Out-of-state 529 college savings plans may have pitfalls
By Michelle Singletary
NASD announced recently that it has ordered Minneapolis-based Ameriprise Financial, formerly American Express Financial Advisors, to pay a fine of $500,000 for failing to adequately supervise the firm's sales of Section 529 college savings plans.
In addition NASD, the private-sector regulator of the securities industry, ordered the firm to pay about $750,000 to compensate more than 500 customers whose accounts were "disadvantaged by those supervisory failures."
So why exactly was Ameriprise fined? First, you have to understand what a 529 plan is and why it pays to know whether your state provides a tax-advantaged reason to sign up with its plan.
There are actually two types of 529 plans:
Although the 529 plans are sponsored by states, you can invest in any plan regardless of where you live. For instance, if you live in California you can invest in a 529 plan in Illinois or Wisconsin if you like.
There are varying tax incentives for residents of 26 states and the District of Columbia, NASD points out. For example, a resident of New York state who invests in its 529 savings plan can get a state income tax deduction of up to $5,000 — or $10,000 for married couples filing jointly. (Hawai'i doesn't offer a state income tax deduction for investing in its 529 plan.)
In states with the incentives, it might turn out that the tax break isn't worth it when compared with the high expenses or poor performance of the individual state's savings plan.
Still, investors ought to be told about the benefit, and it was a failure of Ameriprise to properly advise customers of state tax breaks that riled the NASD.
From May 2001 through October 2003, approximately half of the states offered tax benefits to residents who purchased an in-state plan. During the same period, however, NASD found that Ameriprise offered and sold only one 529 plan — a plan sponsored by the state of Wisconsin.
How could that one plan be appropriate for all their customers?
Well, NASD didn't think it was.
Approximately 32 percent of Ameriprise's sales — more than $200 million — were to customers who lived in one of the tax-advantaged 529-plan states.
Investors in five of those states — New Mexico, South Carolina, Illinois, Colorado and West Virginia — could have received unlimited state income tax deductions for investments in their home state's 529 plans.
NASD said Ameriprise didn't have adequate procedures in place to take state income tax benefits into account when determining the suitability of 529 sales to its customers.
In settling with NASD, Ameriprise neither admitted nor denied the allegations. "We are pleased to have resolved this matter and we have modified our procedures with respect to 529 plans," said David Kanihan, a spokesman for Ameriprise. The company now sells nine different 529 plans.
There are a number of online tools to help you choose a college savings plan:
