In the very first post of this blog, I talked about 529 plans and why I thought they were the best way for most parents to save for college. That was more than five years ago. In some ways, much has changed since then. The crash of the markets in 2008 led to lawsuits and the restructuring of a lot of individual state plans. Generally, this restructuring led to better investment options and lower fees, such that the bad plans started looking more like the good ones.
The basic regulatory structure has remained the same for 529s, although there have been some notable developments over the past few years. Perhaps the most significant of these is that the Pension Protection Act of 2006 made permanent tax-free withdrawals from 529 plans, for qualified educational expenses. This didn’t come as a big surprise, but it removed an element of uncertainty that made these plans even more popular. In 2009 and 2010, the costs of computers and other computer technology for college students were included as qualified expenses, but that provision expired on December 31, 2010.
An obscure decision in 2006 undoubtedly increased the value of 529 plans for contributors. It was made by a regulator of the plans, and specified that brokers must inform customers that they may be eligible for state income tax breaks if they invest in their home state. Ameriprise Financial Services was fined for selling clients only one plan (which presumably compensated them handsomely) regardless of where the client lived and what tax benefits were available for the clients.
One of the questions that I often get about these plans pertains to what happens if the beneficiary receives a scholarship and doesn’t need all of the money that has been set aside. It’s probably notable that a much less frequent question involves what happens if the beneficiary chooses not to go to college. In any case, there are a couple of options in the case of a scholarship. One is that the funds can be ported to another beneficiary, such as a sibling, without any consequence. If there are no siblings, or they all receive scholarships, an amount equal to the scholarship award can be withdrawn from the 529 account without penalty. Taxes will still be due on the funds that are withdrawn.