATOR DUNCAN asked for Mr. ANDREWS to respond to CHAIRMAN GREEN's
question about why the fund couldn't be managed by a private firm.
MR. ADAMS said it is due to the concept of economic benefit and the
fact that a participant in this type of trust cannot receive an
economic benefit. The trust money would have to remain an asset of
the state, within the Department of Revenue, in order that the
argument could be made that participants do not have an economic
benefit.
SENATOR DUNCAN mentioned that Deferred Compensation is another
example of where the state holds money in trust for people and MR.
ANDREWS noted that those monies are also, technically, assets of
the state. CHAIRMAN GREEN asked if all of those instances are based
on an employee/employer relationship and SENATOR DUNCAN replied
they are. MR. ANDREWS added that Rabbi trusts can be structured to
accommodate independent contractors as well.
MR. STEVE BRANTNER commented that deferred compensation plans,
sometimes called "golden handcuffs" are structured along the same
lines, where money will be kept as an asset of the corporation
until some triggering event allows dispersement. He believes this
same structure should apply here, and noted recent rulings have
said this structure is possible without the employer/employee
relationship. MR. BRANTNER restated the fact that the money would
have to remain an asset of the state. He said he also believes that
all ongoing administrative costs could be absorbed by the program
itself and this would be reasonable and appropriate.
SENATOR WARD asked how this would impact eligibility for public
assistance or medical assistance if dividends continue to be held
harmless. MR. BRANTNER replied that throughout the course of the
period in which those assets are held in trust the treatment would
be the same. The build up of the value of the trust would not have
any effect on the gain or loss of any benefits.
SENATOR WARD asked if he had a copy of the Rabbi trust and MR.
BRANTNER said it consists of several sections of the IRS code and
it is not just one particular document. SENATOR WARD asked if they
had a copy of the code and MR. BRANTNER replied that there is no
particular section of the code that establishes a Rabbi trust, but
rather it comes from a court interpretation of the code. SENATOR
WARD said he knew this and was showing how some people had already
spent a lot of money to do this privately. MR. ANDREWS commented
that if an individual wanted to do this, they would run into the
obstacle of whom the holder of the trust would be. He restated that
the State is the only candidate able to hold the trust without
constructive receipt. He said that is why the bill is written
narrowly, giving it a higher probability of a favorable ruling from
the IRS.
Ms. DEBORAH VOGT, representing the Department of Revenue, said this
bill will affect both the Permanent Fund and Treasury Divisions of
the department and would require some training and the preparation
of forms for program enrollment. She said they would also solicit
and print an information page in the dividend application packet
and post information on the division's web site. She reported the
ongoing cost to the division would be $16,000 to add a page to the
dividend packet, but said it would not take long before all this
could be paid from the participants. MS. VOGT said the treasury
division would set up and manage the fund, performing
administrative and record keeping functions that would cost about
10,000 dollars initially and 10,000 each year thereafter. MS. VOGT
also quoted a 1.5 basis point fee for external management, based on
the assumption that 35 per cent of the fund would be invested in
equity. She said also some personal services costs for the treasury
division would be allocated to the trust fund, although no new
personnel would need to be hired. MS. VOGT projected the cost of
the legal opinion to be 100,000 dollars and proposed it would
happen in two phases: the initial determination that competent
attorneys believe the trust would meet tax deferral status, which
she estimated at a cost of 60,000 dollars, and then the process
itself with the IRS, to which she assigned an estimated cost of
40,000 dollars. MS. VOGT said the cost could be debated but they
would want the best opinion available and she believes it will cost
a fair amount of money to get that. She said the Legislature might
find it appropriate for the trust to pay those costs, but the costs
are reflected as general fund dollars in the fiscal note submitted.
MS. VOGT explained that, regardless of the source of the money, the
appropriation ought to be a continuing appropriation as it often
takes a fair number of years to get a ruling from the IRS. She
would assume the program would go forward if the initial ruling
from counsel was favorable, and she imagined this could be obtained
in this legislative session. She said the department would then go
forward with the plan in the next dividend year with the caveat
that the fund had not been ruled on by the IRS and, in the case of
a negative ruling, the dividends would have to be refunded.
TAPE 98-9, SIDE A
Number 001
MS. VOGT said, assuming only 5,000 participants in fiscal year
2000, the cost to participants for funding some of the set up costs
and all of the ongoing cost would cost the participants the
equivalent of 57 basis points as compared to a general mutual fund
charge of 100 basis points for fund management. She said this cost
would diminish quite quickly as more participants joined the
program.
SENATOR MILLER said he is generally supportive of this program but
wondered what might happen if a participant died or moved from the
state. DEBORAH VOGT hadn't thought about this last question but
assumed any money deposited in the fund would be left there until
the individual turned 18 and then would have dispersement choices.
In the case of death, she assumes there would be a beneficiary form
like is used for deferred compensation and this form would be filed
with the other records.
SENATOR WARD asked if there was anything in the bill that allowed
an educational institution to preencumber any of these funds. MS.
VOGT replied no, her understanding of the legal requirements of a
fund of this nature mandated it be an asset of the state which
could not be encumbered by another party. SENATOR WARD asked if
anything in the legislation would preclude a child from attending
a private school and MS. VOGT said at the time of dispersement the
money could be used for any educational purpose. She also noted
that any money left in the trust would have to be dispersed at the
age of 25. SENATOR WARD said he was thinking in terms of the fact
that his granddaughter would be incurring costs for 18 years of
private school and was wondering if this would help with that.
CHAIRMAN GREEN remarked it would only be available to reimburse.
SENATOR MILLER asked what would happen if an individual dropped out
of school. MS. VOGT said if an individual was not in school the
proceeds would be dispersed to them. SENATOR DUNCAN interjected
that the bill does not force anyone to go to school.
CHAIRMAN GREEN mentioned that she was looking over the list of
agencies that can attach a permanent fund dividend and asked if
this list included the Department of Corrections garnishing
juveniles who are liable due to destroyed property. MS. VOGT said
the Legislature has made incarcerated people and felons ineligible
for the dividend. The equivalent amount that would be paid to those
ineligible in the form of dividends then goes to the Departments of
Corrections, and Public Safety, and victims' assistance.
CHAIRMAN GREEN questioned if this was the bill she was referring
to. She wanted to be sure there was a trigger mechanism for this
payment. CHAIRMAN GREEN asked if MS. VOGT had an opinion on the
bill and she responded she did not. She thinks the big question
will be whether or not the trust qualifies for tax deferred status.
She has expressed her reservations about this to SENATOR DUNCAN and
said, in her experience, she has never seen anything written about
Rabbi trusts outside the employer/employee relationship. She
proposed that is why the tax counsel might be so costly. She noted
the concept breaks new ground and the IRS is not likely to decide
on it quickly.
JIM BALDWIN said it is difficult to estimate the cost of the tax
opinion and said if he has erred, he erred on the high side so as
to not leave the program short. SENATOR DUNCAN added this issue is
specific and might be compared to other cases and wondered why the
opinion would be so expensive. MS. VOGT said the only similar issue
she is aware of is the Advanced College Tuition (ACT) program which
has piggybacked on the experience of several other states,
resulting in less expense for Alaska. SENATOR DUNCAN concluded he
did not want to short change the program but said her reservations
are likely lessened after hearing of other Rabbi trusts occurring
outside of the employer/employee relationship. MS. VOGT agreed.
MR. SCOTT CALDER from Fairbanks said he saw no compelling reason to
address this issue. He observed that, currently, parents can invest
money for their children for education. He mentioned their is no
guarantee of achieving tax deferred status and it is possible it
might cost hundreds of thousands of dollars to find this out. He
said this draws attention away form the desirability of parents
saving or investing on behalf of their children and seems like it
discourages private financial planning. MR. CALDER said it makes no
sense that it would be a state asset in the short tem but not in
the long term. He expressed his overall skepticism with the bill,
and suspicion of the IRS, asking if the committee might find the
time to protect the people from that organization rather than spend
money seeking their opinion.
CHAIRMAN GREEN asked again about teenagers getting in trouble and
being held liable for property damage. SENATOR DUNCAN said he
assumes any future dividend could be withheld from the trust and
CHAIRMAN GREEN wanted to make sure that mechanism was in place.
DEBORAH VOGT said she imagined there would be a court order binding
on the individual, requiring action by them and not the division.
CHAIRMAN GREEN remarked she did not want this to be overlooked.
SENATOR DUNCAN moved SB 322 out of committee with individual
recommendations and accompanying fiscal notes.
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