Legislature(1999 - 2000)
01/27/2000 03:12 PM House HES
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HOUSE HEALTH, EDUCATION AND SOCIAL
SERVICES STANDING COMMITTEE
January 27, 2000
3:12 p.m.
MEMBERS PRESENT
Representative Fred Dyson, Chairman
Representative Jim Whitaker
Representative Joe Green
Representative Carl Morgan
Representative Allen Kemplen
Representative John Coghill
MEMBERS ABSENT
Representative Tom Brice
COMMITTEE CALENDAR
HOUSE BILL NO. 268
"An Act relating to the Alaska Higher Education Savings Trust;
and providing for an effective date."
- HEARD AND HELD
HOUSE BILL NO. 260
"An Act relating to coverage of children and pregnant women under
the medical assistance program; and providing for an effective
date."
- BILL HEARING POSTPONED
PREVIOUS ACTION
BILL: HB 268
SHORT TITLE: COLLEGE TUITION SAVINGS PLAN
Jrn-Date Jrn-Page Action
1/10/00 1889 (H) PREFILE RELEASED 12/30/99
1/10/00 1889 (H) READ THE FIRST TIME - REFERRALS
1/10/00 1889 (H) HES, FIN
1/10/00 1889 (H) REFERRED TO HES
1/27/00 (H) HES AT 3:00 PM CAPITOL 106
WITNESS REGISTER
REPRESENTATIVE LISA MURKOWSKI
Alaska State Legislature
Capitol Building, Room 406
Juneau, Alaska 99801
POSITION STATEMENT: Testified as sponsor of CSHB 268.
BOB MANLEY, Estate Planning and Tax Attorney
Hughes, Thorsness, Powell, Huddleston and Bauman
550 West Seventh Avenue
Anchorage, Alaska 99501
POSITION STATEMENT: Testified in support of CSHB 268.
CHRIS LYNCH, Program Director for the Western Region of the U.S.
Tuition Financing Inc.
TIAA-CREF [Teachers Insurance and Annuity Association-College
Retirement Equities Fund]
730 Third Avenue
New York, New York 10017
POSITION STATEMENT: Testified on CSHB 268.
JIM LYNCH, Interim Vice-President for Finance
University of Alaska
P.O. Box 755120
Fairbanks, Alaska 99775
POSITION STATEMENT: Testified in support of CSHB 268.
DANA OWEN, Special Assistant to the Commissioner
Department of Revenue
P.O. Box 110400
Juneau, Alaska 99811
POSITION STATEMENT: Expressed some legal concerns on CSHB 268.
ACTION NARRATIVE
TAPE 00-5, SIDE A
Number 0001
CHAIRMAN FRED DYSON called the House Health, Education and Social
Services Standing Committee meeting to order at 3:12 p.m.
Members present at the call to order were Representatives Dyson,
Whitaker, Kemplen and Coghill. Representatives Green and Morgan
arrived as the meeting was in progress.
HB 268 - COLLEGE TUITION SAVINGS PLAN
CHAIRMAN DYSON announced the first order of business as House
Bill No. 268, "An Act relating to the Alaska Higher Education
Savings Trust; and providing for an effective date."
REPRESENTATIVE COGHILL made a motion to adopt the proposed
committee substitute (CS) for HB 258, version 1-LS1235\H, Ford,
1/24/00, as a work draft. There being no objection, proposed
CSHB 268 was before the committee.
REPRESENTATIVE LISA MURKOWSKI, Alaska State Legislature, sponsor,
came forward to present CSHB 268. She indicated this is a very
exciting concept, and there doesn't appear to be any opposition.
Everyone she has talked to about this has been very enthusiastic
about the prospects for opportunities to invest for higher
education savings accounts. She referred the committee to
articles in their packets which discuss what has happened on the
national level with regard to qualified state tuition programs.
In 1998 there was federal legislation [in the Internal Revenue
Service (IRS) Code] adopting section 529 programs which allow
states to institute qualified state tuition programs that have
certain tax deferred benefits and allow greater contributions
into an education savings trust.
REPRESENTATIVE MURKOWSKI said presently the options are limited
in terms of saving for higher education. There is an IRA
[Individual Retirement Account] that one can put in $500 per year
and the University of Alaska has the Advanced College Tuition
(ACT) program. This legislation allows greater flexibility and
options to individuals as they set up these trust accounts. She
referred to an article in the packet which shows what the 50
states are doing in terms of education savings plans. Alaska's
ACT program is rated the lowest possible simply because it is not
structured to take into account the smorgasbord of options. This
legislation would allow Alaska to offer very positive, flexible
plans for investors for their children's educational future.
Number 0470
BOB MANLEY, Estate Planning and Tax Attorney, Hughes, Thorsness,
Powell, Huddleston and Bauman, testified via off-net from
Seattle. He told the committee he has been practicing in this
area for 25 years. He is part of an informal group of tax and
estate planning attorneys that do pro-bono work by assisting with
technical review of legislative issues in their area. He is not
representing anyone regarding this bill. His interest comes from
seeing many of his estate planning clients sending money outside
Alaska for other state's programs, and he likes the idea of
keeping the money inside Alaska.
MR. MANLEY believes that CSHB 268 is good for Alaska and for the
university. These plans are often called section 529 plans
because the IRS Code section 529 authorized states to adopt these
kinds of programs. Forbes magazine called section 529 the
sleeper tax break of the 1997 Tax Act. He explained the plan is
not state specific. For example, people can invest money for
their children's higher education in the Arizona program and the
children can use it in Massachusetts or wherever. It is a
flexible financial vehicle for saving for college. Every state
is in competition so it is important to offer one of the best
programs.
MR. MANLEY said this program will be good for Alaska because it
will allow savings in anticipation of college expenses. From an
income tax view, it is like an IRA. There is tax-deferred
accumulation, the money goes into the account, and there are no
income taxes paid on the money earned or the capital gains until
the money is withdrawn. When the money is withdrawn, it is
usually withdrawn for a student's higher educational expenses,
and it is taxed at the student's income tax rate, which is
usually much lower than the parent's tax rate. Under the new tax
bill pending in Congress and under the last tax bill President
Clinton vetoed, the withdrawals would have been income tax free
if they are used for higher education. There is a good chance
that type of provision will be enacted in future federal law.
MR. MANLEY indicated this program is good from an estate tax and
gift tax point of view. Under federal law, contributions to
these kinds of plans qualify as completed gifts. That means
people can use their $10,000 per year annual exclusion from gift
tax, and they can forward average five year's worth of exemption.
So people can give $50,000 to an account for a single student and
elect to use the next five year's $10,000 exemption from gift
tax. Husband and wife could each do that.
MR. MANLEY added there is tremendous flexibility in this program
which provides a tax break that is available to the rich and not-
so-rich alike, unlike the Roth IRA and many other tax advantages.
In addition, up to $100,000, or possibly more, per beneficiary
can be put in the account. This is controlled by the cost of
higher education which is the highest cost of all higher
education expenses for a normal program. Montana has calculated
the maximum up to $172,000. The university can decide what to
set the maximum at to qualify. The best thing is the participant
control where the parent can change beneficiaries within the
family or can even pull the money out. This is a big distinction
from the normal gifts to children, like a uniform transfer to
minors act account, where the money goes in and when the child
reaches 21, the money will be the child's no matter what. Here
the parent can pull that money out at any time, but if it is not
used for higher educational purposes, then there is a penalty.
That penalty can be as low as 10 percent of the earnings, and the
penalty goes to the University of Alaska.
MR. MANLEY said this program is good for Alaskans because the
assets put away for the child's college are protected from
creditors. This program is good for the university because the
university will be able to earn fees regarding administration and
management of the program and receive penalties as mentioned
before. Non-Alaskans will benefit also because they can invest
in the Alaska program because there will be more money under
management. Non-Alaskans will have the opportunity for a
spendthrift trust creditor protection. Under current bankruptcy
law, other states can't probably protect non-residents. For
example, an Alaska investing in Maine's program probably won't be
protected from creditors and bankruptcy. However, Alaska has a
unique spendthrift trust law. That is why Alaska's trust law has
been so successful and why it has developed new business in
Alaska, and why Delaware, Nevada and Rhode Island have copied
this trust legislation. Those are the only states which have
legislation to allow spendthrift trust protection for these kinds
of plans. Alaska will have a competitive advantage over most of
the other states. Alaska should be able to attract back the
money going out-of-state to section 529 plans in other states.
In addition to being able to change beneficiaries and terminate
the program with a penalty, these accounts can be rolled over.
In addition to new investors, Alaska may be able to get rollovers
from other states.
MR. MANLEY expressed support for this legislation.
Number 1011
REPRESENTATIVE WHITAKER asked if the benefit of the $10,000 gift
exclusion accrues to the tax recipient or the giver.
MR. MANLEY answered if he gives $10,000 to someone, and it is not
categorized as a completed gift, then that feeds into unified
credit against the state gift tax. Instead of being able to give
over his entire lifetime $675,000, that would be reduced by
$10,000. If it is a completed gift, there is no such reduction
and no potential of gift tax. The person avoiding gift tax is
the person who gives the money. The recipient never ends up
paying a gift tax on gifts.
Number 1131
CHRIS LYNCH, Program Director for the Western Region of the U.S.,
Tuition Financing Inc., wholly owned subsidiary of TIAA-CREF
[Teachers Insurance and Annuity Association-College Retirement
Equities Fund], testified via off-net from New York. He said
TIAA-CREF is honored to be selected as program manager for more
state-sponsored section 529 programs than any other organization.
He related the development of the section 529 savings market
place over the past few years. The section 529 prepaid plans
existed since the late 1980s, but the most growth of states
participating has been in the past two years.
Number 1217
MR. CHRIS LYNCH noted the majority of assets that are invested in
section 529 programs are in the prepaid model plan such as the
plans in Florida, Michigan and Texas. Those programs have
existed for a number of years. The trend is toward state-
sponsored savings programs recognized by the national financial
press, about 20 states are either offering or in the process of
implementing state savings programs. Most of those 20 states
have moved in that direction over the past two years. He
believes that the section 529 programs have been recognized by
these states as a fundamentally better way to solve a fairly
daunting problem of financing higher education.
MR. CHRIS LYNCH noted there are a variety of models out there.
In addition to the federal tax deferral, when the proceeds are
withdrawn for qualified education use, they are then taxed at the
beneficiary's rate which is almost always an advantageous
situation. That is the hook of the section 529 program
generally. The difference between the section 529 and
traditional prepaid programs and savings programs is on the
investment aspect of these programs. Funds directed into a plan
such as Alaska's plan would be directed into individual accounts
where the account owner and beneficiary would bear the risk of
the underlying investment portfolios. The prepaid model has the
risk shifted away from the account owner and the beneficiary and
towards the schools or whoever is administering the program. In
some ways analogies have been drawn between the savings model and
prepaid model to the traditional defined benefit type of pension
plan and a defined contribution type of pension plan.
MR. CHRIS LYNCH mentioned the national ratings add to a more
competitive environment for these programs. One of the primary
reasons that savings programs do better in the scoring is the
fact that the money is invested in a different way. In most
situations the money is directed toward mutual funds investments
where there is risk involved, but the returns can be greater.
Most of the existing state savings programs offer, either
exclusively or as a component of their investment structure, what
could be defined as a management allocation or banded allocation
approach. An account owner will purchase a savings program,
contract or certificate, and the money that someone directs
toward that program will be allotted toward the (indisc.)
allocation model usually made up of stocks and bonds or may
include a money market or guaranteed investment. Some apportion
those benefits based on the age of the beneficiary. The younger
the beneficiary, the heavier the weighting towards the equity
investments. For a beneficiary who is two years old, maybe 60 or
70 percent of the investment would be weighted toward higher risk
investments and 30 percent would be weighted toward lower risk
investments. As the beneficiary grows up, the investment
allocation shifts. Some state programs have people move from one
investment allocation band to the next every two years, some do
it every five years, but fundamentally every program that uses
this approach has individuals move from the more aggressive
allocations in the early years to a more conservative allocation
as they approach college age.
MR. CHRIS LYNCH noted the national trend is towards offering
individuals some choice in addition to the traditional banded
managed allocation type investments. More recently programs have
started offering a guaranteed option for people who are more
conservative than average or an all equity option for those
willing to take more risk with their money. While people do get
favorable tax treatment on this, an individual does not have
investment discretion the way they would under a mutual fund.
One of the criticisms of the section 529 programs is that people
can't trade their accounts, which is not necessarily a bad thing.
The Alaska program could offer both a banded allocation approach
and either a more conservative option or more aggressive option
or something in between. Staying competitive would encourage
adding options besides just a single managed allocation type
option.
MR. CHRIS LYNCH said the distribution flexibility of the program
is very important. Individuals who are participating in the
Alaska program need to have the ability to have that money go
towards room and board as well as tuition fees. Failure to have
a program that allows for room and board expenses would be
counted against the program.
MR. CHRIS LYNCH repeated that one of the important aspects of
these programs is the fact that a beneficiary in Alaska can
attend an institution anywhere in the country. That is often the
number one reason people will participate in a program of this
type. The fact that CSHB 268 has beneficiary flexibility worked
into the bill is favorable to a successful program. Another
popular feature of these programs from the purchaser's
perspective is it gives people the ability to name contingent
account owners, making things run more smoothly should the
original account owner pass away. From a corporate perspective,
TIAA-CREF also believes the protection from creditors will also
make this program popular in Alaska as well as other states. The
maximum amounts people can contribute are important as well as
the minimums that are established within the contract. Most
people are probably going to start out at low levels.
Establishing low barriers of entry to this program is the surest
way to expand the reaches of the program across the socio-
economic spectrum. Currently there are programs that allow
people to participate for as low as $25, or if it is through
payroll deduction, it is as low as $15. That doesn't make for
large accounts immediately, but it does get people to participate
in the programs.
MR. CHRIS LYNCH told the committee that keeping program expenses
on the low side is clearly favorable. The break point for this
in their experience is keeping it under 100 basis points in terms
of expenses. [One basis point is equal to one-hundredth of a
point.] This will be seen as a program that is offering good
value provided they are flexible in terms of the investments out
there and flexible in the other things he mentioned. There are
programs that operate significantly under 100 basis points, but
100 points seems to be the line drawn in the sand for these
programs.
Number 1851
JIM LYNCH, Interim Vice-President for Finance, University of
Alaska, came forward to testify. He told the committee he is a
member of the College Savings Plans Network (CSPN) and one of the
original drafters of the Advanced College Tuition (ACT) program.
The ACT program is an arcane program which is only about eight
years old. At the time the program was implemented, it was
probably a cutting edge program. The problem was it was designed
under a different tax code, and section 529 really turned the
tables upside down on the Alaska program. He relayed information
from the [CSPN] national conference in July. At that time there
were 17 prepaid states, 15 savings states and one state offering
both programs. The other states that were at the meeting
indicated they would have programs by 2001. Clearly there is a
shift to savings programs which function much like defined
contribution pension plans and away from the prepaid programs
which function similar to defined benefit pension plans.
Number 1923
MR. JIM LYNCH shared some history behind the programs. Michigan
started their plan in 1987, filed for an IRS ruling, and the IRS
came back and said the Michigan program was a taxable entity, and
investment earnings would be taxed. People could take a
deduction for the payments that they make out to the participants
ten or fifteen years later. Florida filed their tax return and
filed suit, they lost in circuit court, went back on appeal, and
this was about the time the Alaska program entered the market.
By that time Florida, Ohio and Alabama had programs. Kentucky
had the one savings program out there which was a taxable
program. There was no way to even create an argument that a
savings program was exempt. Michigan then won their appeal, and
the IRS chose not to take it to the Supreme Court. Instead the
IRS took on another of the state programs in another circuit to
see if they couldn't get some wins under their belt. At that
point, the IRS issued notices that they were going to give
adverse rulings to the other state programs including Alaska.
That notice initiated a movement to get section 529 passed, and
it was passed in August 1996.
MR. JIM LYNCH noted at that point there was an explosion of
savings programs because there is essentially little or no risk
for the state offering the program. Most of the prepaid programs
have a risk, whether there is a guarantee or not, that there
won't be enough money in the account when the student shows up to
go to school. Even if there is no legal risk, there is a moral
risk. That is also true with the ACT program. In 1997 the ACT
program was changed essentially to make it look more like a
savings program. It functions much like a mutual fund at this
point, but it earns only around 4.5 percent interest, and that is
why it rates so poorly nationally.
MR. JIM LYNCH indicated the university had been trying to work on
a plan to initiate a savings program when Representative
Murkowski and Senator Kelly developed the concept of the Alaska
Higher Education Savings Trust. At that point they got together
to try to figure out how to make the Alaska savings trust work
with ACT program. There are some long term commitments, probably
30 years out, under the ACT program for students to come to
school. The market is small in Alaska so there really can't be
two programs functioning very well competing with each other,
particularly one that is not going to do very well. They will
wind up with a lot of liabilities with one program and all the
money somewhere else. The ACT program needs to be fixed to make
it competitive and compatible with the savings trust program.
Then people would have multiple options to choose from, and that
is the intent of CSHB 268.
Number 2062
CHAIRMAN DYSON asked Mr. Lynch if the university approves of CSHB
268.
MR. JIM LYNCH stated that the university is very supportive of
CSHB 268. They have a program, whether anybody likes the program
or not, they are stuck with it, and they want it to be a success.
It does give the university access to a lot of future students,
and that is where the university will benefit. They haven't
developed a business plan to know what fees the university will
receive. He would like it to break even, and if they have some
monies to support the program, that would be wonderful. This
program provides financial access to education for the citizens
of Alaska. Currently there is only merit-based and need-based
aid available. For the students who are neither scholars nor
qualify for need-based aid, there is very little support for
their education. They wind up in loan programs which have to be
paid back.
Number 2126
REPRESENTATIVE GREEN asked about the fund being protected from
creditors.
MR. MANLEY explained that as long as the money stays inside the
trust or plan, it is protected from creditors similarly to the
protection of an IRA. Upon withdrawal of the money, there may be
a right for an injured person to get to it. It is like other
protected assets like IRAs, 401Ks, limited interest in insurance
and homestead protection.
REPRESENTATIVE GREEN asked whether this plan would be compatible
with what the President has put forth.
Number 2212
MR. MANLEY said he believes the state program would be compatible
with anything that comes along and there is not a good reason to
defer action on this.
MR. JIM LYNCH stated that the IRS has been the biggest
obstruction to making these programs successful for the last ten
years. It isn't without reason; if this works for college
savings, maybe there would be a lot of other good reasons why tax
exempt or tax deferred vehicles could be created. All of the
benefits for the state programs have come because of
congressional action and the White House pretty much stays away
from providing any benefits at all. It has been difficult to get
anything through the Clinton Administration at this point for
state programs.
REPRESENTATIVE COGHILL asked if there was any law that prevents
this type of trust being done on a private level.
TAPE 00-5, SIDE B
Number 2305
MR. JIM LYNCH answered that only states can offer or sponsor the
programs, and that is what makes the programs attractive to firms
such as Smith Barney and Merrill Lynch and TIAA-CREF. They are
unique and only states can do it.
REPRESENTATIVE COGHILL agrees with the idea of the trust, but he
objects to the state being the warehouse of so much money. He
would like to see it more in private industry. He isn't against
the university having the benefit.
MR. JIM LYNCH said the university will not be managing the trust.
It will be out-sourced. There will be a contract with firms like
Merrill Lynch, Smith Barney or TIAA-CREF who will do the work.
The firms are the registered brokers.
Number 2263
CHAIRMAN DYSON asked Mr. Chris Lynch how a firm like TIAA-CREF
gets paid for providing these services.
MR. CHRIS LYNCH indicated that TIAA-CREF is a non-profit
organization. He explained the way they get their investment
back from a given program is through the program expense
structure. Their programs typically run from about 65 basis
points to about 80 basis points. They recoup their investment
through the expense charges built in to the program. There are
programs where the payback is done via commissions or some kind
of annual fee. It is not uncommon to see with other companies
that they get it entirely through the expense ratios.
Number 2214
CHAIRMAN DYSON asked for a rough idea of what percentage it takes
to reimburse the companies for the expenses.
MR. CHRIS LYNCH said they are all less than 1 percent. The
expectation is that once an organization is named as the program
manager for the state that they have a relationship with the
state for a contract term typically between five, seven or ten
years duration. They are able to decrease the amount of the
expense ratio depending upon the length of the contract.
Number 2080
REPRESENTATIVE GREEN referred to page 3, Section 3 and asked Mr.
Jim Lynch what sort of investments would this program be limited
to and if they are like some of the IRAs which are very
conservative.
MR. JIM LYNCH answered it will be the university's responsibility
to select a program which provides the range of alternatives
which could run from fairly aggressive to very conservative. It
is the same as managing a pension program. The university has a
fiduciary responsibility to select quality investments. The
university will create a program with a provider that takes
mutual funds and select a portfolio that is unique for the
program. The university will not be held responsible for what
the market does. They will be responsible to the extent that the
law provides for any negligence.
REPRESENTATIVE GREEN referred to page 4 and asked if (f) "A
participant has the right to change beneficiary..." and (h) "An
account is not subject to involuntarily transfer or
alienation..." were conflicting statements.
Number 1934
MR. MANLEY answered he doesn't believe so. He explained that
alienation is simply transferring away from the owner and
involuntary transfer would be a judicially enforced transfer.
They are not inconsistent, and it makes the intent clearer to any
judges who might review it.
REPRESENTATIVE COGHILL asked at what degree is the person filing
the trust active in the portfolio.
MR. JIM LYNCH answered that the participant can't do anything
except choose one of the options available. Section 529 has a
prohibition against the participants directly or indirectly
controlling the investments. There may be several offerings and
the participants can select which offering; they could put money
in all of the offerings, but they can't change in mid-stream.
REPRESENTATIVE GREEN asked if trade schools are qualified
institutions.
MR. JIM LYNCH said that vocational/technical schools are
qualified institutions.
REPRESENTATIVE GREEN asked if he doesn't use the money for higher
education and withdraws it, would he be subject to taxes that
year.
MR. JIM LYNCH answered that if the money was withdrawn and the
beneficiary was not using it, it would be taxable to the
participant in the year the money was received.
Number 1804
REPRESENTATIVE GREEN asked if it is like an IRA where he can
withdraw a little at a time.
MR. JIM LYNCH noted theoretically he would change the beneficiary
to someone else.
REPRESENTATIVE COGHILL asked if it was possible to rollover from
this program to an IRA.
MR. JIM LYNCH said he didn't believe at this point in time there
would be a rollover allowed to an IRA account. Rollovers to
beneficiaries are basically limited to members of the family as
defined in the code of the beneficiary.
Number 1753
DANA OWEN, Special Assistant to the Commissioner, Department of
Revenue, came forward to testify. The department is supportive
of the concept of the bill, but he wanted to alert the committee
of an objection to one feature of the bill which probably was
drafted in oversight. The department is working with the sponsor
of the legislation to craft some language that might fix the
concern. The concern is that while they have created a shelter
from litigation, the department would not like to see that
shelter applied to child support. He would like to make sure
that this is not inadvertently a vehicle for hiding assets for
purposes of evading child support. There is not language today
to fix this problem, but he would not object to the committee
passing the bill out today because there is time to amend the
bill later.
The committee took an at-ease from 4:15 p.m. to 4:16 p.m.
Number 1683
REPRESENTATIVE GREEN made a motion to move CSHB 268, version 1-
LS1235\H, Ford, 1/24/00, from committee with individual
recommendations and the attached fiscal note.
REPRESENTATIVE COGHILL objected for purposes of discussion. He
said he didn't know if he agreed with the fix and would like the
opportunity to debate the issue.
CHAIRMAN DYSON asked Mr. Owens how soon he expected to have the
new language.
Number 1658
MR. OWENS answered in the next couple of days.
Number 1632
REPRESENTATIVE GREEN withdrew his motion.
CHAIRMAN DYSON announced they will revisit this on Tuesday.
[CSHB 268 was heard and held.]
ADJOURNMENT
Number 1594
There being no further business before the committee, the House
Health, Education and Social Services Committee meeting was
adjourned at 4:17 p.m.
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