Thank tax law for college savings plans

Aug. 17, 2006, was probably the happiest day in the history of the Section 529 college savings plan business.

On that day, President Bush signed the Pension Protection Act of 2006, putting into effect a provision that the industry had sought for years: a permanent federal tax break for money withdrawn from the plans and used for higher-education expenses.

Since the landmark legislation, assets in 529 plans have soared, rising to $112 billion last year, according to Boston-based Financial Research Corp. — a 23.4% increase from the $91 billion in assets in 2006. The bulk of inflows continue to come from financial advisers, who account for about three-quarters of sales, according to industry estimates.

The tax provision was critical because the federal-tax exemption was due to expire in 2010, and industry officials were concerned that uncertainty over the future tax status of college savings plans was discouraging people from using the plans.

“It definitely had a chilling effect,” said Bill Raynor, vice president, national sales, for 529 college savings plans for New York-based OppenheimerFunds Inc.

The industry put together a sophisticated lobbying effort led by the College Savings Foundation, a Washington-based advocacy association, and the Lexington, Ky.-based College Savings Plans Network, an organization that represents state administrators of 529 plans.

The fate of the tax permanency provision was uncertain until the last minute. “No one was sure it was going to happen,” said Joe Hurley, one of the industry’s most prominent public advocates, and president and chief executive of Pittsford, N.Y.-based Savingforcollege.com LLC.

The law was the culmination of a series of battles the industry had waged since it began in 1988, when Florida and Michigan launched prepaid-tuition plans. For the next 10 years, the industry fought one court case after another to secure tax breaks until the Internal Revenue Service issued favorable regulations under Section 529 of its code.

After that breakthrough, large mutual fund and financial services companies began to manage and administer 529 college programs for states, led by Boston-based Fidelity Investments’ partnership with New Hampshire.

New York-based TIAA-CREF was another industry pioneer and emerged as the industry’s leading program manager by 2005, having secured contracts in a dozen states.

As state contracts came up for renewal, however, the power shifted to firms such as The Vanguard Group Inc. of Malvern, Pa., which offered states more investment options with lower fees. Vanguard, which has teamed with Newton, Mass.-based Upromise Investments Inc., manages more than $20 billion in assets in 20 states, second only to Los Angeles-based American Funds, which manages more than $25 billion for the Virginia 529 plan.

Age-based investment options offered by Vanguard and other firms also have proved to be especially popular among 529 investors since the passage of the PPA, as have passively managed index funds.

Despite the healthy growth in college savings plans, state administrators and program managers are concerned that the 529 industry needs to market itself better to consumers to sustain growth. Nearly half of American parents surveyed by the CSF last year said they had either never heard of 529 plans or didn’t know exactly what they were.

“We are well aware of the fact that awareness of 529 plans is not where we as an industry wish it to be,” said Jackie Williams, CSPN chairman and executive director of The Ohio Tuition Trust Authority in Columbus. The organization is exploring options for a national marketing campaign, but she has cautioned that promoting and funding such a campaign is “an enormous expense to undertake.”

E-mail Charles Paikert at [email protected].