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529 E-ditorials

00-9: It's My Money
Joe Hurley
Wednesday, April 5th 2000

Before investing in a state 529 plan you will probably want to know that you can get your money back upon request (preferably with earnings). At least I would. But some states don't think you should be able to. Once they get your dollars they make sure you can't get a refund before the named beneficiary reaches college age, short of death or disability or a good sob story. In my opinion, this lack of liquidity is one of the worst features I come across in my review of 529 plans.

Several states operating college plans place this restriction on refunds, including prepaid tuition plans in Colorado, Ohio, Massachusetts, Michigan, and Tennessee, and the new savings plan in Tennessee. Wisconsin's EdVest savings plan (started in 1997) has several limitations, including a restriction on refunds. I was very happy to see Wisconsin take steps recently to create a new 529 savings plan designed along the lines of some of the other more popular state savings plans. Now we learn, however, that Wisconsin's new savings plan, to be signed by the Governor next week, prohibits refunds before the beneficiary turns 18 and decides not to attend college.

Federal tax law Section 529 and the IRS require that refunds be subject to a reasonable penalty on any earnings, thereby discouraging improper tax-motivated use of accounts. But they do not feel there is a need to place restrictions on the account owner's ability to claim a refund, so why should these states?

Although actuarial considerations and program structure may play a role, the primary reason for the restrictions on refunds is simply a case of over-protectiveness. Some of these states feel that the beneficiary needs to be protected from the avariciousness of the account owner, even when the account owner is the child's own parent or grandparent. Since the money is supposed to be used for the student's college education, the state is going to make sure that no one has the opportunity to pull the rug out by requesting a refund of the account before the kid has a chance to spend it on college costs.

We respect the states' right to design their college savings program in any manner they feel is best. But they should also understand that if one of their residents is considering the option of saving for college in an illiquid 529 account within the state, or going with a more flexible plan through a different state, the decision in many cases will be to go with the flexible plan that allows refunds. This will be the case even for donors who have absolutely no intention ever to request a refund.

Why is the ability to request a refund so important?

Because things happen. Circumstances change. Uncontrollable events occur. Many families that decide to take advantage of special benefits available with their home state's 529 plan find that they later have to move to a different state while the kids are still in grade school. Shouldn't they have the right to get their money back when the state-specific benefits lose their value? What happens if the family suffers a financial hardship? Some of these states will make an exception in such a case, but why should the family have to plead for a refund and disclose their private financial affairs? Some families may discover that they have too much put away in the 529 account, perhaps because the student receives an inheritance or because the grandparents declare that they will pay tuition directly for estate planning purposes. These families should be able to get their money back now when they know that it won't be needed later.

What happens if Congress or the state change their laws and make 529 plans less attractive as a way to save for college? Or consider the possibility that a program falters. It can be pretty nerve-wracking if you really want to get out but there's no exit. Some participants in the Colorado Prepaid Tuition Plan recently went through this experience as a result of some negative publicity directed against their plan. The Colorado plan ultimately decided that any unhappy or worried participants could get their money back upon request, despite the refund prohibition in the plan.

There are many other good and valid reasons for desiring a refund after the 529 account is opened. But the bottom line is that the money you put into a 529 plan is your money. If you need it back, or just want it back, you should have the right to get it back.

The nice thing about the state laws controlling 529 plans is that overly restrictive provisions can usually be fixed fairly easily. Simply pass a new bill with corrections. We've seen it happen numerous times in states like California, Kansas, and Utah. We certainly hope that Wisconsin will decide to make a change to what otherwise looks to become a very good 529 plan. Other states should consider doing the same.

» 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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