HOUSE BILL NO. 268 An Act relating to the Alaska Higher Education Savings Trust; and providing for an effective date. REPRESENTATIVE LISA MURKOWSKI explained that Alaska, through the student loan program and the Advance College Tuition program has traditionally offered its residents seeking higher education, solid financial options. HB 268 continues this trend and will allow residents and non-residents alike the ability to put money into a trust fund to be used for higher education expenses. The bill will ensure that Alaskans will continue to have flexible and powerful financial options to utilize for their higher education. Representative Murkowski continued that under IRS Code 26 USC 529, commonly known as "Section 529", it is recorded that states are allowed to create "qualified State tuition programs". Section 529 defines "qualified State tuition program" as a program established and maintained by a state or an agency under which a person may either purchase tuition credits or certificates on behalf of a designated beneficiary. That then entitles the beneficiary to the waiver or payment of a qualified higher education expense for the beneficiary, or they may make contributions to an account that has been established for the purpose of meeting the qualified higher education expenses of that designated beneficiary. Representative Murkowski continued that HB 268 would establish a qualified State tuition program. The program would be administered by the University of Alaska and would be known as the "Alaska Higher Education Savings Trust". The bill would also change the structure in order to conform to the new IRS codes and changing the name of the program to the Advance College Tuition Savings Fund. In order to keep the overhead down and the record keeping and marketing costs to a minimum, HB 268 would place both programs under one administrative head. Representative Murkowski urged members to pass the bill from Committee. Co-Chair Therriault asked about "rolling" the program into the University services. JIM LYNCH, INTERIM VICE PRESIDENT FOR FINANCE, UNIVERSITY OF ALASKA, FAIRBANKS, explained Section #529 and the federal regulations of that section. He noted that in 1996, he had participated in the drafting of Section #529. Mr. Lynch stated that he had argued the tax-exempt status to the University's Advanced College Tuition (ACT) program before the National Office of the Internal Revenue Service (IRS). He added that the University of Alaska administration is in support of the proposed legislation. The institutions could use that are eligible for federal financial aid purposes. He added that the legislation would support education by subsidizing programs and making loans available. He commented that the legislation would encourage prospective students to save in advance for college. Co-Chair Therriault asked if the bill would dismantle the current University program. Mr. Lynch explained that the legislation would add a higher education trust and would modify the ACT program from a tuition program to a savings program. Mr. Lynch provided background history regarding the legislation. He noted that there are essentially two types of savings programs. The first is a prepay program; the other is like a defined benefit pension plan. Mr. Lynch pointed out that the first state program made available was in Michigan in the late 1980's. Michigan established a prepaid tuition program and filed with the IRS for exempt status. The IRS came back and told them that they were a taxable entity. It took five to six years for the State of Michigan to win the appeal of the program. The Alaska Program was started in 1991, and was designed to be tax exempt to accomplish some of the items listed in Section Mr. Lynch spoke to the taxable criteria of the tuition costs. He noted that there have been gift tax exemptions built in and tuition credits for the kids as a completed gift. They would qualify for the $10,000 dollar gift tax exclusion. He added that the program is deeply connected to the University, as it is an unrestricted liability of the University. The intent of this was to make the organization exempt. The IRS never accepted any of the arguments maintaining that these were loans by citizens to the University and the increase in value was essentially interrupting income to those individuals. At that time, the Alaska Program was running and the IRS lost its case against the State of Michigan. Following that, various states got together and passed Section #529 in 1996. Mr. Lynch noted other events which had occurred regarding the concern. In 1998, the Alaska Legislation passed the Alaska State Trust Act, which does provide a creditor protection vehicle to be associated with it. Mr. Lynch explained that Section #529 basically exempts State programs and that private entities would not be able to issue to them. The earnings are tax deferred and the beneficiaries are the ones taxed on this money. Mr. Lynch pointed out that there are a number of state tax break benefits that are associated with it. There is a special averaging provision which allows a person to put up to $50,000 into one of these accounts for a beneficiary and then take the exclusion for the next five years. For a husband and wife, that means that they could put $100,000 dollars aside for a child's education. Mr. Lynch added that there are some generational "skipping" provisions within Section #529, intending that no generation be skipped. He stated that it is one of the few vehicles in which you can make a gift and continue to control it and then take it back from the beneficiary. The other advantage to Section #529 is that there are no income limitations on who can put the money into the fund. He pointed out that after Section #529 passed, there was an "explosion" in the number of college savings programs. Mr. Lynch advised that the bill would create one administrative structure within which to manage two programs. ? The advanced college tuition program; and ? The higher education trust. The bill would help to combine the benefits of Section #529 with the creditor protection trust laws in Alaska. It would help complete the transition of the ACT program from a prepaid to savings program. Savings vehicles have special treatment in terms of determining what the taxable portion of the earnings are under those savings and the treatment for federal financial aid purposes. Mr. Lynch pointed out that the bill would allow the two programs to develop on a complimentary basis, while at the same time, it would allow for one record keeper. Co-Chair Mulder commented that the main advertisement was somewhat misleading, indicating that the money would be tax deferred. Mr. Lynch replied that a person pays tax on the money when it goes into the account. Co-Chair Mulder asked what would happen if the child decides that they are not going to school. Mr. Lynch explained that in Alaska Plan, they could not get the funds out of the account unless they go to school and instead, the money would revert back to the grantor of the trust. Mr. Lynch added that the granter of the trust could change the name of the child as long as it is a member of the family. Co-Chair Therriault inquired if the funding would reflect on the child's assets for federal college assistance. Mr. Lynch replied that at this point, that decision has not been made. Many of those decisions will be left up to the individual. He noted that they would receive better treatment than through the prepaid tuition. Mr. Lynch testified that unfortunately, the financial aid rules do penalize for saving. That can not be avoided at this time. He acknowledged that it is not clear how a savings program will be treated down the road. (TAPE CHANGE, HFC 00 - 28, Side 1) Mr. Lynch noted that this would have to be limited to eligible institutions. Eligible institutions are defined within code Section #529 as a "Group of institutions that qualify for federal financial aid as of the date the act was passed". Co-Chair Mulder asked if Alaska Vocational Technical Center (AVTEC) would qualify. My Lynch understood that the school in Seward did not initially qualify, however, they do now. Vice Chair Bunde thought that the legislation would encourage more students to leave the State. Mr. Lynch agreed that there needs to be more incentives to encourage students to go to college within the State of Alaska. Mr. Lynch stated that through the Advanced College Tuition program, there is a guarantee that if you come to school at the University of Alaska, you would receive education at that equivalent, at some point in the future. Vice Chair Bunde reiterated that the money from this program could be used for attendance of any school throughout the United States. He believed that it would encourage more "brain drain" from Alaska. Co-Chair Therriault pointed out that these funds are portable. Mr. Lynch replied that it is difficult to get people to buy into a program isolated to the University of Alaska. He emphasized that incentives need to be provided. ANNE ALLEN, SENIOR COUNCIL, SECTION #529, GOVERNMENT RELATIONS DEPARTMENT, TIAA-CREF, New York, (TESTIFIED VIA TELECONFERENCE), offered to provide a resource of information to Committee members. She encouraged Alaska to offer this program. She stated that these are flexible programs and they can be used for any type of higher education including vocational schools, technical schools, and would cover the costs for room, board and books. She noted that there are a wide variety of donations that can be make to this program. The accounts act somewhat like a ROTH IRA and are affordable. She stressed that it is important to encourage these programs and that a lot of states do have the tax deductions and incentives to attract people to their state program. She emphasized that Alaska would be carving out its own niche. She explained that the age of the beneficiary would determine the investment risk and that various risk factors could be considered. Ms. Allen pointed out that account owners can not move money around. Ms. Allen referred Page 2, pointing out language that indicates that there can be multiple investment managers to an account. She noted that at this time, there is only one state that has multiple mangers. She noted that there has been negative testimony regarding the use of multiple managers. She proposed that the multiple investor's concept could lead to increased costs to the participants. Ms. Allen concluded that HB 268 is a good bill and urged the Committee's support. Vice Chair Bunde asked if the main difference between HB 268 and parents putting money into their own mutual fund would be that the earnings would be taxed deferred. Ms. Allen agreed that it would be tax deferred on the federal level. She emphasized that whom ever opens the account, would have the assurance that this money would be used for education. Additionally, she noted that there is a "potential" to receive a higher investment at the state level. Representative Austerman questioned the fiscal note and the indicated interest earnings. Mr. Lynch replied that he had prepared the fiscal note for the University conceptually creating a business plan. The product must first be established. He added that the fiscal note would be providing for the child's education and plans for a future event. The restrictions on Section #529 are that you only choose once. He agreed with Ms. Allen that the cost would be the key point. Mr. Lynch explained that initially, the State will need to adopt a business plan by undertaking an analysis of what other states have done. Attorney fees will be accessed in establishing a complicated trust. Securities and Exchange Commission (SEC) will depend on how the program is marketed. The intent is to take the $25 million dollars in the ATC program and combine these two programs for record keeping and investment and then use today's program as a carrot for the providers. He noted that what makes the program work is the volume and the earnings from that the program would be used to support it. Co-Chair Therriault asked if the existing program would be converted. Mr. Lynch explained that the bill would make a common administrative structure for the two programs. Co- Chair Therriault asked if the programs would remain separate. Mr. Lynch replied that they would. One is a formal trust program and the other is a contract. Representative Austerman assumed that the operating cost of $100 thousand dollars would cover the cost of one employee. Mr. Lynch replied that most of the costs would be out- sourced. Otherwise, it would be contracted out with a major consolidator, as they know how much it will cost to manage the money. After that, it is important to access what services you expect to receive from the provider. The question is what the fee would be used for to determine the investment returns. Co-Chair Therriault asked if this would be similar to the Supplemental Benefits System (SBS) portfolio. Mr. Lynch explained that the investment program can not be changed. Most programs are set up based on the age of the participant. This would be the same concept as the Alaska Target 2005, 2010, or 2015. You would be required to choose the asset allocation and stick with it. Co-Chair Therriault asked at what age a child is no longer paying at the parent's rate of unearned income. Representative Murkowski replied that was at age 14. Mr. Lynch replied that the child would not be paying until the money is withdrawn. Representative Austerman questioned how the program would work. Mr. Lynch replied that the sponsor would receive a portion of the fund for the investment work. He explained that you have to invest money to receive it. The larger the fund becomes, the more will be received. Co-Chair Therriault inquired who the sponsor would be. Mr. Lynch replied that would be the State of Alaska or the University of Alaska. He noted that there are a couple of ways that the fees come in. The provider will set the fee amount for establishing the account. He added that there are fee revenues associated with the plan. Representative Austerman pointed out that the income received back would be determined by how the market was doing. Mr. Lynch replied that even if the mutual fund is loosing money, the manager would still be receiving their fees. Representative Austerman questioned how the percentage fee would be determined. Mr. Lynch replied that this would be an account opened for the child through the sponsor. Representative Austerman asked if the remaining amount, after the cost for running the program, would be issued to the participants. Mr. Lynch replied that there is no guarantee that a specific amount would be received. Mr. Lynch acknowledged that it will take a while to obtain the objective for the invested money. If the fund is doubled, the program would pay for itself. Representative Austerman asked if the plan is not paying for itself, who is paying for it. Mr. Lynch replied that the University would be subsidizing the program initially. Vice Chair Bunde requested to see the revenue neutral. He believed that the program would be subsidized by the State. He pointed out that manager fees will always be included. He added that there is a potential liability to be able to pay the managerial fees. Mr. Lynch stated that the subsidized costs would not be to the managerial fees. The upfront costs would be used for consulting and attorney costs to establish the program. Mr. Lynch noted that the purpose of the Alaska Prepaid Tuition Program (APPTP) program is to help change the view of parents and children and to get them thinking about higher education. Mr. Lynch stressed that program does have the potential to grow. HB 268 recommends a defined benefit program that will go up with inflation and tuition and providing a guaranteed education program. Co-Chair Therriault noted that HB 268 would be HELD in Committee for further consideration.