SB 186-COLLEGE TUITION SAVINGS PLAN SENATOR TIM KELLY, sponsor of SSSB 186, introduced Jim Lynch, Acting Vice President for Finance at the University of Alaska, and informed committee members that Mr. Lynch has been instrumental in the creation of the Alaska college tuition savings program which began in 1970. SENATOR KELLY explained the IRS passed a new tax bill in 1996 which allows for more flexibility in tax-deferred education plans. SSSB 186 is an attempt to update Alaska's existing advanced college tuition savings fund and institute a new Alaska Higher Education Savings Trust that allows a more sophisticated investor to place more money into a tax-deferred education fund for a beneficiary. SSSB 186 also takes advantage of some of the creditor protections available in the State of Alaska. SENATOR KELLY asked that Bob Manley, an estate planning attorney in Anchorage who helped to draft the legislation, testify first. He also noted that committee members have a proposed committee substitute before them labeled 1-LS1084\M. SENATOR WILKEN moved to adopt CSSSSB 186(HES), with individual recommendations, as the working document of the committee. There being no objection, CHAIRMAN MILLER announced the motion carried. SENATOR KELLY indicated the bill has two fiscal notes. The fiscal note from the Department of Revenue does not apply to the committee substitute as that version will have no fiscal impact on the department. The costs in the University of Alaska fiscal note should be borne out of program receipts. Number 502 MR. ROBERT MANLEY made the following comments on his own behalf via teleconference. He has been practicing as an estate planning and tax attorney for about 25 years, and he works with an informal group of other tax and estate planning attorneys who do pro bono work in the area of legislation review. He became interested in this legislation because some of his estate planning clients are sending money outside of the State of Alaska to non-Alaska programs. SB 186 sets up a program that is good for Alaskans and good for the University of Alaska (UA). Internal Revenue Service (IRS) Code Section 529 authorizes states to adopt programs of this type. Forbes magazine calls Section 529 the "sleeper tax break of the 1997 tax act." The use of this program for education is not specific to the particular state it is set up in as long as the money is spent on higher education expenses, therefore the state that offers the best program for everyone will be the most successful. The program that would be created by CSSSSB 186(HES) is good for Alaskans because it allows Alaskans to save for anticipated college expenses. The program is set up similar to an IRA in that contributions are income tax deferred until the money is withdrawn by the student who is usually in a lower income tax bracket than parents. Under a tax bill that is now pending, the withdrawal for higher education expenses would be totally free of income tax. One benefit from an estate gift tax point of view is that one could contribute $10,000 with a gift tax exclusion and elect to take five years of the exclusion at one time, which allows a contributor to forward average and contribute $50,000 at one time. MR. MANLEY continued. The program is flexible as it is not based on income. One can contribute up too $100,000, or possibly more. The State of Montana currently allows contributions of up to $172,000, depending on anticipated education expenses. The most favorable aspect of the program is participant control. The beneficiary can be changed or the program can be canceled and the money withdrawn. If the money is not used for higher education, a penalty must be paid. That penalty would be collected by the UA, not the IRS. Another advantage for Alaskans is that the childrens' college education funds would be protected from creditors. The UA will benefit by receiving administrative and management fees, plus any penalties. The program was purposely designed to attract non- Alaskans because the UA will benefit from more participants. All states are in competition for this investment money. MR. MANLEY stated the program is good for non-Alaskans for the same reason that the Alaska trusts are; it contains a spendthrift trust protection provision which allows the participant to preserve the assets if the participant went into bankruptcy or had financial reverses outside of Alaska. Other states have similar creditor protection provisions but they do not have the Alaska Trust Act so they cannot offer that benefit to non-Alaskans. That economic benefit is the reason the State of Delaware "copy-catted" Alaska's trust laws. Last, this program will attract college savings money invested by Alaskans into Alaska because accounts can be rolled over from one state to another. He asked committee members to support the legislation. Number 908 SENATOR KELLY explained that the first five pages of CSSSSB 186(HES) create the new Alaska Higher Education Savings Trust and the remainder of the bill amends the original Alaska advanced college tuition payment fund to change it to a savings fund. MR. JIM LYNCH, Interim Vice President for Finance for the University of Alaska, and one of the founding board members for the National Association of College Savings Plans (NACSP), and a principal director of the Alaska advanced college tuition program, gave the following background on the milestones of college savings programs. In the late 1980's, the State of Michigan was the first state to implement a prepaid college savings program. That program worked as an installment contract for the purchase of tuition. The State of Michigan requested a revenue ruling from the IRS and received an adverse ruling making the program was a taxable entity. Michigan then filed suit against the IRS. It lost the case and filed an appeal. During that time period, the states of Alaska, Florida, Ohio, Alabama and Kentucky started programs. In the mid 1990's Michigan prevailed against the IRS in appellate court. The IRS had been holding the revenue ruling request for exempt status from the other states. It then sent the states notices that it planned to issue adverse rulings for all states except Florida and Ohio which had guarantee provisions for full faith and credit of the state which required voter approval. In 1996 the NACSP mustered support in Congress to pass IRS Code Section 529 which provides tax exempt status to all college savings programs. Since that time, there has been a rush of money into the savings programs. Those programs function much like a defined contribution pension plan. He calculates as of July, a total of 32 programs are either open or in the process of opening by the year 2001. MR. LYNCH continued. When Section 529 was enacted, Alaska's prepaid tuition program was modified to look more like a savings program which has advantages in the calculation of taxable earnings and in financial aid eligibility. The UA then looked at creating a savings program but it did not have the trust concept built in as Senator Kelly's bill does. They then got together to develop a sensible program including the UA's prepaid tuition program and the trust concept. CSSSSB 186(HES) will benefit the UA as well as Alaskans and it will allow the UA to leverage its current prepaid tuition program which contains about $25 million to make the new program successful. Number 1100 SENATOR KELLY asked how many participants are involved in the prepaid tuition program. MR. LYNCH replied it has approximately 11,300 participants and 8,500 beneficiaries. SENATOR ELTON asked how much the UA would charge to administer the contract with a private company. He said his experience is that the UA charges a hefty overhead amount. MR. LYNCH said it is the product of how the UA budgets its services. The UA participates in a lot of activities, particularly research activities, and recovers its direct costs plus a portion of its indirect costs. The costs are high but they are not much different than the costs charged by the private sector. Profit is not built into UA's overhead cost. If a professional is hired to do any service, one pays twice the cost of the salary. The UA charges the cost of the professional's time, plus identifiable costs, plus an overhead and that calculation is based on federal standards. SENATOR KELLY asked Mr. Lynch to elaborate on how the program would work. MR. LYNCH explained that the UA supports the administration of the present program and costs are paid out of UA revenues, not from program revenues. The UA has utilized some of the set up fees and it has some transaction fees for people who change participants. Other than those fees, the UA is not using funds from the program to support it. The idea is to build up the fund to the point where it is self sustaining. The initial period of one of these programs is very difficult. Number 1367 SENATOR ELTON said he intuitively believes the Department of Revenue or Alaska Commission on Postsecondary Education could administer the contracts less expensively. SENATOR KELLY clarified that any agency will contract with an investment company such as Fidelity to run the program. The investment company will return a certain amount of basis points to the UA as a licensing fee. The UA would not hire employees to do the work on a day-to-day basis but instead it would contract with one of the large, national financial managers who are looking for states to make these agreements with so that they can market these programs nationally. He added that the financial institutions are looking for at least one state that they can contract with because they need a state to allow for the non-taxable status. MR. LYNCH agreed the UA does not intend to manage money as that is not its area of expertise. SENATOR WILKEN asked if the concept would be similar to Alaska's Permanent Fund, which is administered by a board through different managers with the cost being 17 basis points. The UA Board of Regents would only come into play when they would entertain and decide on the award. He noted the administrative fee should be relatively small. SENATOR KELLY said that is correct but a small basis percentage of a large amount of money can be lucrative for the UA. He pointed out that 15 basis points of $1 billion equals $15 million per year. He indicated he hopes Alaska can attract investors from throughout the nation. MR. LYNCH added the UA's intent is to combine and outsource the recordkeeping function which is the problematic part of these programs. The UA cannot create the internal administrative systems needed to manage the recordkeeping systems. SENATOR KELLY explained that he got involved with the bill because a proposed vendor came to him indirectly and proposed such a program. As he looked into it, he learned that while the guaranteed tuition program is a defined benefit program, it may or may not be as profitable in the long run as an education trust, depending on the stock market. The vendor was looking for a vehicle to market nationally. He emphasized that there are some big companies that want to use this program and the process will help Alaska and its students, therefore given Alaska's unique competitive position, it would be foolish not to go forward with it. Number 1609 SENATOR WILKEN referred to the word "may" on page 3, line 18, and asked if that word should be changed to the word "shall" in relation to line 24. He questioned whether it would be better to say the board will require trust participants to pay administrative fees. MR. LYNCH explained that, eventually, the UA may outsource enough of the program so that the revenues to the UA may not come in the form of fees, they may come in the form of a license fee or a commission from the fund provider so they decided they did not want to be restricted to fees. SENATOR KELLY indicated that the UA charges fees for the existing program but he maintained that the word "may" was intended for subsections (1) and (2). He believes it is clear there will be administrative fees. SENATOR WILKEN said what he is getting at is that a time may come when the Board does not want the participants to pay the administrative fees so it would derive those monies from some other source. He maintained that using the word "will" would require the fees to come out of the investment itself so that it would be a burden upon that particular investment vehicle to carry its own administrative costs. MR. LYNCH stated it does not make sense to have two separate administrations for two programs: the prepaid tuition program and the Alaska Higher Education Savings Trust. He envisions a common administrative system and a common marketing program to deal with both but with that system it will be impossible to segregate the costs for each fund. SENATOR WILKEN asked if there will be only one fund named the Alaska Higher Education Savings Trust. MR. LYNCH explained there will be an overall umbrella program named the Alaska Postsecondary Education Savings Program. Within that, there will be the advanced college tuition savings fund, which is not a trust - it is a fund within the UA, and the Alaska Higher Education Savings Trust. The program will have different vehicles within it and they are trying to create a good package that will benefit Alaskans and one that will be marketable externally. SENATOR WILKEN clarified he is concerned that some time in the future, the fund costs $10 million to administer, the word "may" would allow administrative costs to be paid with tuition, vending fees, or general funds. MR. LYNCH said he did not want the UA to be required to charge a specific fee because it could come through licenses or commissions as opposed to fees to participants. The recordkeeper must get the money somewhere. Someone will take basis points off of the investments or they will charge specific fees on a regular basis. He said he never conceived of the UA using general fund support to maintain a program for non-Alaskans. He noted that SB 186 requires a commitment although the risk is very limited. It is similar to a defined contribution pension plan and there is very low risk of getting stuck on the administrative side because the cost should come out first. SENATOR WILKEN referred to page 4, line 4, and asked whether the UA could take into account the fact that a person has $50,000 invested if the person applied for a scholarship based on need. MR. LYNCH explained the intent of that provision is that it not affect the issuance of scholarships. SENATOR KELLY clarified that provision was included to allow students in the top ten percent of their classes to continue to be eligible for the scholars program even though they may have money invested in the education fund. MR. LYNCH pointed out the provision applies to state-funded scholarships because, in general, scholarship donors determine the criteria for scholarship eligibility. SENATOR ELTON asked Mr. Lynch if both the prepaid tuition program and the Alaska Higher Education Savings Trust will be placed under one umbrella and, if so, whether one could transfer assets from one fund to another. MR. LYNCH replied that question requires a ruling from the IRS. The UA hopes to allow participants a one-time opportunity to transfer the funds. He believes the IRS will rule favorably because those participants were not given a choice when they originally got involved. SENATOR KELLY added that participants will not have to transfer funds. MR. LYNCH pointed out the primary source of contributions for the current program is from the permanent fund dividend. Number 2084 SENATOR WILKEN asked if he put funds into the advanced college tuition program in 1990 and now decided to put funds into the trust, whether statements for each program would come from the same financial institution. MR. LYNCH replied he hopes the statements will come from one source. From the perspective of the IRS, the programs will be considered to be a single program for reporting purposes. SENATOR KELLY asked Mr. Lynch to elaborate on the potential size of the accounts. MR. LYNCH explained that Section 529 requires a limit but the draft regulations have never been adopted. According to those regulations, the limit is the amount required to attend the highest cost institution covered by the program. Other states allow the cost of the highest institution in the country. He suggested most programs have a limit of at least $100,000 because that amount allows for the maximum gift tax benefit for a husband and wife. Number 2199 ANN ALLEN, Senior Counsel with the Teachers' Insurance and Annuity Association (TIAA), informed committee members TIAA is one of the largest administrators of education investment programs in the programs. She commended committee members for looking at this type of legislation and she felt the committee has done a good job looking at the issues involved. Regarding the discussion of the cost of administrative fees, TIAA is relatively low-cost. TIAA charges a basis-point fee which includes the state's administrative cost. On average, TIAA charges around 65 basis points. That rate can increase to up to 130 basis points depending on the marketing plan used. The state would have to decide whether it wants to have marketing directed toward state residents or out-of-state residents. The federal government has wanted states to be involved in these programs to ensure that the monies are used for educational purposes. If Alaska decides to use its program for a national program, the basis rate is usually a little higher. MS. ALLEN said she was interested in the rollover language because states can set up their own rollover plans between state plans, however other types of accounts cannot be rolled into these plans according to Section 529. The money from these accounts can be used for room, board, and books, as well as tuition. Also, multiple accounts can be set up for one beneficiary. Number 2382 SENATOR ELTON asked Ms. Allen if the contractor usually absorbs the cost of a national marketing program because the contractor will benefit from a larger program or whether other trust participants may be paying for the national marketing program. MS. ALLEN replied if the vendor who is running the program is trying to appeal to a national market, the cost is usually built in to the basis point charge. Because marketing is very expensive, she suggested asking the vendor for a breakdown of the cost and what each basis point charge represents. 2353 CHAIRMAN MILLER asked Dana Owen to address the Department of Revenue's fiscal note. DANA OWEN, Special Assistant at the Department of Revenue, stated the committee substitute removes the section in the bill that mandated that the Department of Revenue act as the custodian of the funds, therefore the department no longer has a role in the program. There being no further questions, testimony, or discussion, SENATOR WILKEN moved CSSSSB 186(HES) out of committee with individual recommendations and the University of Alaska fiscal note. There being no objection, CHAIRMAN MILLER announced the motion carried.