How It All Began
UESP kicks off its 20th anniversary
Carol Withrow can call herself a trailblazer. On the last day of 1996, with her grandson’s future in mind, Withrow opened a college savings account with the Utah Educational Savings Plan.
Her account was one of just 157 UESP accounts opened in 1996, mere months after the Utah Legislature established the new tax-advantaged, state-sponsored college savings plan qualified under Section 529 of the U.S. Internal Revenue Code.
Withrow created the account to help with the future college expenses of her first grandchild, Scott Hilton, who was 6 years old at the time.
“I guess I’m part of a unique crowd,” Withrow said recently.
Two decades later, her account is still active, and Withrow continues to fund it. The account helped Hilton study at Westminster College for two years and will probably help him again this fall. Hilton is weighing a combined bachelor’s and master’s degree program in computer science and mathematics at the University of Idaho.
“It’s a good resource to have, and it’s nice to know it’s there,” Hilton, now 25, said of the account his grandmother established when he was a child and when UESP was a newborn.
Success for plan, students
Now 20 years old, UESP has outgrown its formative years to reach the top tier of the nation’s 529 plans.
At the end of 1996, UESP had just $200,000 under management in a handful of accounts owned by Utah residents. Today, UESP manages more than $8 billion total in over 300,000 accounts. Owners live in every U.S. state.
And for 10 of the last 12 years, including the past five consecutive years, UESP has received the highest rating from investment research firm Morningstar Inc., validation that Utah’s 529 plan is one of the best.*
“It’s been wildly successful. Nobody even talked about a billion dollars in those days,” said Edward Alter, who served as treasurer of the State of Utah from 1981 to 2009. Alter now chairs UESP’s Investment Advisory Committee. He also sits on the board of directors of the Utah Higher Education Assistance Authority, which oversees UESP.
More important to Alter is how UESP has improved the lives of thousands of Utah students.
“I think it’s definitely helped people save for college,” he said. “There is no doubt in my mind that more kids are going (to college), and they are coming out of school with less student loan debt than they would have.
“Clearly, it’s helped people,” Alter said.
How 529 plans came to be
The drive to help families save for college arose in response to escalating tuition. Over the past 40 years, tuition has consistently increased at two to three times the rate of inflation, according to the College Savings Plans Network (CSPN), which represents 529 plans. In the late 1980s, states such as Florida and Michigan developed prepaid-tuition plans out of concern for families struggling with the burden of financing their children’s higher education without relying on loans.
The movement gained speed in 1994, when a U.S. Court of Appeals upheld the tax-exempt status of Michigan’s prepaid tuition program. Two years later, a bipartisan effort in Congress to provide federal tax relief for state-sponsored plans resulted in the creation of Section 529 of the Internal Revenue Code. It permitted tax-deferred treatment of account earnings if used to pay for qualified higher education expenses. In 2001, qualified withdrawals became exempt from federal income taxes for a limited time, and in 2006, Congress made the federal tax exemption permanent.
During the early 1990s, Utah policymakers had watched as students and families in other states flocked to their state-sponsored plans, but they weren’t sure how Utah should proceed. These early programs were prepaid plans that only locked in future tuition costs at state colleges and universities and did not cover other costs.
Alter said those plans carried a flaw. Tuition inflation would likely always exceed the investment returns that Utah could earn on the premiums it collected, and a funding gap would develop. Eventually, the state would owe more money in benefits than it could pay. Today, just 12 states offer prepaid tuition plans, down from about 20 several years ago, according to CSPN.
“We kind of held back and watched, and then we saw the first one or two actual savings programs initiated, and we thought that’s obviously the way to go. We needed to get a tax-advantaged savings program established so that people could save for college education and accumulate some funds that would be available when their kids got old enough to go to college,” Alter said.
Fitting in families
Because many young Utah families do not have a lot of spare dollars to put aside for college, extremely low fees would be essential for a Utah plan to succeed, said Stephen Nadauld, a former Dixie State University president who has served on the UHEAA board since UESP was established.
“We also wanted a plan that would have low minimum initial and continuing (contributions), so somebody could put in $50 or $100 anytime they wanted,” Nadauld said.
House Bill 1003, legislation that enabled the state to set up UESP, was introduced by former Rep. Doug Peterson, R-Riverdale, during a 1996 special legislative session. The law became effective July 1 of that year, and on November 1, then-Gov. Mike Leavitt set the plan in motion at a press conference in a kindergarten class at Bennion Elementary School in Salt Lake City.
At the outset, account owners had one investment choice, the Public Treasurers’ Investment Fund managed by the Office of the Utah State Treasurer, which Alter ran at the time. Unlike today, the interest rate environment in 1996 was relatively high. The Public Treasurers’ Investment Fund’s rate of return averaged between 6 percent and 8 percent, and over the previous 10 years the average was 5.5 percent, “so it was at least decent,” Alter said.
In 1999, UESP introduced several investment options that consisted of Vanguard stock and bond index funds. Vanguard was the obvious choice for UESP. Alter’s office already had a longstanding relationship with the investment management company.
“I had state land funds that were already invested in Vanguard,” he said. “And I said, ‘If you (UESP) want to piggyback on that relationship, I’ll take the money up to the treasurer’s office, and I’ll invest it alongside the state land fund money already invested in Vanguard funds.” So we did that.”
The move worked to the benefit of UESP’s growing base of account owners. Because the treasurer’s office already had a lot of state money invested with Vanguard, UESP account money could be invested at a lower cost and take advantage of the combined size of investments held by Utah entities. The savings were passed to account owners through lower account fees. The arrangement continued until UESP direct investments in Vanguard funds were large enough to qualify for Vanguard’s lower fee structure by themselves without piggy-backing onto the state’s investments.
Alter said the federal tax deferral benefit, which gave 529 plans an investment advantage, was vital to the success of UESP. Deferring taxes on interest earnings allowed account balances to grow faster. The benefit was so important that it eclipsed the value of the Utah state income tax deduction parents could take on contributions up to a certain amount in the first years of the plan, he said. In 1996, the maximum deduction was $1,200 per beneficiary. (It is now a 5% credit on contributions up to $1,900 for a single-filer in 2016.)
“If you have to pay taxes on the earnings every year, it just bleeds (the investment) dry. The tax (deferral) was key,” he said.
At the close of 1999, UESP had grown to $2.5 million under management in 1,100 accounts. Utah’s 529 plan was on the threshold of explosive growth as it entered the 21st century. Fired by sophisticated and innovative investment options, low fees, and strong management, UESP would soon draw interest from influential consumer experts and attract thousands of new customers that would make it one of the most sought-after college savings plans in the country.
Coming in April: UESP’s growth accelerates.
*Rated “Gold” or its equivalent by Morningstar 2004-2007, 2009, and 2011-2015; rated “Silver” or its equivalent in 2008 and 2010. The Morningstar Analyst Rating® for 529 College-Savings Plans is not a credit or risk rating. To determine an Analyst Rating, Morningstar’s analysts consider five factors: the plan’s strategy and investment process; the plan’s risk-adjusted performance; an assessment of the individuals managing the plan’s investment options (people); the stewardship practices of the plan’s administration and parent firm (together, parent); and whether the plan’s investment options are a good value proposition compared to its peers (price). Plans are then assigned forward-looking ratings of “Gold,” “Silver,” “Bronze,” “Neutral,” and “Negative.” The top three ratings (Gold, Silver, and Bronze) indicate that Morningstar’s analysts think highly of a 529 plan; the differences correspond to the level of analyst conviction in the ability of a plan’s investment options to collectively outperform their respective benchmarks and peers through time, within the context of the level of risk taken. Morningstar does not rate all 529s every year; it rated just 63 of 93 Plans in 2015.
Analyst Ratings are subjective in nature and should not be used as the sole basis for investment decisions. Analyst Ratings are based on Morningstar analysts’ current expectations about future events and therefore involve unknown risks and uncertainties that may cause Morningstar’s expectations not to occur or to differ significantly from what was expected. Morningstar does not represent its Analyst Ratings to be guarantees.
Please visit Morningstar.com for more information about the Analyst Ratings, as well as other Morningstar ratings and fund rankings.