College Bound St. Paul: City picks savings account over stock market for kids' college funds

Dec. 29--Editor's note: This is the second in a two-part series examining St. Paul's plan to start a college-savings fund for every newborn in the city. The first story ran on Sunday, Dec. 22.

St. Paul's new city-run college savings program will pass up millions of dollars in potential growth in order to promote local banking and ensure undocumented children are not left out.

Starting Wednesday, the city will set aside $50 in a savings account at Bremer Bank for every child born in 2020 or later who either lives in St. Paul or moves to the city by age 6.

The initiative, announced at Mayor Melvin Carter's January 2018 inauguration, joins dozens of programs nationwide that seek to instill a college-going mindset in children while boosting the financial literacy of their parents.

The city, however, is not routing College Bound St. Paul through Minnesota's 529 college-savings plan, which offers state and federal income tax benefits and major growth potential in the stock market.

Instead, Bremer will pay a near-zero interest rate comparable to that found in a checking account.

On its website for the program, the city says: "Families can contribute additional money and watch their college savings and dreams grow along with their child over time."

But the potential difference between saving with the city and investing in a 529 plan is massive:

-- By summer 2038, when the program's first class of students heads off to college, the city will have made around $4.6 million in initial $50 contributions.

-- In a savings account paying 0.03 percent per year -- the rate Bremer offers its regular customers -- that money would grow by about $12,500.

-- Had the city instead invested in a 529 plan, assuming a total return of 7 percent per year, the initial $4.6 million in deposits would double.

The actual difference in that scenario likely would approach $10 million as the city's public and private partners add bonus deposits and families make their own contributions to the plan.

Besides the growth potential, parents who add their own funds to the city-run account will miss out on a state income tax incentive worth up to 50 percent of their annual contribution to a 529 plan.

"If I were putting it together, I'd try and piggyback on the 529," said Joe Downes, a financial planner from St. Paul who recommends the government-sponsored plans to clients planning for college. "We think it gives the best flexibility, as well as tax benefits, if there's a high probability of a child pursuing higher education."

BANKER-LED TASK FORCE

Mayor Carter got the college-savings idea from a friend, Tishaura Jones, who is treasurer for the city of St. Louis, which holds its College Kids funds at a local credit union.

To design St. Paul's program, Carter appointed a 50-person task force in consultation with both city staff and Prosperity Now, a Washington, D.C.-based nonprofit that helps communities establish children's savings accounts.

That task force included seven employees of four local banks and credit unions, including Rick Beeson of Sunrise Banks, who served as co-chair along with Ann Mulholland, executive vice president of the St. Paul and Minnesota Foundation.

The state's 529 plan was not represented.

Nonetheless, Mulholland said, "We debated the 529 pretty thoroughly. They're a super program and can and will complement these custodial accounts, for sure."

Bremer Bank was one of three local financial institutions that sought to be the program's account holder, according to emails the city provided in response to a public records request. The others were Sunrise Bank and Hiway Federal Credit Union.

Bremer, which has experience with college-savings matching programs, pledged $30,000 for the city-run savings program soon after Carter announced his plans in 2018.

The city is not paying the bank for its participation, and the city has said its account holder may not use program records to solicit business from residents.

"We're in this project for the community impact," said Erin Dady, Bremer's chief marketing officer and a task force member.

529s AND IMMIGRATION

Mulholland said the trouble with 529 plans is they have to be connected to a Social Security number, so any undocumented child who moves to St. Paul would be unable to participate.

"If we really want to serve everyone in our community ... that notion of a portion of our population being left out was not acceptable to us," Mulholland said.

A consultant who designed a child-savings program under consideration in Minneapolis -- which would use the state's 529 plan -- does not see that as a barrier, however.

Because the city or county would own the account on behalf of the children, it would "not need to name beneficiaries or provide taxpayer identification numbers," according to their December 2018 report.

Mulholland said the St. Paul group also felt the federal government's 529 plan spending rules would be too restrictive for the kinds of post-secondary programs residents might want to pursue.

According to the city, however, the funds can be spent at "private colleges, public universities, community colleges, vocational training or trade schools," all of which also work with 529 plans.

A third factor was familiarity and access: Most Americans don't know what a 529 plan is, and the 20 percent of St. Paul residents without a checking or savings account would be unable to transfer money into a 529 plan.

"The key factor in making this recommendation is the greater accessibility of savings accounts over 529 college savings accounts for low-income families," the task force wrote.

Children's savings accounts nationwide have struggled to persuade families to invest their own funds, whether they use a 529 plan or not.

Although the state's 529 plan was not included in the city's task force, the parties have talked about the project, said Jim Mandler, senior marketing manager for the Minnesota College Savings Plan, which is operated by the financial service company TIAA.

Mandler said TIAA is "there to support the initiative in any way possible," but he has no problem with the city's decision to use custodial savings accounts.

By tapping Bremer Bank as its account holder, Mandler said, the city will benefit from having "an actual brick-and-mortar presence" for both deposits and financial education for families.

"That, in and of itself, is of value," he said.

Prosperity Now takes no position on which account type communities should use.

In its program design blueprint, the nonprofit says savings accounts are familiar and easy to understand, which is an important factor for less financially-savvy families.

However, "a major trade-off ... is that the interest rates are usually very low or even nonexistent, while 529s generally have a significant rate of return ... and savings in the account grow tax-free."

Across the country, college-savings programs have worked to overcome the drawbacks of the 529 plan in order to take advantage of their growth potential and tax incentives.

In California, the Oakland Promise provides kindergartners both a $100 college scholarship and a $50 matching contribution for families that fund a 529 account. But there's also a savings-account option that enables undocumented families to get the $50 match.

In some Indiana communities, foundations and local banks are facilitating contributions to the 529 plan. Grocers are helping, too, with shopping rebates that are deposited in the college accounts, making it easy for lower-income people to participate.

STATEWIDE AMBITIONS

St. Paul's decision to exclude the state 529 plan could make it more difficult to expand the program beyond the city's borders.

State lawmakers and the Department of Human Services have pledged over $1 million for staff to get the program running and to help fund the initial and bonus deposits.

"The hope of the (children's savings account) is to serve as a pilot for the rest of the state," state Rep. Kaohly Her, DFL-St. Paul, said at a hearing for her bill providing matching grants for the program.

Nationwide, about half the comparable programs use custodial savings accounts, but the larger ones generally employ state 529 plans, said Shira Markoff, children's savings director with Prosperity Now.

"It makes sense; it's a state apparatus. It's kind of the only vehicle that's going to reach statewide," she said.

That's a key reason Minneapolis is looking at the 529 plan for its child savings program.

"Thinking about scale, there is no financial institution that has a footprint everywhere," said consultant Lucy Mullany, who created the model for the Minneapolis Youth Coordinating Board.

In Indiana, the selection of the state's 529 plan over a local bank has made it easier to grow to additional cities and counties, according to a paper from William Elliott, a University of Michigan professor and the leading researcher on college-savings accounts.

Elliott's paper painted Promise Indiana as a model for using 529 plans in children's savings accounts. Organizers there reduced the paperwork required to enroll in a 529, boosted low-income families' accounts with philanthropic gifts and rallied their communities to support the program.

"It transforms what is currently a largely regressive, but widely-available, financial instrument -- the 529 -- into what some (children's savings account) champions have long believed it can be: a valuable platform for universal and progressive asset interventions," he wrote.

Like Indiana, Minnesota offers generous income tax incentives for residents who contribute to a 529 plan. But very few low- or middle-income Minnesota families have taken advantage.

There are no tax incentives for saving for college inside a savings account. However, because the College Bound accounts are being held by the city, the funds should not hurt a family's ability to secure need-based financial aid.

For better or for worse, both types of programs limit families' access to the funds for purposes other than college.

In a 529 plan, a recipient pays income taxes plus a 10 percent penalty for withdrawing funds for non-qualified purposes.

Under St. Paul's plan, families won't be allowed to withdraw city contributions for any reason besides higher education; and any money families add to the plan will be tied up until the participant turns 25, unless the city approves a request for an emergency withdrawal.

Elliott, the Michigan researcher, declined an interview request because he is under contract to evaluate St. Paul's program.

His colleague at Michigan, Trina Shanks, said in an interview that some communities automatically transition their accounts from basic savings to a higher-growth instrument, such as a certificate of deposit, when they reach a given dollar amount.

She suggested St. Paul at least explain the benefits of the 529 plan to families looking to invest their own funds for college.

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