Executive Summary
Under the existing rules for 529 plans, account owners can only make investment selection adjustments once per year (or when there is a change in beneficiaries). Under the new relief just released from the IRS for 2009, 529 plan account owners will now be eligible to make changes... twice.
In IRS Notice 2009-1, the IRS updated its existing guidance from IRS Notice 2001-55, to stipulate that for 2009 only, 529 plan account owners may make investment changes twice in the calendar year (as well as if/when there is a change in beneficiary), to provide additional flexibility in light of the turbulent investment markets. The rules still require that the investments of the 529 plan be broad-based, and do not allow for additional direct or indirect control of investments by the 529 plan owner (as required under IRC Section 529(b)(4)).
Clearly, the new rules have been issued to give 529 plan owners a little more flexibility to manage their investments in light of the bear market, which has ravaged many college savings plans in the same manner as retirement accounts. But, is this useful additional flexibility for financial planners when working with clients and their 529 plans?
Probably not, for the simple reason that most financial planners do not encourage clients to make frequent changes in 529 plan investments anyway, especially to the extent that a wide swath of 529 plan investors already use the available age-based investment choices that incrementally make the portfolio more conservative over time.
Is it possible that some 529 plan owners will wish to make changes to their investments in light of the bear market? Absolutely - especially if the bear market has highlighted that perhaps there was too much risk in the college savings portfolio. In some cases, clients who selected static portfolios years ago may find that the account is now too aggressive as the child is nearer to college, and may opt to reduce volatility and/or now adopt an age-based portfolio. However, investors have already had the opportunity to make a change for 2008, and again for 2009. Is having yet another opportunity to make changes in 2009 really necessary or helpful?
Critics will probably note that the increased flexibility essentially encourages clients to try to "time" the markets. Providing additional trading options may lead some clients to try to "get out" and make the portfolio more conservative in early 2009, with the hopes of then "buying back in" later in the year when the markets are more appealing. Of course, the risk to this is that the client gets the timing wrong - especially since they only get one chance to get "out" and "back in" - so I suspect most financial planners will be unlikely to encourage clients towards such a strategy, unless the planner is just outright forecasting an ongoing significant bear market. Of course, if that's the case, the more conservative 529 plan changes were already probably made in 2008.
Nonetheless, the relief is probably welcome for some. For clients who really were not willing to tolerate the current market volatility at all, this provides them the opportunity to take the peace-of-mind steps necessary to batten down the portfolio's risk in early 2009 (and/or now, if action hasn't been taken in 2008 already), and still make an additional change next year when the market volatility is more tolerable.
Overall, though, I suspect we will probably not see this provision utilized very much, especially amongst financial planners who tend to recommend a buy-and-hold (or age-based portfolio buy-and-hold) strategy for college savings plans.
Michael,
Good point RE: the added trading opportunity. I too feel it is not very valuable.
On a separate yet related note, you mention age-based or target-date investments as perhaps the most attractive option for 529s. Those funds have come under fire lately for being less effective at auto-risk reduction than previously thought. Do you have any thoughts about that criticism?
Why doesn’t the IRS remove the income limitation for
Coverdell accounts? Why the emphasis on 529 plans where
the tax benefits are geared toward the wealthy. Parents
should have investment flexibility, low cost alternatines
and not limited to 529 plans that have high administrative
cost, state controlled investment options and limited
switching flexibility…Twice a year!
In Fact, think about it, why do we need 529 plans? An
unrestrictive Coverdell would be better for most of us.
Is there any hope on the horizon to be able to use 529
funds to pay off student loans? We would like to be able
to wait to use our 529 since it has lost so much in 2008.
Hi Michael-
Thanks for this post on the change. I hadn’t heard about it elsewhere.
I have one comment– we have a few clients for whom taking a loss in a 529 (closing out the account for 60 days) has been extremely beneficial. Of course, in order to take this as a miscellaneous deduction you can’t be in AMT, and you must be over the 2% limit (which many investment management clients are). I think writing about this for a future post or Kitces Report topic would be beneficial to most advisors (but not to the IRS).