The Pension Protection Act wasn’t just about defending pensions from financial failure. Among other provisions, it also permanently extends the tax advantages of Section 529 college savings plans, according to details in the new law.
That change presents a fresh opportunity for advisors to point out to boomers the significant benefits of establishing a 529 plan for their children or grandchildren, says one financial advisor.
Under earlier legislation, the tax advantages of 529 plans were to end in 2010. The PPA eliminated that threat, making permanent a 2001 change that allows tax-free withdrawals from 529 accounts as long as the money is used for education.
Section 529 of the Internal Revenue Code allows each state to set up its own college savings plans. That provision exempts taxpayers from paying federal income taxes on either contributions to or normal distributions from such plans. States, too, often provide such exemptions, although usually only for investors who are residents of those states.
Financial planners often use 529 plans as an estate-planning tool. These plans are attractive to boomers as a way to help look after their children’s or grandchildren’s future. For grandparents, there’s also the appeal of helping their immediate family save on estate taxes.
Nearly $100 billion is invested in 529 plans nationwide. That could increase significantly, predicts Bruce Harrington, vice president and director of product development and marketing, MFS Investment Management, Boston..
“The sunset provision was looming over everyone’s’ head,” says Harrington, who is also product manager of MFS’s 529 college savings plan program. “I often heard from advisors and clients that they wouldn’t even consider buying a 529 because they were afraid the tax breaks would sunset. But now you’ll see people who had been sitting on the sideline getting involved.”
For advisors who hadn’t been working with 529s, the PPA is the stimulus to get them started selling the products, while those already involved can now go back to clients and tell them about the changes, Harrington says.
He urges advisors not familiar with the plans to learn how they work under different state rules and understand the impact on clients’ financial planning.
Harrington expects to see a shakeout in investment firms that serve as advisors and marketers of state plans, Harrington says. That should simplify the task of evaluating different plans.
“A lot of firms got involved in 2001 and 2002, and most of those contracts were for 5 years so are about to come up for renewal,” he points out. “Now you are going to see states make some decisions.”
Although often viewed as an investment for the affluent, Harrington believes 529 plans benefit a wide variety of investors.
“The average 529 plan balance is from $8,000 to $10,000,” he says, “so they appeal to people with middle incomes and higher.”
Indeed, a survey last year by the market research firm Claritas Inc., San Diego, found boomer households with children across a wide range of income levels increased use of these savings plans appreciably, from 7.4% of boomers in 2003 to 10.2% in 2004.
These plans are “still in their infancy” and therefore present strong growth potential, Harrington says. The extension of the tax breaks on the plans is “great news,” he adds. “Any advisor who wasn’t in the business should get involved.”