Financial Planning Blog

You’re a couple of years away from sending your son or daughter to college and you’ve done everything “right”. You’ve saved diligently in your state’s 529 plan, placed your money into the conservatively managed “1 to 3 years to college” portfolio, and you then you watch in horror as your 529 account loses almost 30% in the last year. Would you be a bit upset? Apparently, a number of folks across the border in Oregon are, as are many in other states with 529 plans managed by OppenheimerFunds Inc.

The Wall Street Journal reported yesterday that the Oregon Attorney General has filed suit against OppenheimerFunds Inc. on behalf of the state treasurer to recover losses in the Oregon College Savings Plan. At issue is the abysmal performance of the Oppehheimer Core Bond Fund (OPIGX), which was a critical fixed income component in the five age-based portfolios in the Oregon plan. This intermediate bond fund lost almost 36% in 2008 and another 10% so far in 2009. Needless to say, this performance was far behind the Barclay’s Aggregate Bond Index which gained over 5% in 2008. So much for a conservative investment!

Oregon estimates that 529 plan participants lost at least $36M, and the suit alleges that Oppenheimer was negligent and breached its contractual and fiduciary duties. The state claims that the bond fund changed from a conservative fund to one investing in aggressive and risky securities including credit default swaps and other derivatives. "The Core Bond Fund was no longer a plain bond fund," the complaint says. "It had become a hedge-fund like investment fund that took extreme risks."

Oregon wasn’t the only state burned by OppenheimerFunds 529 plan management. Illinois is one of a handful of other states trying to negotiate a settlement with Oppenheimer due to the huge bond fund losses. An interesting note is that Illinois’ Bright Start Program was singled out by Morningstar in “The New Gold Standard Among 529 College Plans” in August ‘07 and still topped their 529 rankings in August ‘08. Apparently they missed the impending problem with the intermediate term bond fund selection.

I think a number of people—plan sponsors and individual investors—will be taking a closer look at their 529 plan investments, if they haven’t already.

The “Bad Bank” episode of This American Life referenced in the recent post “The Economy Explained” featured an interesting conversation with Columbia Business School professor, David Beim. Besides talking about a bank run in ancient Rome (AD 37) and why not loaning out the government bailout money is the right course of action for the less healthy banks to take, Beim showed a striking chart measuring the level of American household debt. Now showing a chart on the radio is generally not effective, but his description of the trends sure caught my attention. (Click here for a shorter version of the story.)

The latter part of this chart, which shows the ratio of household debt to GDP in the US from 1916 to the present, is not surprising. As Beim describes it, “From 2000 to 2008, it just goes, almost a hockey stick, it goes dramatically upward…It hits 100% of GDP.” This sounds bad, but you have to see the rest of the chart to gain the proper perspective. The ratio moves slowly from around 30% of GDP in the late 1930’s to about 50% of GDP in the mid 1980’s. In the latter part of the 1980’s it accelerates above 50% and goes though 70% by year 2000. Then the real hockey stick move to 100% in 2007.

This may be a bit scary, but hardly a shock if you’ve been paying attention the last twenty five years. What is truly sobering, however, is the second peak of the graph off to the left. As it turns out, this ratio of household debt to GDP reached 100% earlier in our history. The year was 1929—the year of the great stock market crash and start of the Great Depression.

Beim goes on to explain, “That chart is the most striking piece of evidence that I have that what is happening to us is something that goes way beyond toxic assets in banks, it’s something that had little to do with mortgage securitization, or ethics on Wall Street, or anything else. It says the problem is us. The problem is not the banks, greedy though they may be, overpaid though they may be. The problem is us. We have over-borrowed. We have been living very high on the hog. We are, our standard of living has been rising dramatically over the last 25 years, and we have been borrowing to make much of that prosperity happen.”

Now I’m not going make too much out of this one piece of data. Even without this amazing coincidence between 1929 and 2007, it just feels right that there would be eventual consequences to the rampant borrowing we used to finance an ever-improving standard of living. Although I won’t try and predict how the rest of the current economic turmoil plays out, I remain optimistic that we will work through this.

The sad thing is this data is the combination of millions of individual families who have borrowed too much and have lived with too little financial margin. Certainly some are victims of difficult circumstances, but others made poor choices and have lived beyond their means. Although as individuals we cannot control the economy as a whole, we do have control over the spending decisions in our homes. I am hopeful that the trials American families go through today will result in a fresh look at our priorities and produce wiser decisions in the future.

So much is going on with the economy and the government’s response to the financial crisis it’s hard to keep up. For those of you with children in college or about to start, you’ll want to pay attention to recent changes to the various federal tax benefits for education. Although these changes may not make up for recent losses in your 529 plans or retirement accounts, they will provide significant savings for some of you.

The American Recovery and Reinvestment Act of 2009 expanded the Hope Credit program in a couple of very important ways. First, for those of you unfamiliar with the Hope Credit, it is a sizeable tax credit for qualified tuition and related college expenses which can be taken by either the parents or student—whoever claims the student as an exemption on their tax return. In 2008, the credit was for 100% of the first $1,200 of qualified expenses, and 50% of the next $1,200, for a maximum amount credit of $1,800. The student was required to be in their first two years of college and enrolled at least half-time. Just to be clear, this is per student, so if you are lucky enough to have multiple children in the first two years of college, you can claim multiple credits. Unfortunately (or fortunately, depending on how you look at it), some of you are ineligible for the credit in 2008 because of the adjusted gross income phase-outs that start at $96,000 for married filing jointly, and $48,000 for others.

Fast forward to 2009, and a good deal gets a good deal better. First, the Hope credit has been raised to $2,500 (100% of first $2,000, and 25% of the next $2,000 of qualified expenses). Second, eligibility for the credit has been extended to four years, instead of only two. And, for those of you frustrated because you missed out in 2008 because of the AGI limitation, these have been made significantly higher also. Now the AGI phase-outs don’t start until you hit $160,000 for married filing jointly and $80,000 for single filers. As this isn’t enough, the credit is now 40% ($1,000) refundable, in order to allow low income students to take advantage.

These enhancements provide a little something for almost every family with a student in college. However, the expansion of these benefits is only for education expenses in 2009 and 2010, although there are proposals to make the changes permanent.

The Hope Credit’s less attractive sister, the lifetime learning tax credit, was not similarly expanded. At least for the next couple of years, the Hope Credit will be a much better deal for all students who are enrolled at least half-time. For part-time students (less than half-time) it is still worthwhile to check out the lifetime learning credit which provides a 20% credit on up to $10,000 of qualified expenses per household.

A few other caveats regarding the Hope Credit should be noted. Qualified expenses include mandatory fees and tuition, but not room and board. You cannot use the Hope Credit and lifetime learning tax credit, or the tax deduction for tuition and fees, for the same student in the same year. You cannot use the same qualifying expenses for the Hope Credit that you use for a tax free distribution from a 529 plan.

If you’re interested in more information on education tax benefits check out http://www.finaid.org/otheraid/tax.phtml
or IRS publication 970 (although this has yet to be updated for 2009).