The State of Illinois is revamping a little-used college savings program that lets Illinois residents buy into designated mutual funds for as little as $50 a month and earn interest free of state taxes.
The maximum tax saving offered under the program is $60 a year for each account, so the tax advantage is not as attractive as other investment alternatives that are free from both state and federal taxes. An investor would need to generate $2,000 in interest income to achieve the $60 tax saving.
But Illinois officials hope to use the tax-favored program to encourage saving by residents who might have difficulty meeting the minimum investment required by most mutual funds.
The state exempts from state taxes the first $2,000 of interest earned for each family member who sets up an account under the program. Thus the maxmimum tax savings for each account will be $60. So an ambitious parent could set up an account for each of four children and earn the favorable tax status for each.
Unlike many mutual funds that require minimum investments of $1,000 or more, the state-sponsored program allows residents to buy shares of designated mutual funds for as little as $50 a month.
That contrasts with the more popular Illinois college bond savings program, which last year required an investment of $1,400 for the least expensive bond-the one that carried the longest maturity date for an eventual value of $5,000.
“The question is, how do we encourage people to get started?” said Gary Rieman, director of capital development for the Illinois Student Assistance Commission.
The state has offered a version of the mutual fund-oriented college saving program since 1990, but has put little marketing effort behind it.
In the next few weeks, state officials will announce the new lineup of players in the revamped program, which include Massachusetts Financial Services Co., of Boston, which is offering 11 of its funds, and Merrill Lynch, offering 26 of its mutual funds. Bank One’s Springfield office still is negotiating details on its plan to offer a special tuition savings account in the program, Rieman said.
Although the state has yet to announce the program, Massachusetts Financial Services and Merrill Lynch say their plans are available now to Illinois investors.
“We have endorsed 11 portfolios for the program,” said Paul McConville, Massachusetts Financial Services regional vice president. The Boston-based firm is offering a range of funds, including three equity funds, two balanced funds that buy stocks and bonds and a variety of bond funds that specialize in varying maturities or types of bonds.
Some of Massachusetts Financial Services’ funds carry sales charges, or loads, that range from 2.5 to 5.75 percent of the initial investment. Others carry 12(b)1 fees that are assessed over several years, so investors should choose carefully.
Similarly, Merrill Lynch offers several general-equity funds as well as specialty funds that buy stocks of certain industries, nations or regions. It also offers several bond funds, including tax-exempt municipal bond funds and corporate and government bond funds. These all carry loads and other sales charges.
“Investors can do systematic investment on a regular basis in a number of Merrill Lynch funds as well as any (individual) equities,” said Mary Postiglione, vice president at Merrill Lynch for corporate savings marketing.
Some of Merrill Lynch’s fund offerings highlight a critical point for investors: Tax inducements are meaningless if the underlying investments are inappropriate for an investor’s tolerance for risk.
Five of the specialty funds offered by Merrill Lynch in the program posted losses last year, mostly because of conditions in the markets-overseas or in a particular industry-in which the funds specialized, according to Morningstar, the Chicago publisher that rates mutual funds.
Estimates of how much the program will cost the state in lost taxes vary widely, and depend heavily on the popularity of the as-yet-untried program and the rate of return earned by investors in all the different investment vehicles.
But Tom Sakos, of the Illinois Student Assistance Commission, estimates that over the first 10 years of the program, the tax exemption may cost the state $3.3 million to $11.6 million in lost tax revenue.
To participate, investors must contact a broker, financial planner or financial institution.
