The "529 Plan" Isn't Dead... But It Needs Help

The 529 higher-education savings/investment type of account is losing popularity despite its tremendous tax advantages. Folks are worried because of what happened to their balances during the recent market collapse.

Contributions are down. Fewer 529 accounts are being opened. Folks are looking for more conservative places to invest money for college, like CDs and bank savings (nevermind that most 529s offer a "stable value" investment option).

Understandable reaction, but the wrong strategy. Most people will need to earn a lot more than bank interest, so they need to be investing for real, and ideally they will do so in tax-advantaged investment accounts. The 529 is one of the few places to do that...

But the 529 is far, far from ideal, and that is completely separate from the market value declines the investments therein suffered in 2008 along with most of the rest of the investment marketplace. 529s have other, perhaps bigger, problems that must be fixed.

Limited investment selection, and limited portfolio adjustments, are the biggies. Specifically, here is what needs to be fixed:

1) Scrap the state-sponsorship of 529 plans. We should not be stuck with investment choices limited to those offered by investment firms that get sweetheart deals from the sponsoring states. For example, if you are in the Alabama 529 plan, you're stuck with Van Kampen mutual funds. Nice deal for Van Kampen, and that's a decent fund company, but why should folks from Alabama have to suffer investment choice limitations in the first place just to get the in-state tax deductions? Not having free access to your money before college is a fair trade-off for the tax breaks, but there's no such logical relationship with social policy and a mutual fund dealer.

2) Lift the transaction restrictions. Most (all?) 529 plans restrict how often the owner of the account can rearrange the portfolio. In Virginia's 529 from American Funds, for example, ya get one annual re-jiggering of your portfolio. What if the markets are volatile that year and you want to move in or duck for cover? Folks, in this day and age, we need to be nimble and flexible. I'm not advocating frequent trading of mutual funds, as you probably already know, but I do not want my hands tied. Most 529s tie your hands.

Instead of this arbitrary and dubious 529 structure, let's open-up Education Savings Accounts (formerly known as Coverdell IRAs, after the late-Paul Coverdell, a Senator from GA who championed the idea of higher contribution limits on tax-deferred contributions for college savings). They are better than 529s, except you may contribute only a small fraction as much as to a 529.

"ESAs" can be established at almost any financial services institution, on your own or with the help of a financial advisor. You can invest in just about any stock, bond, mutual fund or exchange-traded fund. The contribution may or may not be tax-deductible, but any growth is tax-deferred, and withdrawals for approved higher-ed expenses are tax-free.

Don't let this deter you. Save for college. But voice your opinions. We should be allowed to save more, more freely and dynamically, in tax-advantaged accounts for college. Open-up the 529s, or shut 'em down and open-up the ESAs instead.

Bug your U.S. Representative about it by calling (202) 225-3121 and asking to be connected to your congressman/woman's office. Find your U.S. Rep at www.house.gov