Investors scramble to find safety in 529s

They make changes to investments in plans, inquire about options such as rollovers

Nov 16, 2008 @ 12:01 am

By Charles Paikert

Politics isn't the only place where people are opting for change. Nervous account holders spooked by the recent turmoil in the markets are either switching over to more conservative investments in their Section 529 college savings plans or inquiring about options such as account rollovers, according to state officials in charge of the programs. "We've seen a dramatic increase in investment changes, and 99% are being made into certificates of deposit, which we began offering in October," said Megan Perkins, program director for Wisconsin's College Savings Program in Madison. The state's EdVest direct-sold plan, which offers the CDs, has about $1.2 billion in assets. "We have had a lot of inquiries about everything," said Jim Lynch, a trustee for the Fairbanks-based Education Trust of Alaska, which oversees about $2 billion in the state's college savings plans. "Many [investors] were concerned and merely wanted reassurance," he said. "We've also had a number of participants inquiring about guaranteed or insured products or who moved into money markets and more conservative portfolios." In the Illinois Bright Start College Savings Program, there has been increased interest in a fixed-income investment option that guarantees principal protection but may not earn any returns, said Shirley Yang, the Chicago-based director of the adviser-sold plan, which has more than $2 billion in assets. And to accommodate demand for investment changes from ac-count holders in the Richmond-based Virginia Education Savings Trust plan, which has more than $1 billion in assets, the state last month waived a $25 fee for existing ac-count owners who open an additional account. According to Internal Revenue Service rules, 529 account holders can change allocations to an account for the same beneficiary only once during a calendar year. As a result, industry officials say, a number of account owners who have already made the one change, or "rebalancing" permitted by law, are considering rolling over their account from one state plan to another so that they can make a change, or have already done so. Michigan's Education Trust prepaid plan, for example, has seen a 16% increase in 529 accounts rolled over from other states for the year ended Sept. 2, said Robin Lott, the plan's Lansing-based executive director. Last year, 383 accounts were rolled over into the plan, which has nearly $1 billion in assets, compared with 445 accounts that came into the plan through the first nine months of this year. Since then, Ms. Lott said, "we've had a lot of calls regarding rollovers because the market has not been behaving so nicely and people are panicking." Joe Hurley, president and chief executive of Pittsford, N.Y.-based LLC, has seen "an absolute increase in interest in questions about rollovers" throughout the country. While account holders can in-deed roll over a 529 account from one state plan to another with different investment options in order to make changes, they need to be aware of other options and caveats, according to Mr. Hurley and other industry experts.
For example, states that offer an income tax deduction for 529 contributions may have "recapture" provisions for rollovers, said Christopher Houston, a tax attorney with Ropes & Gray LLP in Boston who specializes in college savings. In other words, he said, account holders may have to pay state taxes on all or a portion of whatever amount they were allowed to deduct over the lifetime of the account. A 529 account holder can also simply close the account, Mr. Hurley said. With the proceeds they can then open a new one, without any tax penalties, as long as they act within 60 days. The transfer, however, only qualifies as a tax-free rollover if there were no other rollovers for the same beneficiary during the past year. An account owner could also simply liquidate the 529 account and not have to worry about a tax penalty because the account has no earnings, Mr. Hurley said. If that were the case, he added, the loss may be claimed as a miscellaneous itemized deduction. Rolling over a 529 account that is underwater, Mr. Hurley, said, may make sense "if you're convinced a different 529 plan has a better investment option." Another reason to consider a rollover, he said, is to avoid a gift tax that may be incurred if a 529 account was liquidated and a new account was opened more than 60 days later. Under the law, annual contributions of more than $12,000 to a 529 account (increasing to $13,000 in 2009) may use up some of a donor's lifetime gift tax exemption or be subject to a 45%gift tax. Overall, Mr. Hurley cautioned, "people have to be really careful. They have to check the rules in their state, and they should talk to a knowledgeable accountant."
Investors who liquidate an adviser-sold 529 account may have to pay an exit fee, warned Susie Bauer, a vice president and 529 manager for Robert W. Baird & Co. Inc., a Milwaukee-based broker-dealer. What's more, she said, if that investor then buys another adviser-sold 529 account, he or she will have to pay another upfront sales charge for a new account. "My advice to our advisers is to talk about a timeline for clients who are concerned about their 529 accounts and find out what the clients' concerns and ultimate goals are," Ms. Bauer said. "If clients want to try a new money manager, they may want to put new money into a new account and simply stop funding the one they're unhappy with."
Michelle Goldstein, a fee-based financial planner in Dallas who specializes in college savings, said that she would advise against clients considering rolling over or liquidating a money-losing 529 account "if they are interested in chasing returns." "When you get into the game of chasing returns, it ends up being a losing game in the long run," according to Ms. Goldstein, who is principal of Goldstein Financial Future, a planning firm that doesn't manage money. But, she said, "Moving from a non age-based account to an age-based [that automatically re-balances the account to more conservative funds as the child gets older] absolutely makes sense in this environment."

Age-based asset allocation options are also highly recommended by Jonathan E. Thornberry, a senior investment consultant for Baird who works in Cincinnati with The Sittenfeld Stuard & Thornberry Group.

"The bottom line is we are not recommending making significant changes [to 529 plans] as long as the client was in the proper investment selection, unless something has significantly changed in the client's situation or planning," said Mr. Thornberry, whose group manages about $400 million in assets.

Another option for concerned 529 account holders, industry ex-perts say, is simply to change the beneficiary to a sibling or another qualified relative in the same generation.

The account holder can then change investment options in the account and afterward go back to the original beneficiary.

"I've gotten more questions about this than anything else lately," Ms. Bauer said. "You can change beneficiaries at any time, and you can change it back."

But changing beneficiaries on a 529 account may be challenged by the 529 plan or the IRS if they thought it was being abused, Mr. Houston warned.

"Changing beneficiaries can have adverse income tax or transfer tax consequences in some cases," he said. "Therefore people should be careful and consult with counsel."

E-mail Charles Paikert at


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