Financial Update (First Quarter 2003)



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Section 529 College Savings Plans: A Good Choice for Investors?

Changes in the U.S. tax code have brought Section 529 plans to the forefront of investment vehicles for college savings. Not surprisingly, the number of investors using Section 529 plans and the amounts invested in them have grown rapidly; about $25 billion flowed into such plans in 2002, and that figure is expected to balloon to $200 billion by 2007. But are these plans a wise choice?


Recent tax law changes have magnified the importance of Section 529 plans, and their appeal is now much greater.


Previous research concluded that the prespecified asset allocations used by many Section 529 college savings plans can make them poor options for most investors compared to some other investments. In Atlanta Fed Working Paper 2003-1, Ramon P. DeGennaro takes another look at the issue. He shows that even if the earlier finding was accurate at one time, it is true now only for a much smaller number of savers and for reasons other than those previously asserted. The earlier work could mislead investors and tend to deflect attention from investment options and strategies that would benefit many college savers.

DeGennaro's paper explores the important distinction between the decision to allocate funds to a Section 529 plan and the decision to allocate funds within the plan. Investors can widen their range of investment alternatives by selecting plans outside of their states of residence. Such choices can eliminate the potential problems that previous research has identified while retaining the tax advantages of college savings plans.

Recent tax law changes have magnified the importance of Section 529 plans, and their appeal is now much greater. For most investors, the plans are now fully tax-exempt at the federal level, and investment limits are typically much larger. Investors saving for college need to understand the implications of their choice of investment vehicle and of their portfolio choices.

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