Financial deception is not new to the American people. We are intimately familiar with Bernie Madoffâ€™s ponzi scheme, Charles Keatingâ€™s Savings & Loan swindles, colorful accounting at Enron Corp., the bankruptcy of WorldCom, and many more.
But only recently have we begun to see deceptive practices aimed at college savers. It should probably come as no surprise, since there are over $328.9B in 529 plans alone. Scammers go where the money is and, according to the College Board, public college tuition inflation grew at 3.1% annually over consumer inflation this past decade. As a result, there is no shortage of anxious parents looking for ways to beat the market to ensure their kids can afford the best schools.
Following are some of the worst college savings scams and deceptive marketing practices being targeted at college savers today.
Section 7702 Plans
A few years back someone creative in the insurance industry saw that Section 7702 of the U.S. Internal Revenue Code was the section that defined life insurance contracts. A 7702 Plan is not an actual financial product, itâ€™s a marketing label for a cash value life insurance policy.
Life insurance is pretty straightforward: You pay a monthly premium and, if the insured individual dies, the insurance pays the stated amount to the beneficiary of the policy. Cash value life insurance policies are a little more complicated. They set aside a portion of that monthly premium in a savings account. Cash value policies offer a fixed return guaranteed by the insurance company for the life of the policy so long as the premiums are paid. Variable life is similar, but instead of a guaranteed return it allows you to put that savings towards other investments. The policy could track an index or fund so that the cash value builds (or declines) with time. Earnings grow tax-deferred, and the value of the policy â€“ variable or otherwise – is excluded from the federal financial aid formula. It all sounds great on its surface.
However, selling insurance as a 7702 Plan and further as a college savings plan is misleading, if not outrightly deceptive, to consumers. Earnings grow tax-deferred, but distributions from a cash value policy are taxable to the recipient as income in the year they are received. Plus, it has a negative impact on financial aid eligibility. If the distribution is to the parent it will count against them at a whopping 20% in the EFC (Expected Family Contribution) formula for the following year (the EFC is part of the financial aid formula used by the federal government to determine your eligibility). If that distribution is to the student it rises to 50%. You have to reapply for financial aid every school year, so that payout will hurt for years.
Anyone soliciting a â€ś7702 Planâ€ť is doing so with the intent of deceiving the consumer, and should be avoided, if not reported to the National Association of Insurance Commissioners.
The Gerber Life College Plan
Gerber is well-known for its baby food, accounting for over 80% of total sales in the U.S. The brand is synonymous with a safe & healthy child. Nestle, the parent of Gerber, works hard to maintain that image. In addition to food, Gerber also offers a handful of other products stamped with their brand, such as clothing and bottles.
The Gerber Life Insurance Company is a subsidiary of Gerber Products Company. Founded in 1967, it is primarily known for offering life insurance for children. Life insurance is not necessary for most children, especially healthy children, but it is not an inherently bad thing. For a risk-averse individual a life insurance policy for their children can ease the financial burden on their family in the event of an untimely death, and is generally inexpensive.
But Gerber also offers something called the, â€śGerber Life College Plan.â€ť While Gerber markets it as a college savings product, itâ€™s really an endowment life insurance policy. Endowment life insurance is a little different than straight life insurance. The policy wll still payout at death, but there is also a guaranteed payout at a set time â€“ in this case 10 or 20 years. Endowment life insurance is a bundled product,Â it’s a mashup of a life insurance policy and a savings product. While this might sound great on its surface, it is a poor college savings vehicle relative to alternatives. If you broke the product apart, you would get less expensive life insurance and a better investment return from the separate products.
Many of the same drawbacks of cash value policies apply as well. Assets in the policy are not included in the EFC, for example, but the payouts will be. Plus, earnings on endowment life policies are taxable, so youâ€™re going to lose a chunk of your return once your receive the payout.
Unauthorized Account Access
In 2018 Connecticutâ€™s 529 plan CHET (Connecticut Higher Education Trust) had over $1.4 million stolen from its account holders as a result of a â€śdata security breach.â€ť While TIAA-CREF Tuition Financing, Inc. (TFI) made the account owners whole, meaning they reimbursed the stolen funds, it highlights the importance of safeguarding your account information.
In this case the fraud occurred when online access was established for over twenty account owners that previously had no online activity. What this means is that avoiding internet access doesnâ€™t make you safer anymore. Someone impersonating your identity could set up online access because you did not, as they did here. At a minimum, take some basic steps to safeguard your accounts:
Also, while there is a big push to go paperless, consider getting physical copies of all statements and storing them for three years. If there is ever an issue with your account, their systems, online access, or making a claim, you have physical evidence to back you up.
College Applicant And Attendee Scams
The Late Payment Scam: It is common for college parents and students to receive a call from someone pretending to be from the financial aid or bursars office. They will feed the recipient a line like, â€śYour payment is late/was never received. Please provide your credit card number so that we can process your payment immediately, or you will incur significant late fees.â€ť In this event, try to take down as much information from the caller as possible, hang up, and contact the schoolâ€™s official bursar or financial aid office.
The Scholarship Scam: There are thousands of fake scholarships out there. The typical warning sign is an application fee. If you have to pay to apply for the scholarship, itâ€™s probably either fake, or funding the scholarship with the application fees and awarding it to a small subset of students to keep the ruse going. There are many ways to find legitimate scholarships, so do some research before applying.
The Financial Aid Scam: There are hundreds of services offering to help you complete your financial aid application. However, the FAFSA is completely free â€“ it says so in the title, â€śFree Application For Student Aidâ€ť â€“ so you shouldnâ€™t have to pay to apply. Itâ€™s a relatively straightforward document, and the U.S. Department of Education has extensive resources to support applicants throughout the process on its official site or by phone at 800-4FED-AID.
Legitimate College Savings Products
The good news is that there are a bevy of financial products available to college savers.
Those are the two big ones, but there are a lot of other routes you can go. There is an education tax exclusion on U.S. savings bond redemptions, taxable accounts allowing you to invest in whatever you want, and in some cases IRAs. However, itâ€™s generally not a good idea to use your retirement savings for college expenses, so using a Roth or Traditional IRA for college savings will not make sense for most investors (though they are great vehicles). UGMA/UTMA accounts are legitimate accounts for college savers, but less desirable for most investors due to changes in tax laws over the years (more info via Forbes). 529 plans and Coverdells typically offer the best mix of tax-deferred investing for higher education currently available, though you should talk to a financial professional if you are unsure.
For more information on 529 plans, Coverdells, and other college savings products, consider the following resources:
This information does not constitute tax advice and is provided for informational purposes only. Please consult your tax advisor, financial advisor, local taxing authority, and/or plan provider or sponsor for more information.