Disclosure push imperils some plans

The mutual fund industry is demanding certain disclosures that could make it tougher to sell out-of-state 529 college savings plans.

The Investment Company Institute recently sent a letter to the Municipal Securities Rulemaking Board in Alexandria, Va., asking it to require all broker-dealers that sell 529s to disclose in writing the state tax consequences of such investments.

The mutual fund trade group notes in the letter that some investors may be buying into out-of-state 529 plans without knowing that their home state’s plan provides tax breaks for its residents.

“Without question, the tax issue should be a piece of information that goes into the consumer’s decision-making process,” says Bob Shipley, president and CEO of 529 Solutions, a Raleigh, N.C., firm specializing in the plans.

missing out

Of the 43 states with Section 529 plans in place, 23 offer tax deductions on contributions to such plans.

And 36 states provide a state tax exemption on withdrawals. Arizona, Colorado and New Jersey exempt withdrawals even from out-of-state plans.

Under a federal law enacted last June, all plans allow withdrawals for qualified college expenses – such as tuition, room and board, and books – to be exempt from federal taxation.

But with so many plans to choose from – eight states sponsor more than one plan – and advisers steering investors into plans that they get a commission for selling, the chance for investors to miss out on state tax benefits exists.

“As these plans started getting more popular, we realized that this area is one where investors would benefit from improved disclosure of the tax situations,” explains Chris Wloszczyna, a spokesman for the ICI.

The 529 plans, established in 1996 by Congress as part of the Internal Revenue Code, are trusts created by states. That means municipalities control the trusts.

The Securities and Exchange Commission and the Municipal Securities Rulemaking Board have concluded that 529 plans involve the sale of municipal fund securities, which means that the board’s rules govern plan sales.

“If you look at traditional municipal securities, which don’t have the same disclosure [requirements], the investors are sophisticated,” says Mr. Wloszczyna.

“That’s not necessarily the case with 529 plans,” he says. “The average investor, the folks who are saving for their children’s or grandchildren’s college education, would benefit from this kind of disclosure.”

Disclosure

The ICI’s letter includes two disclosure examples used by its members, one of which reads, “Some states offer favorable tax treatment to their residents only if they invest in the state’s own plan. You should consult with your tax adviser about any state or local taxes.”

But whether the rulemaking board would push for the ICI’s proposal is another question.

“It’s harder to get that kind of rule through the MSRB than if it had to go through the SEC,” says Mercer Bullard, chief executive of Fund Democracy LLC in Chevy Chase, Md.

“They don’t operate the same way. It’s unclear what will happen in this case.”

Calls to the rule-making board were not returned.

Mr. Bullard suggests that states take it upon themselves to prevent other states from selling on their turf – without making investors aware of the tax treatment.

“This is essentially a disclosure that would help the home state,” says Mr. Bullard. “For instance, why doesn’t Maryland already say, `You can’t sell a 529 plan here if you don’t point out the advantages to the in-state plan?”‘

Mr. Shipley warns, though, that home-state tax treatment should be just one factor taken into consideration.

“The value of the [tax treatment] can be overweighted easily,” Mr. Shipley says.

“If that information is presented in such a way that the consumer then believes that it’s so important that it should be the principal deciding factor,” he says, “that would be a disservice to customers also.”