Investments in 529 plans are not as popular as they could be — and that's saying something because they are pretty popular right now.
They are, in fact, the fastest growing product in financial planning, with the only real rival in terms of percentage growth being hedge funds. According to the Financial Research Corp., assets in 529 college savings plans rose to an estimated $55.4 billion at the end of 2005's first quarter — a 38.6 percent rise from same quarter last year.
Still, there is one serious challenge to this growth: At the end of 2010, the regulatory provision that makes earnings from 529 plans tax-free is set to disappear. Absent this provision, 529 money becomes immediately taxable at the account owner's current tax rate. A tax-free investment morphing into a taxable one — there are few more surefire ways to freak a client.
But this is not as bad as it seems. The reality is that the regulators are likely to make some changes that will the allow tax exemptions to live beyond 2010. The trick for advisors who provide 529 plans will lie in keeping clients calm as this plays out. This means staying as current as possible on what regulatory changes might be coming. Here's a guide to what the Washington-types have in the works.
529 On the Hill
The most encouraging talk, from an advisor's perspective, involves making 529s permanent tax-free earning fixtures in the Internal Revenue Tax Code. A bill, H.R.2386, College 529 Invest in Education Savings for Tomorrow Act of 2005, was introduced in the House of Representatives on May 17. It would make permanent the educational savings provisions for qualified tuition programs originally enacted with the 2001 tax cuts.
“This legislation is critical because it keeps 529 plan earnings tax-free and maximizes the incentive to save,” says Joe Hurley, who operates Savingforcollege.com. “It's important that families save for college, without shortfalls.”
This is far from the only regulatory change on the horizon. The SEC recently released a proposed rule change (Release No. 34-50919; File No. SR-MSRB-2004-09), relating to advertisements of municipal fund securities. The proposal would have all advertisements for 529 plans include performance data to comply with the method of computing and displaying performance data provided under SEC Rule 482 (with some modifications). It also would require that proper disclosure be given to investors about risks involved in investing during the advertisement.
Over at the IRS, there are potential changes brewing as well, including a bill that would amend the Internal Revenue Code of 1986 to permanently increase the maximum annual contribution allowed to Coverdell education savings accounts, and to provide for a deduction for contributions to education savings accounts. The increase would more than double the current $2,000 maximum contribution.
“529 plans would still beat the Coverdell because 529s have higher contribution limits, no income restrictions on depositors and can be left to grow longer than the Coverdell — which must be used by the time the beneficiary turns 30,” says Kevin McKinley, a CFP in Eau Claire, Wis. (He also is a columnist for this magazine and the author of Make Your Kid a Millionaire: 11 Easy Ways Anyone Can Secure a Child's Financial Future (Fireside, 2002).)
McKinley adds that there is “too much ambiguity in what's going to happen with 529 plans, too much ambiguity in what's happening with a family's ability to help their children save for college.”
How are the KIDS?
There is also talk on the Hill about so-called KIDS accounts. Part of the Americans Savings for Personal Investment, Retirement and Education (ASPIRE) Act, KIDS would provide every child, at birth, with a small savings account that can be used to fund, among other things, college. (The bill is S.2751 in the Senate and H.R.4939 in the House.)
Each account would be endowed with an initial $500 contribution. Children living in households below the national median income would be eligible for a supplemental contribution of up to $500. Children in households earning more than the national median income will be eligible to receive a dollar-for-dollar match on the first $500 contributed to their accounts each year. After-tax contributions of up to $1,000 a year could be made to the account, and the account itself would remain tax-free. Accounts are redeemable beginning at age 18, restricted to use for education, home ownership or retirement.
The bill's sponsors — who include Senators Rick Santorum (R-Pa.) and Jon Corzine (D-N.J.) — estimate that an account holder, by the age of 18, could have an account worth at least $20,000.
True, numbers like those are not going to make the average financial advisor rich. But college savings accounts are important in other ways. For starters, they let an advisor get involved in one of the most emotional processes for clients: preparing a child to leave the nest. It also gives the advisor an introduction to a potential client on the cusp of adulthood.