Choosing 529 plans or qualified tuition programs as a savings strategy for the college-bound got more enticing in 2006 as the programs' tax-exempt status gained permanency, and student-owned accounts would no longer need to be reported on financial aid applications."New legislation in 2006 created a significant advantage in 529 plans," said Joe Hurley, CPA and founder of "Accounts owned by students or custodians by the Uniform Transfer to Minors Act are no longer reported on financial aid applications if the student files as a dependent student. Before, they were reported as student assets and assessed at a very high rate."

Those funds, Hurley added, need to be transferred into a 529 account before filing a Free Application for Federal Student Aid application.

The Deficit Reduction Act of 2005, enacted in February 2006, has already taken effect on this year's financial aid applications. The law removes 529 plans and Coverdell Education Savings Accounts owned by a dependent student - including a custodial 529 account funded from an existing Uniform Gifts to Minors Act/UTMA account - from the expected family contribution in the federal financial aid formula, according to Hurley.

"Some people are speculating Congress will go back and change it," Hurley said. "I think Congress really intended families to save with 529 plans and Coverdell ESAs."

Mark Kantrowitz, president of M.K. Consulting Inc., in Cranberry Township, Pa., and publisher of FinAid, a Web site that guides parents and students through the financial aid process, called the change a "drafting error" and anticipates that legislators will tackle it in 2007.

"What they intended to do is to say it should not be counted as an asset of the student, it should be counted as an asset of the parent," Kantrowitz said. "That was what their intention was and that makes a lot more sense. The idea behind these 529 plans is to afford more favorable treatment, and when it's in the child's name it's always been treated more harshly. But the literal language of what they passed is not an asset of the student. The legislative language is being taken very literally by the U.S. Department of Education. They intend to fix this error."


Arbab Hassan, education planner for 401Kid Inc., a New York City-based financial software company that manages education savings plans, said that when talking to parents, they identify saving for their kids' college among the top three savings priorities, next to saving for a home and saving for retirement - with good reason.

According to Trends in College Pricing 2006, a report by the College Board, average published tuition and fees in 2006-2007 are $5,836 at public four-year colleges and universities, $2,272 at public two-year colleges, and $22,218 at private nonprofit four-year colleges and universities. In 2003-2004, the most recent year for which statistics are available, Americans spent an estimated $82 billion in tuition for public, private not-for-profit and private for-profit degree-granting institutions, according to Tom Snyder, director of the annual reports program for the National Center for Education Statistics.

In August, President George W. Bush signed the Pension Protection Act, which allowed 529 plans to gain tax-exemption permanency, instead of expiring in 2010, a benefit that does not extend to Coverdell ESAs. In 2011, Coverdells will no longer be tax-free for K-12 expenses; the annual contribution limit of $2,000 will drop down to $500; and accountholders will not be able to take a tax-free distribution from an ESA in the same year that a dependent child claims the Hope Credit or Lifetime Learning Credit.

"The only other real change expected is a regulation from the Internal Revenue Service," Hurley said. "It will attempt to prevent abuse on 529 plans for purposes other than college use."

Directed by the PPA, the Treasury Department has been charged with possibly creating restrictions or penalties for those who misuse the original educational intent of 529 plans.

"I think they're getting on it," Hurley said. "But they've been trying to come up with regulations now for eight years, and they haven't been able to do it. I think now there's a sense of urgency, because the law specifically tells them you have to come up with these regulations."

That concern might come to the forefront sooner, rather than later, according to James Canup, a partner with Troutman Sanders LLP, a Richmond, Va.-based firm. He said that both those in the Treasury and on Capitol Hill are keeping a close eye on the matter. "If there are changes in regulations, it will be to make sure that when someone puts money into an account, it will only be for that beneficiary and to confirm that this will be used for college savings," he said.

Canup, who is also chair of the College Savings Plan Network's Corporate Affiliate Advisory Board, said that after the Pension Protection Act went into effect, investments in 529 plans jumped to more than $90 billion. With the help of the new law, and the minimum amount of money required to open and maintain accounts decreasing, Canup predicted $100 billion in assets by January 2007.

Kantrowitz, through his FinAid site, projected that there will be upwards of $250 billion invested in 10 to 15 million 529 savings plan accounts by 2010.

"The big thing is the federal tax permanency, that's obviously critical," said Chris Hunter, program manager for the National Association of State Treasurers. "Recent trends indicate states and programs looking to lower underlying mutual fund fees and program management fees. Hopefully that trend will continue."

At press time, the Senate Finance Committee had scheduled hearings in December to examine incentives and exemptions for higher education. Hunter said that he didn't anticipate the discussions affecting 529 plans directly, but instead would look at how families are participating in higher education. Most states, he said, are looking to increase participation by families in the middle- to low-income range.

Fred Amrein, of Amrein Financial in Wynnewood, Pa., said that advisors need to encourage their clients to be more pro-active and learn the different options available to them. Keeping in mind the state in which an investor lives is critical, because it will dictate the state income tax advantage and how other state plans can be used. "Only a few states prior to 2006 had state tax incentives," he said. "Both advisors and people investing need to understand what's available in their state and the tax ramifications."

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