The Obama administration's Middle Class Task Force held a press conference on Sept. 9 to highlight some of its findings and goals to expand education and lifelong training opportunities. Making Section 529 college savings plans more accessible, effective and reliable for the middle class is one way the task force proposes to expand higher education opportunities. At the Sept. 9 press conference, the task force released a report that assessed the effectiveness of the current 529 program and provides recommendations to better accomplish the administration's goals.

Section 529 plans are an attractive and convenient means of saving for college because they can be easy to set up, require minimal initial investments, and the tax benefits can be substantial, according to the report. Existing tax benefits can increase the effectiveness of saving by between 6 percent and 39 percent depending on the marginal tax rates of the saver, the length of the savings period, and whether there is a state deduction or credit for contributions.

While Section 529 plans offer tax benefits to any family with sufficient income to pay federal income tax, they are of greater benefit to high income families whose tax rates tend to be higher, the report found. This tax advantage is likely part of the reason why Section 529 account balances tend to increase disproportionately with increases in income. Because the most effective way to help low income families with college expenses is through direct student aid, and Section 529 plans are targeted to higher income families, the report focuses on making Section 529 plans more accessible, effective and reliable for the middle class.

This report makes five recommendations that the Obama administration encourages states and others to consider implementing to make Section 529 savings plans more attractive, effective and reliable for middle class families, and those who aspire to join the middle class through college attendance.

Recommendation 1

Provision of Age-Based Index Funds. Section 529 savings plans tend to offer a wide array of investment options that accommodate a variety of families' tastes for risk and expected return. The most popular option, and one that is well suited to the circumstances of many families, is an age-based fund that automatically sheds equities and adds fixed income assets as the beneficiary approaches college age. Yet five of the 48 states offering a direct sold savings plans do not offer an age-based fund. Equally troubling is the fact that only 23 of the 43 states that do offer an age-based fund offer it in the form of index funds. Historically, index funds have performed well relative to actively managed funds because they have low fees, and they are especially well suited to investors who do not wish to spend time acquiring information and evaluating the investment philosophy and track records of actively managed funds.

Recommendation 2

Eliminate Home-State Bias. There is widespread agreement that Section 529 fees have declined substantially in recent years, and that increased plan competition is in large part responsible. Yet there remains surprisingly large variance in fees assessed for similar age-based index funds offered by the 24 plans across 23 states, suggesting that inter-plan competition is far from perfect. While the index funds analyzed do not all share the same asset composition targets, and hence should not be expected to have precisely the same fees, fees appear to be higher than necessary in at least some states.

A potentially important hindrance to inter-plan competition is home-state bias in state tax policies. Currently 34 of the 42 states that both have an income tax and sponsor Section 529 savings plans offer either a deduction or a credit for contributions to their own Section 529 plan, but only five of those states -- Arizona, Kansas, Maine, Missouri, and Pennsylvania -- offer a deduction for contributions to Section 529 plans administered by other states. In addition, 13 states exclude all or some Section 529 account balances from assets for purposes of calculating eligibility for state student financial aid, but none of those states offer a similar exclusion for the Section 529 account balances held in the plans of other states. As a result of this home-state bias, families have strong incentives to choose their home state plan even if other plans offer preferable investment choices. Some families may be deterred from even investigating other plans under the possibly false assumption that the state tax benefits of choosing the home plan necessarily outweigh any possible advantages other plans might offer. If these barriers to competition were eliminated -- as they are currently in five states -- the result would be more investment options for consumers, more intense competition between plans, and probably better service and lower fees for many customers.

Recommendation 3

Per Beneficiary Contribution Limits. Currently there are effectively no limits on Section 529 account balances. States offering savings plans refuse contributions to accounts once the account balance exceeds a dollar limit that varies between $224,465 and $368,600, and averages $291,000. Because 43 states offer plans open to residents in other states, however, a beneficiary can have accounts in as many as 44 states, each state with a limit exceeding $224,465. Putting a true limit on Section 529 contributions requires making the limits per beneficiary rather than per beneficiary per state. Per beneficiary limits would reduce the tax benefits to high income families and, by lowering federal tax expenditures for the program, would potentially free up federal resources for education aid better targeted to low and middle income families. Per beneficiary limits would best be enforced at the time distributions are made. Specifically, each distribution for a particular beneficiary's qualified educational expenses would be divided into a principle portion counting against the contribution limit and an earnings portion. At such time as a beneficiary reaches the contribution limit, distributions would be nonqualified and subject to penalty.

Recommendation 4

Improved Transparency. The College Savings Plan Network (CSPN) has done a valuable service by collecting information on Section 529 savings plans and making it available in a convenient form on the Internet. However, because there is no established format for reporting historical investment returns for the various investment options, CSPN can only offer links to historical return data for the various plans. It would be a great help to investors if a standard reporting format were developed and the information was available directly on the CSPN web site. Also, there is little information currently available on how Section 529 plan participation varies with income, on the distribution of annual contributions and account balances, and on how Section 529 plans are invested at the account level. Such information would help policymakers. To help fill this gap, Treasury worked with the CSPN and the College Savings Foundation to devise a survey questionnaire. Treasury will analyze these data when they become available and share further findings with relevant policymakers.

Recommendation 5

Improved Monitoring and Compliance. Section 529 accounts are still relatively new. To reduce the potential for abuse, Congress and the states should work together to strengthen compliance and monitoring of Section 529 accounts and their disbursements.

Posted 09/28/09 to www.NASFAA.org. Redistribution to non-NASFAA institutions is prohibited. Please submit Web site questions or comments to Web@NASFAA.org.