More states consolidate on 529 college savings plans

ByABC News
February 24, 2008, 2:38 PM

— -- As families strive to save money for college, several small states are dumping their 529 college-savings plans and urging the investors to roll their money over to other states' lower-cost plans.

Investors can use any state's 529 plan and later pull out all the funds, federal tax-free, for college costs. But many invest in their own state's plan for state tax breaks and convenience.

Tennessee is closing its 529 savings plan this year because of lackluster demand. Investors can roll their money over to any state's plan, but Tennessee is recommending that they consider Georgia's much larger 529 plan. Both plans are managed by TIAA-CREF.

The move follows the closing two years ago of Wyoming's plan; Wyoming now encourages its residents to consider a 529 plan sponsored by Colorado. Mississippi may be next. It says it's "considering options" such as partnering with Georgia to offer a 529 plan. Georgia says it's also talking to a few other small states about rolling over assets to its plan.

States say that by shutting unpopular 529s, they can partner with bigger states to give families more cost-effective savings options. "We don't have the economies of scale to have a program with low fees and a wide range of investment choices," says Steve Curry, assistant to the Tennessee state treasurer.

The drawback, college financing experts say, is that investors might be tempted to pull their savings out, rather than roll it over to another plan. When Wyoming's plan closed in 2006, only 17% of 529 accounts rolled over to the Colorado option, according to state data. It's unclear whether most investors moved their money to other states' plans or withdrew it altogether. Those who use 529 money for purposes other than higher education face income tax and a 10% penalty on the earnings.

There's also the danger that some investors will take states' advice blindly shifting into the 529 plan that's pitched to them once their own state plan closes without researching other, possibly more attractive, options, says Kalman Chany, a financial-aid consultant.