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529 E-ditorials

00-19: The 3 Stupid Rules of 529
Joe Hurley
Monday, October 9th 2000

No matter how much we might appreciate the wonderful and unique aspects of 529 plans, we still have to be somewhat dismayed with Three Stupid Rules found in the tax law for “qualified state tuition programs” (some may argue there are more than three). In this 529 E-ditorial I’ll discuss Stupid Rule Number 2 and Stupid Rule Number 3. I’ll save Stupid Rule Number 1 for the next 529 E-ditorial.
Stupid Rule Number 2: You can’t have any investment control over your account.
This restriction has no reasonable basis, in my opinion. The rule says that once you have contributed your dollars to a 529 account, all control over future investment decisions affecting those dollars must be turned over to the state maintaining the program. If, later on, you want to make an adjustment to your asset allocation because your circumstances or investment objectives change, well then that’s just too bad. If your 529 plan decides to make new more attractive investment options available, the dollars you already have in the plan cannot be moved to the new choices. Even if the state unilaterally decides to change the way your account is invested and you don’t agree with that change, you still have to go along with it if you wish to keep that account intact.
I can’t say for certain why this rule exists. It’s probably just a relic of the “old pre-529 days”. Several states were already operating prepaid tuition plans before the federal law section 529 came along in 1996, and these programs happened to be very paternalistic in their approach. It appears that Congress, in enacting section 529, was saying to the states “you can have your tax-advantaged tuition plan” but only if you, the state, continues to stay in the driver’s seat. Participants can be there only for the ride.

It’s impossible for a state to develop a single investment approach that fits everyone and every situation. Each family is different, and will have unique objectives and varying tolerances for investment risk. A state-sponsored college investment program should be something that can benefit all families, not just the ones who happen to fit the investment profile adopted by the state. Stupid Rule Number 2 makes this goal difficult to reach. It’s nice to see many of the states are doing what they can to inject more flexibility, including more upfront investment choices. But why not get rid of this restriction altogether and provide families with the investment control? It works for 401(k) and individual retirement accounts, and it would work for 529 plans as well.
Stupid Rule Number 3: You must change the beneficiary if “rolling over” your account.
Stupid Rule Number 3 exists only because of Stupid Rule Number 2. Without Rule # 3, a 529 account owner could easily and effectively exercise investment control over the account (thereby violating Rule #2) by rolling over an account from one 529 plan to another with different investment options. But because the law now requires that the beneficiary of the account be changed, your rollover is motivated purely by beneficiary considerations, not by investment considerations. That’s the theory, anyway. Many people (including the IRS) know that it’s possible under the current rules to stage a series of rollovers to move your account and end up with the same beneficiary you started with. Of course this is gamesmanship, and it’s not only a hassle to transact but it also puts the account owner in the uncomfortable position of wondering how “legal” it is.

What about all the other non-investment reasons for wanting to roll over an account without changing beneficiaries? We live in a mobile society. Families are picking up and moving between states all the time. It seems to me that a family should be allowed to change a 529 account to the state where it resides without triggering penalty and tax? What happens if the state decides to terminate its 529 plan and distribute all the plan assets out to account owners? It’s unfair to say that only those owners willing to name a new beneficiary can escape penalty and tax through a rollover.

There are proposals in Congress that would allow same-beneficiary rollovers on a limited basis, and we would welcome such a change to Stupid Rule Number 3. But it would only act to further undermine the restriction against investment control. The ultimate answer is to get rid of Stupid Rule Number 2.
Next time: Stupid Rule Number 1

» 05-4: The 529 marshals have arrived - 08/30/05
» Our 5.29th-year anniversary - 06/29/05
» 05-2: 529s and the new Bankruptcy Act - 04/28/05
» 05-1: Reform or Deform? - 02/27/05
» 04-6: Perspectives on the 529 debate - 12/28/04
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