Future tax-exempt status of 529 plans in jeopardy

Feb 13, 2006 @ 12:01 am

By Charles Paikert

NEW YORK - The 529 plan industry long has assumed that eventual congressional repeal of the 2010 sunset provision of the college savings vehicles' federal-tax-exempt status was a slam-dunk.

Not so fast.

The exemption from federal tax has been one of the plans' biggest selling points and undoubtedly has spurred their phenomenal growth - to nearly $70 billion in assets last year from approximately $12 billon in 2001, when the tax-exempt status was granted.

But prominent Washington attorney Helen Hubbard, partner at Baker & McKenzie LLP of Chicago and former tax legislative counsel at the Department of the Treasury, warned state administrators and financial services executives attending the opening general session of the recent College Savings Foundation Forum in Miami not to expect Congress to pass any major 529 legislation this year.

The lack of major tax reform on the legislative agenda this year was to blame, she explained. A looming alternative minimum tax crisis could push Congress to wait until 2007 or 2008 to address 529 plan issues, she added.

Slow going on the Hill

The congressional inaction may have had a negative effect on the industry. "Advisers have to tell clients the tax-exempt status for 529 plans may expire in 2010," said Bruce Harrington, vice president and director of product development for Boston-based MFS Investment Management, and a board member of the CSF, a Washington-based industry trade group. "I think it's already having an impact on sales."

In fact, according to figures just released by Boston-based Financial Research Corp., estimated net sales of 529 plans in the fourth quarter of last year fell slightly to $4.1 billion, from $4.5 billion in the fourth quarter of 2004.

Ms. Hubbard's views were underscored the next day by Washington lobbyist James Delaplane and Rosemary Becchi, Washington-based vice president of government relations for Fidelity Investments of Boston.

Mr. Delaplane, a partner in Davis & Harman LLP of Washington who also represents the CSF, said pension legislation that is about to be taken up by House-Senate conferees is the best shot the 529 industry has of extending the federal-tax-exempt status past 2010.

However, he and Ms. Becchi agreed that the odds of a last-minute inclusion of tax-related 529 provisions in the legislation, already passed by the House as The Pension Protection Act (HR 2830) and the Senate as The Pension Security and Transparency Act (S 1783), were considerable.

And if permanent tax-exempt status for 529 plans were not included in the pension package, Mr. Delaplane said, chances of enacting such legislation anytime soon would "fall dramatically."

In fact, he added, if the tax status of 529 plans is not addressed in the upcoming pension bill, the industry may have to wait several years for its next chance at a similar legislative opportunity.

By the end of the conference, some industry insiders were expressing doubts that the 529 sunset provision would ever be repealed, while others pointed out that the longer it remains on the books, the harder it will be to sell uncertain parents on the merits of the plan.

To be sure, many 529 plan officials remain optimistic that the sunset provision will be repealed.

"I think there's a good chance it will be repealed," said John Heywood, a principal of The Vanguard Group Inc. who heads the education-markets group that oversees the Malvern, Pa., firm's 529 relationships at the state level. "The political pressure [to have it repealed] may be bigger than is being anticipated."

And Joan Marshall, executive director of the Baltimore-based College Savings Plans of Maryland, points out that proposed legislation to repeal the 529 tax-exemption sunset already has numerous bipartisan co-sponsors. "The ball is rolling," she said. "We have so many co-sponsors from both sides of the aisle. That's our biggest asset."

But since Congress is highly unlikely to extend 529 plans' current tax treatment as a stand-alone bill, Fidelity's Ms. Becchi explained, the industry must attach the sunset repeal provision to larger, more extensive legislation that already has gained momentum in the House and Senate, and none is on the horizon.

Even if the sunset provision is not repealed by 2010, "it's not the end of the world," said Andrea Feirstein, managing member of New York-based AKF Consulting LLC.

Ms. Feirstein noted that 529-plan accounts would revert to their tax status before 2001, when funds withdrawn from the accounts were taxed at the beneficiary's tax bracket.

"It's going to be a lower tax rate than the parents," she said. "And they're still better off having a college savings plan than not having one."

Michael Steiner, a certified financial planner and certified public accountant, agreed - to a point. "It sounds like it would be similar to taking all Roth IRAs and making them traditional IRAs," said Mr. Steiner, wealth manager for RegentAtlantic Capital LLC in Chatham, N.J.

But a loss of tax-free status for 529s would be disappointing, he said "It's challenging enough for people to meet the objectives of saving for college, and this further compounds the difficulty by not adding that extra little sweetener."


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