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FAQ on 529 investment changes
https://www.savingforcollege.com/articles/faq-on-529-investment-changes-689

Updated: 2017-08-31

by Joseph Hurley

Financial Professional Content

The IRS permits only two investment changes within a beneficiary's 529 account in any calendar year. Given how 529 plans have evolved over the years, this restriction seems unnecessary and inappropriate, but it is what it is. Here are some answers to frequently-asked questions regarding this limitation.

I thought the IRS allowed only one investment change per year. What happened to that rule?

The IRS expanded the number of changes from once-per-year to twice-per-year in 2009, but only for 2009 (IRS Notice 2009-1). This was when the stock and bond markets were in turmoil and more flexibility was being sought by many account owners. Then, in 2014, President Barack Obama signed into law the Achieving a Better Life Experience (ABLE) Act. That law introduced ABLE accounts, but also augmented existing 529 plans, making the ability to perform two investment changes per year permanent.

Why does the IRS impose the investment-change limitation?

The investment change rule developed by the IRS actually represents a relaxation of Code Section 529 as passed by Congress in 1996, which says that a 529 plan participant may not be granted the ability to direct investments in the account either "directly or indirectly." Congress originally felt that the states were in a fiduciary role and would assume full responsibility for investing the contributions made by plan participants, much like they do with state pension funds. While that makes perfect sense for 529 prepaid tuition plans, it seems entirely inappropriate for 529 college savings plans.

The IRS better understands the need to allow investment changes, but cannot make rules that stray too far from the statutory language of Section 529.

Will we ever see another increase in the number of permitted investment changes?

It's likely that we will. Several bills have been introduced into Congress over the past few years to allow more investment changes. Allowing greater flexibility in investment management is widely considered a non-controversial amendment, but passage depends on appropriate tax legislation making it through a divided Congress.

How does the investment change limitation compare to the limitation on rollovers between 529 plans?

The timing rules are different. A beneficiary may undergo one tax-free rollover--i.e. a transfer of assets from one 529 college-savings plan to another 529 college savings plan--once in any 12-month period. The restriction period is not framed by the calendar year, like it is with investment changes.

If my client transfers his money from the state's direct-sold 529 plan into the same state's advisor-sold 529 plan, is it considered a rollover or an investment change?

It is an investment change. The IRS considers all 529 college-savings plans sponsored by the same state to be a single 529 plan for tax-accounting purposes.

When a 529 plan manager replaces the underlying funds in one of the plan portfolios, does it count as an investment change for the participants invested in that portfolio?

No. The investment change was directed by the plan manager and not by the plan participant and so does not count as an investment change.

When a 529 plan participant selects a different investment option for new contributions being made to the plan, does it count as an investment change?

No. Provided the old contributions to the plan are not moved to a different investment option, changing the investment choice for new contributions is not considered an investment change.

If my client has his account spread among several investment options in a 529 plan, is he restricted to just one of those options if he wants to make a change?

No. He can reallocate investments among all the options in the plan, but the reallocation must take place at the same time to be considered a single investment change.

If the same beneficiary is named on more than one 529 account, does an investment change in one of those accounts count against the allowed investment changes in the other accounts during the same year?

The IRS has not issued any "aggregation rules" with respect to investment changes, and so it is possible that they will permit more than two changes per beneficiary per year, even when the account owner and beneficiary are the same on all accounts. This is unlikely, as the IRS has leaned more heavily to treating each account as unique with the repeal of distribution aggregation rules in 2016, but we just don't know for certain. So, ask the plan administrator for their interpretation. When the account owners are different (e.g. husband owns one account for child and wife owns another account for same child), investment changes in one account should not count against investment changes in the same year in the other account.

What happens if my client messes up and does more than two investment changes in a year? Will he owe taxes and penalty?

Your client cannot mess up. The investment change limitation is policed by the plan administrator and not by the participant. If your client requests an investment change, and the administrator improperly accepts the request, your client is not subject to taxes or penalties.

Note the difference with rollovers. If your client violates the once-per-12-months rollover limitation, it becomes the responsibility of your client to report the transfer as a distribution potentially subject to tax and 10% penalty on the earnings portion.

My client made both their investment changes early in the year and now wants to make another before the end of the year. Is there any way around the limit?

There is an exception to the rule. An investment change can be made any time the beneficiary of the account is changed. So by requesting a beneficiary change along with your investment change request, the investment change is not counted against the limitation. In families with at least two children, this appears to be an easy strategy to implement, and the beneficiaries can presumably be changed back in the future.

Financial Professional Content

The IRS permits only two investment changes within a beneficiary's 529 account in any calendar year. Given how 529 plans have evolved over the years, this restriction seems unnecessary and inappropriate, but it is what it is. Here are some answers to frequently-asked questions regarding this limitation.

I thought the IRS allowed only one investment change per year. What happened to that rule?

The IRS expanded the number of changes from once-per-year to twice-per-year in 2009, but only for 2009 (IRS Notice 2009-1). This was when the stock and bond markets were in turmoil and more flexibility was being sought by many account owners. Then, in 2014, President Barack Obama signed into law the Achieving a Better Life Experience (ABLE) Act. That law introduced ABLE accounts, but also augmented existing 529 plans, making the ability to perform two investment changes per year permanent.

Why does the IRS impose the investment-change limitation?

The investment change rule developed by the IRS actually represents a relaxation of Code Section 529 as passed by Congress in 1996, which says that a 529 plan participant may not be granted the ability to direct investments in the account either "directly or indirectly." Congress originally felt that the states were in a fiduciary role and would assume full responsibility for investing the contributions made by plan participants, much like they do with state pension funds. While that makes perfect sense for 529 prepaid tuition plans, it seems entirely inappropriate for 529 college savings plans.

The IRS better understands the need to allow investment changes, but cannot make rules that stray too far from the statutory language of Section 529.

Will we ever see another increase in the number of permitted investment changes?

It's likely that we will. Several bills have been introduced into Congress over the past few years to allow more investment changes. Allowing greater flexibility in investment management is widely considered a non-controversial amendment, but passage depends on appropriate tax legislation making it through a divided Congress.

How does the investment change limitation compare to the limitation on rollovers between 529 plans?

The timing rules are different. A beneficiary may undergo one tax-free rollover--i.e. a transfer of assets from one 529 college-savings plan to another 529 college savings plan--once in any 12-month period. The restriction period is not framed by the calendar year, like it is with investment changes.

If my client transfers his money from the state's direct-sold 529 plan into the same state's advisor-sold 529 plan, is it considered a rollover or an investment change?

It is an investment change. The IRS considers all 529 college-savings plans sponsored by the same state to be a single 529 plan for tax-accounting purposes.

When a 529 plan manager replaces the underlying funds in one of the plan portfolios, does it count as an investment change for the participants invested in that portfolio?

No. The investment change was directed by the plan manager and not by the plan participant and so does not count as an investment change.

When a 529 plan participant selects a different investment option for new contributions being made to the plan, does it count as an investment change?

No. Provided the old contributions to the plan are not moved to a different investment option, changing the investment choice for new contributions is not considered an investment change.

If my client has his account spread among several investment options in a 529 plan, is he restricted to just one of those options if he wants to make a change?

No. He can reallocate investments among all the options in the plan, but the reallocation must take place at the same time to be considered a single investment change.

If the same beneficiary is named on more than one 529 account, does an investment change in one of those accounts count against the allowed investment changes in the other accounts during the same year?

The IRS has not issued any "aggregation rules" with respect to investment changes, and so it is possible that they will permit more than two changes per beneficiary per year, even when the account owner and beneficiary are the same on all accounts. This is unlikely, as the IRS has leaned more heavily to treating each account as unique with the repeal of distribution aggregation rules in 2016, but we just don't know for certain. So, ask the plan administrator for their interpretation. When the account owners are different (e.g. husband owns one account for child and wife owns another account for same child), investment changes in one account should not count against investment changes in the same year in the other account.

What happens if my client messes up and does more than two investment changes in a year? Will he owe taxes and penalty?

Your client cannot mess up. The investment change limitation is policed by the plan administrator and not by the participant. If your client requests an investment change, and the administrator improperly accepts the request, your client is not subject to taxes or penalties.

Note the difference with rollovers. If your client violates the once-per-12-months rollover limitation, it becomes the responsibility of your client to report the transfer as a distribution potentially subject to tax and 10% penalty on the earnings portion.

My client made both their investment changes early in the year and now wants to make another before the end of the year. Is there any way around the limit?

There is an exception to the rule. An investment change can be made any time the beneficiary of the account is changed. So by requesting a beneficiary change along with your investment change request, the investment change is not counted against the limitation. In families with at least two children, this appears to be an easy strategy to implement, and the beneficiaries can presumably be changed back in the future.

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