High school graduation season is around the corner -- what better time to review your 529 college-savings plans? With the economy still in the doldrums and a couple of state bills under consideration that may change the way 529 accounts are treated, parents may want to take a closer look at how those college funds are doing.
529 plans offer parents a way to save money for tuition in tax-deferred accounts. And while a number of states offer tax benefits to all residents for participating in an in-state 529 college-savings plan, some cash-strapped states may become more restrictive about who qualifies for those tax breaks in the future, says Chris Stack, managing consultant for Savingforcollege.com.
Wealthy North Carolina residents participating in their state's Parental Savings Trust Fund, for example, have been enjoying a reduction in state income tax for the past five years. But come next year, the state's temporary waiver on income restrictions for those tax breaks is set to expire, unless the state legislature approves SB 247, which would permanently eliminate the income threshold.
"Right now, there is a zero limitation on income levels [for the North Carolina 529 plan]. You can make $1 million or make $1,000 and still claim the tax deduction," says Stack. "Since 529 plans have been around, there has been a universal trend to enhance [their] benefits. But now that we're in an environment where the states are fighting for limited resources and it'll be a true test for how policymakers treat these plans."
Taking away the bonus of a state income tax deduction on 529 contributions may slightly dampen enthusiasm for the plans. However, parents would still be able to reap the main benefit -- allowing their college savings to grow tax-free.
Rebounding from the Recession
When the recession began, the 529 college savings industry took a hit. In 2008, net contributions fell a whopping 63% to $5.1 billion, says Paul Curley, director of College Savings Research for Financial Research Corp. Since hitting that low, the 529 college-savings industry has begun a gradual recovery over the past two years, with net contributions reaching $9 billion last year and the industry reaching an estimated $138 billion.
"As time has passed, more and more money is coming in off the sidelines," Curley says.
And by 2015, annual net contributions are expected to reach an all-time high, adds Curley. He forecasts net contributions will reach $16 billion in 2015.
Curley sees a number of factors bringing 529 plans back into vogue, key among them being the expansion of product demand, innovations in marketing, and the development of new distribution systems that put college savings accounts on the radar of parents from a wider set of demographics and socioeconomic groups.
Consumers Growing More Comfortable With 529s
With more money under management, profits rebounding, and economies of scale kicking in, program management fees for 529 college-savings plans have been declining over the past two years, says Andrea Feirstein, managing director for AKF Consulting Group, a firm that advises 29 states on their 529 plans.
She estimates that program management fees have dropped by 50% to 60% on average over the last two years. Other costs associated with 529 plans include the underlying cost of the investment, administrative fees and the cost of a fee-based financial adviser if one is used.
Currently, there are about 90 529 college savings plans, of which roughly 59 are offered directly to consumers by states and educational institutions. The remaining funds are purchased through financial advisers. And although most funds are available directly to the public, the majority of accounts handled in the $138 billion industry -- approximately 55% to 60% -- are opened with the help of advisers, notes Feirstein, That figure, however, has dropped from roughly 80% about a year ago as consumers have become more comfortable selecting their own 529 college savings plans, she added.
Financial advisers, meanwhile, are increasingly using a multi-managed funds approach for 529s. That allows participants to sign up for a single 529 plan, yet gain diversification because several different fund companies are used for the plan.
Some of the flexibility in 529 plans is also cropping up with an increasing selection of FDIC-insured plans, Feirstein says. The option provides consumers with a more conservative approach to their 529 college savings plan.
Consumers used to having flexibility in their 401(k)s are seeking similar flexibility in their college savings plans. Stack says a movement is afoot in Congress to give all consumers the right to switch from one fund -- say, a bond fund -- in their 529 plan to a stock fund within the same plan.
"It's more of a question of when, not if, this type of legislation will pass," says Stack.