From the people whose unrestrained appetite has brought billion-dollar deficits …. college plans for your children?
Today’s Wall Street Journal [paid registration required] carries a page one article on the way that states are changing the rules on 529 plans that parents use to save for their children’s college education. While it is an interesting story of feuding states, there’s a more serious philosophical problem that the article never mentions.
A little background, first. The 529 plan, like various forms of the IRA, is a tax-sheltered savings account. It’s meant to encourage people to save for college (usually for dependents). If money is withdrawn from the account for education-related expenses, there is no federal income tax liability. Many states offer similar benefits. The plans are administered by the states, which typically contract out the responsibility to a mutual fund company such as T. Rowe Price. They are attractive to families not only for the tax savings, but because they have high contribution limits–much higher than other tax-favored programs. Wealthy families, who are often not allowed to participate in other plans, can participate in 529s.
The Journal article, by Tom Lauricella, concerns the legal barriers that states are enacting to discourage parents from shifting their money from one state’s plan to another. New York, for example, now imposes taxes if the money is taken from New York and sent to another state’s plan. Some parents quoted in the article complain that states are not changing the rules in the middle of the game, and they are right. How can an investment be properly planned and executed if the rules surrounding the taxation of that investment be changing throughout its lifetime? (The federal income tax code–including the revisions that will be incorporated by the second Bush tax cut–is the supreme example of this chaos).
Are the states not playing nice, by changing the rules? Is Illinois, for example, being unfair imposing taxes on withdraws that it makes from 529 plans offered by other states? Yes. But even more troubling is the fact that Illinois, and each other other states, has 529 plans at all. There are plenty of financial firms willing and able to help parents save for their children’s expenses–usually the same firms that are running the state’s plans. Why should the states even be involved in this activity in the first place? If there is a legitimate policy need to expand the options for tax-sheltered savings, it should be pursued through reforming existing laws, such as lifting the income limits on Education IRAs.
The incentives are all wrong. The state of Virginia, for example, gets $2 million a year in overhead. The Treasurer of Illinois, under a contract with Citibank, gets to direct a significant marketing program for that state’s 529 plan. Her name must, by contract, appear in all advertising for the program, and she often appears in broadcast ads. Nothing to enhance one’s political career than to frequently appear in advertisements, paid for by someone else, that pitch a solution to a highly desired product (the ability to fund a child’s college education).