Section 529 of the Internal Revenue Code authorizes individual states to establish programs to help people save for future college expenses. Each State program permits tax-favored contributions to be made on behalf of a student beneficiary for higher education expenses, including tuition, room, board and related costs. Contributions are typically invested in a variety of equity and bond mutual funds, depending on the amount of time until the student is expected to attend college.
Withdrawals from Section 529 accounts for qualified higher education expenses are free from federal income tax. States typically provide tax-free treatment for withdrawals as well, and some even offer a limited tax deduction for contributions made to a Section 529 account.
All states offer Section 529 plans in which investments can be made directly with a mutual fund and without a sales load or other commission expenses. At least 35 states also offer Section 529 plans through broker-dealers and financial advisors, in which sales loads and other fees are charged to the account.
In the wake of the recent financial crisis, several large broker-dealers are trying to convert individual Section 529 accounts onto their own recordkeeping systems--through a process called omnibus accounting--for the purpose of extracting additional fees from mutual funds and investors. This is being done currently in the Virginia College Savings Plan and is expected to spread to other state Section 529 plans.
This conversion to a new recordkeeping system is being done without any competitive bidding process within individual states, as these broker-dealers possess leverage to charge fees that are higher than those set through normal market forces. This broker-dealer initiative is also less efficient than the current system and will cause operational costs to rise for investors in these broker-sold plans.
CMFI is in the process of educating State 529 Plans about the problems being created by the use of omnibus accounting in these programs. CMFI is encouraging State 529 programs to: (1) use competitive bidding to select recordkeeping vendors; (2) ensure that any savings through improvements in operational efficiencies are passed along to Section 529 investors and beneficiaries; and (3) require full transparency of investor-level information for State program managers, on a real-time basis.
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