Great, But Not Perfect

Although most advisors think the positives of 529 savings plans overwhelmingly outweigh the negatives, they add that clients need to consider the limitations and how they affect their own situations.

"I was very much on the fence when they first came out, but I'm starting to swing around. But you need to know the person's financial-aid situation and make sure it isn't affected in a draconian way," says Kathleen Dollard, president of Nashoba Financial Planning in Boxborough, Mass. She recently opened an account for her 16-year-old son and soon plans to open one for her other son, who is 14.

For federal financial-aid calculations, assets in 529 savings plans belong to the account holder rather than to the student. Parents' assets don't weigh as heavily into those calculations as assets belonging to students. Still, Dollard says, private colleges that give their own financial-aid awards could treat 529 assets as the child's when doing their own calculations. She and other advisors agree it's important to do financial-aid estimates for clients to see what the impact of various savings options are. "Someone with over $100,000 in income with one or two kids won't qualify for a lot of financial aid anyway. But if you have three kids in college at the same time, that would make a difference. You really need to run the numbers," Dollard says. In some cases, she says, the tax benefits gained from a 529 plan may be outweighed by the loss in financial aid.

Still, Miller comments, savings in a 529 plan will affect financial aid less than savings in custodial accounts, which are treated as the child's assets in financial-aid calculations. She that adds the parents' adjusted gross income affects financial-aid awards much more dramatically than assets.

Hurley says one criticism of 529 savings plans that often comes up is that federal requirements don't allow participants to direct their investments. Participants can choose investment tracks, such as aggressive, moderate or conservative, and many plans offer options that adjust the mix of equities and fixed-income investments to make the portfolio more conservative as the child gets closer to college age. Still, account owners can't pick or adjust the individual stocks, bonds or other investments that are part of the portfolio. "They want the state to be responsible for investment decisions. It's a stupid rule ... They just see it as a program that's on the shoulders of the states to make college investment decisions for beneficiaries. But like I say, I don't see any good reason for it," Hurley says.

Klane sees an issue for account owners when earnings are withdrawn. "When the earnings come out, even though they are taxed at the student's rate, the client is probably going to have to pay those taxes because the student is not earning any money. The tax liability has to be accounted for, and the parents will probably have to gift the tax to the child," Klane says.

Christie believes 529 plans would be even better if changes were made in federal law so companies would want to offer them to their employees. "I would like to see, down the road, a change in the tax code to make 529 plans similar to 401(k)s," he says, with contributions permitted pretax and employers making matches through vesting programs. But the way the law is written now, it's difficult to make employer-sponsored plans attractive. "Now, with an employer plan, you'd get the tax deferral on the gains, but the entire amount paid out would be taxable as income to the employee, and gains would still be taxable to the beneficiary," he says. Such employer-sponsored plans haven't been tested yet, but they don't seem as though they'd be very beneficial, he adds.

Other glitches might become apparent after the plans are around a little longer. For example, since the plans are so new, most account holders don't know how the withdrawal rules will work for them in practice.

Evaluating Plans