Highlights from the Berkshire Hathaway shareholder’s meeting 2012

I finally got around to visiting Omaha to hear superinvestor & ‘world’s 3rd richest man’ Warren Buffett and his business partner Charlie Munger hold forth at the annual Berkshire Hathaway shareholder’s meeting on May 5th, 2012.  For those of you who aren’t Buffett fanatics (you should be; start with this, then this, and then read these), Berkshire Hathaway is a conglomerate of insurance companies & other businesses that Warren Buffett has presided over for some 35+ years, and has returned ludicrous results to its investors (which are NOT likely to be repeated, mind you!)

Every year, thousands (about 35,000 this year) flock to Omaha to hear about the condition of their beloved company, to shop at Berkshire subsidiaries like See’s candies and GEICO, and to catch the pearls of wit & wisdom that drop from the mouths of Buffett and Munger.

Watching the dynamic of Buffett & Munger as they each added their ‘2 cents’ to the varied discussions was highly entertaining, and often elucidating.  Buffett, long-spoken, friendly, upbeat, and literary, was contrasted and complimented by Munger’s laconic, pessimistic (he might say realistic), and sharp-tongued (and often hilarious) responses.

My notes

Lest such pearls escape me, I furiously scibbled notes during the 5 hour question & answer session during which Buffett and Munger deftly responded to questions from investors, media, and analysts on a host of topics ranging from investing to politics to ethics.

Here’s the ‘best of’ what I was able to catch and jot down.  Please note that while I often tried to capture exact quotes, a good deal of even the quoted material may not be ‘word perfect.’

The newspaper business

One shareholder asked Buffett about the recent purchase of a (print) newspaper, the Omaha-World Herald.  Given the declining economics of print media, the shareholder was (quite rightly) concerned about the future of newspapers.  Buffett responsed that he “believes in newspapers where there’s a sense of community.”  And explained that papers must have “primacy” (primary importance) in an area that the people who read it are interested in.

He described how traditional domains of newspapers (stock prices, classified ads, real estate listings) no longer have ‘primacy’ for their readership, who have largely moved on to the internet as the primary source for such info.  However, Buffett believes that community papers with local issues (like obituaries) can still thrive in the digital age, so long as those papers can remain as the most important source of that community-centric information for the paper’s readers.

Management of Berkshire’s businesses

Buffett often talks about the quality of management hired to run Berkshire’s subsidiaries.  Buffett claims to do nothing more than 1) make capital allocation decisions with the cash that Berkshire’s subsidiaries create and 2) create an environment (including compensation arrangements) to retain and attract top-quality managers.

Commenting on how independently competent Berkshire’s managers must be when it comes to running their operations, Buffett commented that “if we thought the success of our investment [in a subsidiary] depended on our advice [to management], we wouldn’t make the investment.”  In describing the work environment for managers that he tries to create, Buffett noted that he “can’t create passion in someone, but he can take it away [through a bad management structure.]”

One aspect of creating a good management structure is appropriate compensation. Berkshire has hired two former hedge fund managers to invest funds for Berkshire’s own portfolio.  These managers will receive 10% of any 3-year rolling gains above the S&P 500, incentivizing them to beat the stock market average, but also making sure they have to do it on a long-term basis.  Additionally, 80% of each individual’s bonus will come from his own efforts, but 20% will come from that of the other guy’s performance, as an incentive for them to work together and share investment ideas.

Munger added that “90% of those in the investment business would starve to death on that [compensation] formula.”  (Although I’ll add that each of those two Berkshire investment managers also receive a ‘base’ salary of $1 million per year, so ‘starvation’ probably shouldn’t be taken literally.  Interestingly, any employees or other expenses that these managers create must come out of that $1 million, which I thought was a nice way to sync incentives between the managers and Berkshire.)

Buffett also talked about how Berkshire didn’t use ‘compensation consultants’, who, in Buffett’s opinion, generally just tell CEOs and boards what they want to hear anyway.  In straight-faced monotone, Munger opined that “prostitution would be a step up” from compensation consultant, to which Buffett quickly added “Charlie’s in charge of diplomacy at Berkshire too.”

Creating shareholder value

When asked why Berkshire wasn’t paying a dividend, Buffett answered that “we feel we can create more than $1 of present value per $1 retained.”  Munger said he thought that “Warren’s learned new things each decade, resulting in much better results” at Berkshire than expected at the outset of their venture.  Munger, 88 years old & 7 years Buffetts senior, then added wryly, “but he’s getting old; I’m worried about him.”

Competitive advantages

“We sort of buy[s] barriers to entry; we don’t build them”, said Munger.  Buffett gave the example of the brand strength of Coca Cola, and how virtually impossible it would be to take away their market power.  Richard Branson, found of Virgin Airlines, and other Virgin companies, started ‘Virgin Cola’, which failed.  Buffett made the remark that “people say a brand is a promise.  I’m not sure what [Branson] was promising” with his cola brand.


Buffett noted that “if you caress an ounce of gold for 100 years, you’ll still have one ounce of gold”, and then compared that to the huge growth in what you’d have from growing businesses that pay out and reinvest cash, or to farmland that produces valuable crops every year.

This fundamental principle, that gold doesn’t actually ‘produce’ anything, is behind the fact that only periodic and unanticipated demand for it can drive the price up.  This also explains why, despite the last several years of the run up in gold prices, gold’s real return (after inflation) has only been slightly positive.

If one compares that to the massive growth of stocks, and even the modest growth of bonds, over long periods of time (not to mention the price swings of precious metals), it’s clear that gold is a very poor investment in itself.


When asked about the prevalence of the corporate political fundraising vehicles called ‘Super PACs’, Buffett stated that, even if donations to such a vehicle would increase Berkshire’s profits, he was morally opposed to it, and wouldn’t do it: “The whole idea of Super PACs is wrong, and relatively huge money [going to politicians] from a few people is wrong.”  While he acknowledged that others might defend their contributions to Super PACs by pointing out that their corporate competitors are doing it, Buffett asserted that “you have to take a stand somewhere.”

Munger added that he might consider giving to a Super PAC if he actually thought he could stop something really bad, and gave legalized gambling as an example of something that “does us no good” as a society.  And that “making the securities market more like gambling” was also going on, and also bad.


Buffett said that the tax code is important in sharing wealth, and that it may be the case that the natural “trend in democracy that pushes toward plutocracy.”  Therefore, we should use the tax code as a “countervailing balance” against this anti-democratic, and yet perhaps expected, outcome of our market-based economy and its liberal principles (I mean ‘liberal’ in the free sense, not in the left-wing sense.)

On corporate taxes, actual taxes paid by corporations were 13% of revenues in 2011, versus the marginal rate of 35%.  Despite the play that US corporate tax rates get in the press, Buffett stated that neither corporate tax rates nor balance sheets nor liquidity were holding back the US economy.  Buffett called medical costs the “tape worm” of American business, and noted that they composed about 17% of GDP, versus a mere 2% for corporate taxes.  Munger also added that he thought a Value Added Tax should probably come into play in the US.

Munger thinks that “Paul Krugman is a genius” but that he maybe too optimistic about “Keynesian economic tricks.”  He also asserted that, in the US (and presumably around the world), we’ve lost a good deal of our “fiscal virtue”.  “Everybody wants fiscal virtue, but not yet.  Like [Saint Augustine], who was willing to give up sex, but not quite yet.”

Energy policy

Munger said he supports subsidies for wind and electric cars “to wean us off oil and gas.”  It “would’ve been better to use up other [countries’] oil” and to have kept our own in the US as a “strategic reserve” over the past decades, said Buffett.  Munger agreed with this, saying “I’m a puritan and believe in suffering now and making the future better.  That’s how I believe grown people should behave.”

I thought this was a great quote, and that it bears on several issues facing the US, such as the ballooning debt that’s being placed on the backs of young people in America.  I personally feel that too much is being done in the US to avoid short-term sacrifice at the expense of future prosperity.

Recent market crises (Europe & also 2007-2008 in the US)

“Alan Greenspan overdosed on Ayn Rand as a youth…  Greenspan was really wrong [on his actions that helped precipitate the 2007-2008 US recession.]  He’d think an ax murder was okay if it happened in a free market.”  Harsh, and humorous, words from Charlie Munger on the former US Federal Reserve chairman.

Due presumably to the low interest-rate environment*, and the fact that yields aren’t significantly higher (in Buffett’s opinion) for long-term vs short-term bonds, Buffett noted that he’d “avoid medium and long-term [US] government bonds.”

* Bond prices move inversely with interest rates, so if rates go up, the prices of existing bonds go down (and vice versa.)  The longer-term a bond is, the more its price is affected by interest-rate changes, hence Buffett’s shyness about longer-term bonds.


Both Buffett and Munger dismissed the investment risk ‘measurements’ used today by many large money managers like sigma (standard deviation, generally of a normal distribution), beta, and value at risk (VaR).  According to Munger, ‘value at risk and such are … some of the dumbest ideas ever’.  They criticized heavily the ‘precise’ (but not necessarily accurate or even useful) mathematical models used by finance and math PhDs to try to predict various events with many decimal places of certainty (think of Long-term Capital Management to understand where Buffett & Munger are coming from.)

Munger repeated a story of investor Sandy Gottesman firing a young man who was a major ‘producer’ (i.e.: money maker) at Gottesman’s investment firm.  The producer objected to being fired on the grounds that, despite the alleged riskiness of his investments, he had made a lot of money for Gottesman’s firm.  Gottesman replied “yes, but I’m a rich old man and you make me nervous!”

Buffett equated much of the failure of math-heavy risk management with a poor grasp of history, and of the many investing blow ups of the past.  He said that he keeps copies of newspaper articles from market crashes as a reminder of worst-case scenarios, including one about a man who killed himself in a boiling vat of beer during the May 1901 crash!

Buffett noted in this year’s annual shareholder letter that risk is not the volatility of an asset, but rather the chances of a decline (or unsatisfactory gain, I would say) in purchasing power as the result of an investment.  As a financial advisor that helps clients reach specific goals that rely on the purchasing power of their investments, I agree that this is the only meaningful way to think about financial risk.

He also noted that you shouldn’t “risk what you have & need to get what you don’t have & don’t need.”  Wise words, and applicable to more than just investing.

Avoiding mistakes

“We’re always thinking about worst case scenarios”, said Buffett.  Munger adding “studying other people’s mistakes” was key as well, and that both Buffett & himself were keen students of “folly”.  “People with 180 IQs didn’t have an understanding of human behavior”, noted Buffett when describing the causes of recent blow ups around the turn of the 21st century.

Business schools and how to think about investing

Buffett criticized business schools for teaching ‘fads’, and also suggested he didn’t put much stock (no pun intended) in ‘finance theory’, like that of efficient markets or modern portfolio theory.  Charlie Munger commented that while there was some rationale for these topics, business school teachings on investing were ‘a considerable sin’.  (Despite this, I’d argue from other things each have said that Buffett & Munger do acknowledge some of the more general points of modern finance theory like market efficient MOST of the time.  They take issue with the ‘semi-strong form’ of market efficiency, arguing that publicly available information can be used to make profitable (after controlling for volatility) investments.  I think they also take issue with the use of finance theory as a tool with high predictive value in, say, valuing businesses and stocks.)

Buffett stated that he would have two courses taught to teach students about investing: one on how to value businesses (which I would assume would be done using accounting statements & other means to approximate future cash flows, and then discount those cash flows back to the present.)  The other class would be how to think about markets (e.g.: read Chapter 8 of Benjamin Graham’s ‘The Intelligent Investor‘.)  By thinking about markets, Buffett means that you should treat market prices as random fluctuations that are there to serve you (by sometimes offering prices that are lower than the value of what you are buying), not to guide you (i.e.: causing you to panic and sell when prices fall, or become gleeful when prices rise.)

The result of this business valuation would be to ‘understand’ a business.  To wit: “understanding a business means having a good idea around 1) its competitive position and 2) its earnings power 5 years from now”, said Buffett.

Munger added that if you receive any offer to buy an investment product with a large commission, “don’t read it.”  Instead, he suggested “looking at things other smart people are buying.”  That said, you must make sure you use others’ ideas only as starting points, and do all of your homework to ensure you understand the business, and can value it against its current price, factoring in some ‘margin of safety‘ in case your estimates are wrong.


If you just can’t get enough Buffett/Munger action, or else want to compare the validity of my ‘journalism’ to that of other sources, here’s some alternative coverage of the 2012 Berkshire meeting, along with some other related links:

NY Times considers Buffett’s politics: http://dealbook.nytimes.com/2012/05/07/reflecting-on-buffett-business-and-politics/

Highlights from the meeting from Reuters: http://www.reuters.com/article/2012/05/05/berkshire-meeting-highlights-idUSL1E8G52T920120505

Munger-mania! (Highlights from an awesome 2-hour U of Michigan speech, also available on YouTube) ‘The Motley Fool’: http://www.fool.com/investing/general/2012/05/04/charlie-munger-on-communism-botox-and-goldbug-jerk.aspx

Buffett talks to MBA students at Florida U in 1998 (great talk in 10 parts): http://www.youtube.com/watch?v=ogAxzPaU5H4&feature=relmfu

Do you know how much you need to save for retirement, college, or a home?

This handy savings calculator from Lifetuner.org helps you answer that question.  Just plug in a yearly savings amount (like $200/month = $2400/year), the ages you start and stop investing, your desired retirement age, and an interest rate.  For this last assumption, I would use 6.8% (or 7% if decimals are too much to handle) to match the historical, real (inflation-adjusted) stock market return.  That way you won’t fool yourself into thinking you’ll have more purchasing power (which is what matters) than you really will have.

You can run up to three side-by-side simulations.  Compare starting ages, amounts you save, or the difference due to small interest rate changes.  This is a great calculator for estimating the return from regular investing, or the difference in gain from, say, a 0.5-1% increase in return due to switching to low-fee index funds, which beat the returns from (higher-fee) actively-managed mutual funds 70 – 80% of the time.

You can use this to calculate ANY regular investment, not just one for retirement.  For example, if you want to have a house downpayment in 3 years, assume a bond fund return of 3-5% (rates are low today) and then see how much you’d need to invest yearly to achieve your goal.  The longer you can wait, the more you’ll have.

Or, to calculate savings for your kid’s college (new parents, pay attention!), enter your kid’s current age as the ‘start saving’ age and 18 as the ‘stop saving’ & “retirement” ages.  (“Retirement” in this calculator just means the date when you want to know how much you’re investment will be worth.)  Use the historical, real, stock market return of 6.8% if you have a long time (>5 years) to invest, since that’s where your college savings should be.

In-state college tuition is only for “true” state residents

I quick note to prospective college students and their parents:

I was asked about a myth regarding students qualifying for in-state tuition rates when they go to school out of state. The MYTH is that if a student goes to an out-of-state school for 1-2 years (the typical school residency period), they become a resident for the purposes of receiving in-state tuition at public universities.  This appears to be FALSE!

It is true that there is usually a 1-2 year consecutive period that a person must live in a particular state in order to become a resident for the purposes of in-state tuition.  HOWEVER, the general rule is that IF the person attends school full-time during any quarter or semester in the 1-2 year period, they are a NON-resident and do NOT qualify for in-state tuition.

If you’re thinking about having the student live with Grandma in the state of University X for a year to qualify, think again.  I’ve also read rules that stipulate that prospective students who are dependents (which most kids are) of non-residents (like their parents living in another state) are also NON-residents, regardless of their stay in the new state.

It appears that loopholes are hard to come by for in-state tuition to those who are not residents of a state for any other purpose besides school.  Given that college tuition is expensive (but worth it), you’d better start saving today.

Forbes magazine is full of it: Go to college to become a billionaire

I’ve already railed against Forbes for insinuating that a college degree doesn’t help a person become a billionaire, but they’ve come out with another idiotic article claiming the same thing.   In my prior article, I showed that billionaires in the Forbes 400 list were actually 6 times more likely than the general US population to hold a bachelor’s degree.
Forbes has stated that two-thirds of these billionaires at least have bachelor’s degrees, compared to roughly 25% of the general population.  This new Forbes article goes on to state that “[o]f the 274 self-made tycoons on the Forbes 400, 14% either never started or never completed college.”  Really?  Hmmm, so that means that “self-made” billionaires, presumably those that didn’t start with ludicrous wealth, are even MORE likely (86% versus 66%) to hold college degrees than “regular” billionaires!

In fact, a self-made billionaire is 6.1 times more likely to have a college degree than not (=0.86/0.14.)  Also, it’s not too hard to show that a random person with a college degree is 18 times more likely to be a self-made Forbes 400 billionaire than a person without a college degree*!

You can bet this guy has a college degree!

If you’re not heir to a fortune already, finishing college (or even graduate school) might be the best wealth-building move you can make.  Investing in yourself often pays much bigger returns than anything you could get out of the stock market.  (Save and send your kids too, they’ll thank you later.)

* To prove this, let’s assume a population of 1000 people.  Let’s also assume, for round numbers, that 14 of these are self-made Forbes billionaires.  (It doesn’t matter how many billionaires you assume, the numbers still come out the same.)  We know that 12 of these billionaires have college degrees (86% of 14), and 2 don’t.  We also know that 25%, or 250, of the general population have college degrees.  Therefore, of the 750 people without college degrees, only 2 of them are Forbes self-made billionaires, which works out to 0.267% (=2/750.)  Of the 250 people WITH college degrees, 12 are self-made billionaires, or 4.8% (=12/250.)  Therefore, a randomly-selected person WITH a college degree is 18 (=4.8%/0.267%) times more likely to be a billionaire than a person without a degree! QED: GO TO SCHOOL IF YOU WANT TO BE RICH!

UPDATED: Saving for college – Where should you put your money?

The 60 second recommendation

The 529 Savings plan is usually the way to go.  It allows you to sock away money in an investment account which grows tax-deferred.  If the beneficiary you designate (say, your child, or yourself if you’re going back to school) spends the money on approved higher-education costs like college tuition, books, or lodging, they can withdraw the money tax-free as well.  (This tax treatment is akin to the Roth IRA, but for education rather than retirement.)

First, check to see if your state’s 529 plan has any special benefits that might make you choose it (note to Washington residents: our 529 plan doesn’t have anything special as of this writing, so you can safely ignore it).  (There’s also these even more detailed plan feature comparison that you can check.)

If your state does NOT have any such benefits (like state income tax breaks on contributions, say, or matching dollars from the gov’ment), then head on over to Vanguard, my favorite financial services firm, and open their 529 plan.

For investments, I recommend the ‘set it an forget it’ age-based options.  Of these, I think the ‘Aggressive’ one is the most appropriate choice.  It starts off as all-stock for the first several years of your child’s life, and shifts into bonds as they approach college age.

The ‘full treatment’

It’s a given that your kids should go to college.  How are you going to pay for your kid’s education?  (Or your own, if you’re planning on going back to school.)  College tuition has been rising at an obscene rate, much faster than inflation.  To meet your education savings goals, you need to invest, and you need to start right away to give your money a chance to grow.  How early you invest is the biggest factor in your future wealth. Read the below and start socking away money for education today.

Whether you want to send Junior to an Ivy League private institution or a public state school (where serious students are powerless against the drunken jock-ocracy), I can tell you where to put your college nest egg to get the most bang for your buck.

There is really only one worthwhile education savings vehicles to choose from:

The state 529 savings plan.  This can be any state’s plan, not just your own.

(I used to include the Coverdell ESA as a worthy second option, but its benefits are so mediocre now, that it’s not even worth mentioned.  The material I had in this post on the Coverdell ESA can be read at the very bottom of this post if you like.)

How the 529 Savings plan works

The 529 Savings plan allows the money you contribute for a designated beneficiary (like your child) to grow tax-deferred.  The distributions (money you later take out of the account) are tax-free as long as they are then spent on qualified education expenses (defined later.)  (Unlike, say, a 401k, there’s no option to deduct your contributions to these education plans from your taxable income.)

– 529 savings plan distributions are only tax-fee for post-secondary expenses (like college.)

– Unlike the Coverdell ESA, you can contribute for a beneficiary of any age (even yourself or your spouse!)  If plans change, you can transfer the account to an eligible beneficiary.  These  include the beneficiary’s kids, grandkids, siblings, parents, neices/nephews, aunts/uncles, in-laws, first cousins, and all those folks’ spouses (including the beneficiary’s.)  (Step-family count too.)  This means you could start a 529 for yourself to go back to school, and if you don’t use all the money, give it to your spouse, kids or even grandkids.

– These plans are offered by states, and you can invest in ANY state’s particular plan (not just your home state.)  It pays to shop around, and you should always at least glance at your home state’s plan to see if there are any special benefits in it for residents (like state income tax breaks.)  I checked in my home state of Washington, and there’s no special benefits for residents.  So if you live in Washington state, see the Utah plan below.

In order to save you some virtual leg-work, I particularly recommend Vanguard’s plan (the Utah 529 plan is also great; but since most of your assets should be at Vanguard anyway, because Vanguard is THE BEST, I would go with Vanguard.)  It’s rock-bottom fees and excellent investment options just can’t be beat.  If go with the Vanguard plan and you want to pick a low-hassle, target-fund approach, I recommend choosing the age-based ‘Aggressive’ option.  That way, you don’t have to worry about rebalancing your portofolio from stocks to bonds as your child gets closer to needing the money.

ALWAYS, check out the asset allocations of any investment choice you’re considering to make sure you’re comfortable with the amount of risk/volatility.  You should take a lot of ‘risk’ (= all stocks; higher average return, but volatile) when the child is young, and less risk (= mostly bonds; lower average return, but stable) when the child is a few years from college.

– Morningstar also recommends a list of state 529 plan choices for 2009 in this article.

– There are no income limitations for contributors, so you can make millions and still contribute to a 529 plan.  Also, you can contribute as much as you like, but only up to the gift tax exclusion limit ($13,000 per person; $26,000 for married couples filing jointly, as of this writing) to avoid paying a federal gift tax.

How 529 Savings plans affect federal financial aid

For federal financial aid planning, both Coverdell ESAs and 529 Savings plans count as parental assets.  This is a good thing because in Financial Aid’s eyes, parent’s are only expected to contribute ~6% of their non-retirement, non-home assets, while kid’s are expected to contribute 35% of theirs.

(Note that this exclusion of retirement assets in financial aid calculations is a good reason to have your kid start a Roth IRA once they have some high school job earnings.  The IRA will exclude their assets from financial aid calculations, whereas a savings account or taxable stock account wouldn’t.)

[529 Pre-Paid Tuition plans (versus 529 Savings plans, which I discuss below) are counted as the student’s assets, and thus diminish financial aid eligibility.  This is one reason I don’t recommend them.  Another reason is that the plans guarantee to cover only in-state public school tuition amounts.  Also, many plans only cover tuition, which is often just a fraction (albeit a large one) of the total cost of attending college.]

How do I choose the right education savings option for me?

Generally, for college, the 529 savings plan is the way to go.  It’s tax-deferred growth, great investment options, and transferability to others (maybe Kid 1 rebels and shies away from college; no worries, change the beneficiary to Kid 2!) all make it a great option.

If you’re still not sure, take a look at these what-if scenarios:

– If you need money for pre-college education like private elementary or high school, a Coverdell ESA might be the way to go, as you CANNOT make tax-free withdrawals from a 529 Savings plan for elementary or high school.

– If you have significant state tax benefits from your state’s 529 savings plans, you probably want to use that.

– If the savings are for you, the 529 plan is great since it has no age limits for contributions or withdrawals.

If you’re unable to use any of the above to make your decision, here’s a link from Vanguard to help you choose.  It asks you a few questions and spits out an answer.

So do a little homework, and then start funding the plan you choose ASAP, even if you can only afford to put in a little bit each month.  We didn’t tackle how much to save in this article, so use this college savings calculator to get an idea.

Happy education savings!

Other resources:

Great info on saving for education, including a 529 savings plan comparison tool: http://www.savingforcollege.com.  Their very useful plan feature comparison tool is here.

Fool comparison of 529s and Coverdell Education Savings Account (ESA).

Motley Fool FAQ on 529 plans

* – “Unless Congress acts, certain ESA benefits expire after 2010. K -12 expenses will no longer qualify, the annual contribution limit will be reduced to $500, and withdrawals will not be tax-free in any year in which a Hope credit or Lifetime credit or Lifetime Learning credit is claimed for the beneficiary.” From: Savingforcollege.com

Hopefully Congress will renew these benefits.  I’ll update this post after a decision is made.  Don’t worry though, if the Coverdell benefits fall through after 2010, you can rollover your Coverdell into a 529 plan.

Addendum – What if my kid gets a scholarship

1) The typical 10% penalty that applies to withdrawals NOT used for approved educational expenses would be waived for taking out money equal to the amount of the scholarship earned.  However, there would be income taxes on the earnings (see next question.)

In short from http://www.savingforcollege.com/articles/20100409-7-myths-and-realities-of-529-plans:

“Myth 2: If my brilliant or athletic kid gets a full ride, I lose the money in my account.

Reality: As with the previous example, you can transfer the money to another beneficiary. But if your kid’s so talented that colleges are willing to pay to get him or her in the door, you won’t be heavily penalized, says Mary McConnell, director of college savings products for Charles Schwab in San Francisco. “If a child gets a scholarship, the penalty for making nonqualified withdrawals is waived, and there will be income tax only on the account’s earnings.” ”

In detail from http://www.kiplinger.com/columns/ask/archive/2007/q0423.htm:

We have three daughters, ages 15, 13 and 11, and have accumulated about $35,000 in state-sponsored 529 college-savings plans for each of them. They are all doing very well in school and could be on the road to scholarships. What happens to our college savings if they receive full-tuition scholarships? Can we use the funds to pay for room and board?

If one of your children is fortunate enough to win a scholarship, you’d be eligible to take a penalty-free withdrawal from her 529 account up to the amount of the award. You would, however, have to pay federal and state income tax on the earnings portion of the withdrawal. To avoid those taxes, you could name another family member as beneficiary of the plan.

 Not to worry, though. Even if your child gets a full-tuition scholarship, you’ll probably still have plenty of other bills that qualify for tax-free withdrawals from her 529 plan — including required fees, books, supplies and equipment. As long as your daughter attends school at least half-time, room and board count, too. And if she lives off campus, you can take a qualified withdrawal up to the cost of on-campus housing at that institution, says Doug Chittenden, head of education savings for TIAA-CREF, which administers 529 plans for many states.

In the unlikely event that any money remained after all your children were educated, you could let them use it for grad school, use it yourself, transfer it to another family member, or take it back and pay income taxes on the earnings plus a 10% penalty.

For more information about 529 withdrawals, see IRS Publication 970 Tax Benefits for Education. For details about each state’s 529 plan, see our 529 map.

2) Q: Are the withdrawals post-scholarship taxed at the parent’s income level, or the child’s (beneficiary’s)?

A: Earnings (but not contributions) on the amount you withdraw would be taxed at the scholarship recipient’s tax rate (your child’s, which is good!), but will not be subject to the 10% additional federal tax penalty.


3) Q: Is there are timeline for when the withdrawals can be taken out penalty-free? For example, if the child/beneficiary receives a $10,000 scholarship for calendar year 2012, can the parent take out $10,000 in 2013 (or 2014, etc) penalty-free, or must they, say, take out the $10,000 in the same year as the scholarship (2012) in order to get out of paying any penalties?

A: There is currently no set timeline for when you can withdrawal penalty free. You can withdrawal as early as the same calendar year but unfortunately, the tax law is not clear on whether the penalty exception for scholarships applies only for the calendar year in which the scholarship is provided and each state has developed their own guidelines for withdrawals.



Coverdell ESA ‘archive’ material

Let’s start with the Coverdell ESA

– Coverdell’s have contribution limits of $2,000 per year per beneficiary (= child) in 2012, but that amount drops to $500/year starting in 2013!  This means that you have to make sure that ALL the people (grandparents, parents) who contribute to a Coverdell for a child  don’t contribute more than $2,000/$500 combined in a given year.  You must make these contributions by April 15th (tax day) of the following tax year (same rule as for IRAs.)  This means you can make a 2012 Coverdell contribution as late as April 15th 2013.

– Coverdell ESA’s, like Trix, are for kids.  You can only make contributions for any person who is under 18, unless that person is a special needs beneficiary.  Also, the beneficiary must use all of the money for qualified education expenses before age 30 in order to avoid taxes and penalties.  Alternately, you can transfer the account to another eligible beneficiary who is under 30.

Eligible beneficiaries include the beneficiary’s siblings, parent’s (presumably YOU), kid’s, spouse, in-laws, aunts/uncles, first cousins or any of the prior folks’ spouses.

– In order to contribute the $2,000 max to a Coverdell, your modified adjusted gross income (MAGI) must be less than $95,000, or $190,000 (as of 2009) if you’re married filing jointly.

– You can contribute to Coverdell’s for as many separate beneficiaries as you like.  For example, if you have 5 kids, you can contribute up to $2,000 for each of them in separate Coverdells (Mormons take note.)

– If you’re thinking about private elementary or secondary schooling for your precocious youngster, the Coverdell is the way to go*.  Elementary and secondary school expenses count for tax-free distributions.  (The 529 plans only allow for postsecondary  expenses, like college or vocational school.)  For all levels of education, these qualified expenses include required tuition, fees, room and board, books, supplies and equipment.

For elementary or secondary education ONLY:

Add to the above academic tutoring and even computer equipment & internet service “if it is to be used by the beneficiary and the beneficiary’s family during any of the years the beneficiary is in elementary or secondary school.”

Also, add in the following if they are required or provided by the school:  transportation and “supplementary items and services (including extended day programs.)”

– You can invest in pretty much whatever you want: stocks, bonds, mutual funds, etc.  I recommend you invest regularly into a market-tracking stock index fund like Vanguard’s VTMSX, and then reallocate some of that money to a bond fund (like VBMFX) once the beneficiary gets within 3-5 years of starting college.  If you don’t want to worry about doing the reallocation yourself (or you’re afraid you’ll forget), use a 529 savings plan that offers target-date funds that automatically changes your investment from aggressive to conservative as the child gets closer to college.   (So far, I haven’t found a target date fund made for college that individuals can buy outside of a 529 plan, but if you see one, let me know!)

– You can rollover a Coverdell ESA to a 529 savings plan (but you CAN’T rollover a 529 to a Coverdell.)   So if you think there’s a good chance you’ll want education savings for private elementary or high school, invest that money in a Coverdell.  If your kid doesn’t use it for St. Mary’s Academy, roll it over to a 529 if you like (or just leave it in the Coverdell.)

For federal financial aid planning, both Coverdell ESAs and 529 Savings plans count as parental assets.  This is good because parent’s are only expected to contribute ~6% of their non-retirement, non-home assets, while kid’s are expected to contribute 35% of theirs.  (Note that this exclusion of retirement assets in financial aid calculations is a good reason to have your kid start a Roth IRA once they have some high school job savings.  The IRA will exclude their assets from financial aid calculations, whereas a savings account or taxable stock account wouldn’t.)

[529 Pre-Paid Tuition plans (versus 529 Savings plans, which I discuss below) are counted as the student’s assets, and thus diminish financial aid eligibility.  This is one reason I don’t recommend them.  Another reason is that the plans guarantee to cover only in-state public school tuition amounts.  Also, many plans only cover tuition, which is often just a fraction (albeit a large one) of the total cost of attending college.]

Many college drop-outs are worth billions!!!

Such a title as the one above occasionally surfaces on a Yahoo!Finance or Forbes article. These articles usually throw in some statistics about the ‘growing number of college drop-out billionaires’ and name prominent college drop-outs like Bill Gates and Michael Dell (with an appropriate mention of their large net worth, of course.)

These articles often seem to suggest that a person can do just as well financially without obtaining a college degree as with. Such implications disturb me because I think they are dead wrong. I believe strongly in the value of education (formal and informal) as well as the importance of having a college degree when it comes to finding higher-paying employment than one would with only a high school degree.

The reasoning in these articles is pretty simple: “Many billionaires do not have college degrees, therefore, if you want to be a billionaire, college does not matter much.”

The reason this statement is likely false is this: College degree holders make up a much larger percentage of billionaires than they do of the general population. Therefore, those with college degrees are more likely to become billionaires than those without college degrees.
Let’s crunch a few numbers to see how I drew that conclusion. From a 2003 Forbes.com article (http://www.forbes.com/2003/07/28/cx_dd_0728mondaymatch.html):
2/3 of ‘Forbes 400 members’ have college degrees while 1/3 does not. The average net worth for these Forbes 400 members was about $2.2 billion.

However, the number of people over 25 in America WITH bachelor’s degrees was about 25% in 2003. (We’ll assume that the Forbes 400 list is mostly comprised of Americans, or that the 2:1 stats for bachelor’s:no bachelor’s is the same for American billionaires as it is for the Forbes 400.)

Therefore, bachelor’s degree holders make up only 25% of the population, but 66% of the billionaire population, whereas those without bachelor’s degrees make up 75% of the population, but only 33% of billionaires!

This means that it is 6 times more likely that a person with a bachelor’s degree will be a billionaire than a person without a bachelor’s degree.*** ^^

That’s a pretty significant difference. The above clearly illustrates that those with bachelor’s degrees are much more likely to be billionaires than those without.

Now, before you also draw the conclusion that obtaining a bachelor’s degree will make you more likely to become a billionaire, we would have to face one other fact: Smart, business-minded people, who I believe are more likely to become billionaires, probably are more likely to complete a bachelor’s degree than dumb, non-business minded people. So, if smart people are, say, 6 times more likely to finish college than dumb people, it should be no surprise that those with bachelor’s degrees are 6 times more likely to become become billionaires.

This may be true, but I suspect that even if people of equal intelligence made up the populations of those with and without college degrees, we would still see college degree holders making up more than their fair share of billionaires.

Bottom line though: Those with bachelor’s degrees are 6 times more likely to be billionaires than those without college degrees^^ (using the Forbes article data above.) Go education!

[By the way, even if you’re not interested in being a billionaire, college helps with everyday jobs as well. In the same Forbes article, those with bachelor’s degrees averaged a salary of $52,200 versys $30,400 for those without (during 1997-1999.) That’s a 72% bonus per year for having a college degree!]

*** Here’s how to calculate that from the percentages above. Pretend we have a population of 1000 people and of those 1000, 12 are billionaires (the numbers don’t matter as long as the billionaires are less than the general population.) From the stats above, 25% of people hold bachelor’s degrees (250 people) and of the 12 billionaires, 8 of them hold bachelor’s degrees. Therefore, bachelor’s degree-holders have a 8 out of 250 chance of being billionaires. 8/250 = 0.032 = 3.2%.

Let’s look at those without bachelor’s degrees: 75% of the population have no bachelor’s degree (750 people) and make up 4 of the 12 (33%) billionaires. Therefore, those without bachelor’s degrees have a 0.005333 = 0.533% chance of being billionaires.

If we take the bachelor’s degree holder probability of being a billionaire and divide it by the probability of a non-bachelor’s degree holder being a billionaire we get this 0.032 / 0.00533 = 6, meaning the bachelor’s degree holders have a 6 times better chance of being billionaires than the non-bachelor’s degree holders.

^^ Thanks to Dean Halford for correcting a faulty conclusion that I drew in an earlier version of this article. The bold, italicized statement assumes that the person with the bachelor’s degree is selected randomly from a pool of people that each have a bachelor’s degree. It also assumes that the person without a bachelor’s degree is selected randomly from a group of people that do NOT hold bachelor’s degrees.