June 12, 2007 Mr. Michael J. Desmond
Tax Legislative Counsel
U.S. Department of the Treasury
Room 3040 MT
1500 Pennsylvania Avenue, NW
Washington, DC 20220 Re: Proposed Regulations Regarding 529 Plans Dear Mr. Desmond: The Investment Company Institute1 ("ICI") and the Securities Industry and Financial Markets Association2 ("SIFMA") submit these comments pursuant to our continuing dialogue with the Treasury Department regarding guidance for qualified tuition programs ("529 Plans"). As you know, our discussions have focused on (i) Treasury Department concerns that 529 Plans may be used in certain situations for non-college-savings purposes and (ii) industry requests for guidance that clarifies and enhances the use of 529 Plans for college savings. We appreciate our many opportunities to meet with you and others at the Department to discuss these issues and how they might be addressed in proposed regulations. SIFMA and the ICI strongly support 529 Plans and the opportunities they provide to families saving for college. While we are not aware of specific situations in which taxpayers are misusing 529 Plans, we acknowledge the concerns raised by Treasury Department officials that the existing regime for 529 Plans does not fully foreclose this possibility. Current account balances suggest, however, that the vast majority (or more) of 529 Plan account owners are saving for college through these plans. Specifically, as of December 31, 2006, the average account balance in 529 Plans was $12,500, which is well below the cost of a college education (and even further below the contribution limits of any state program). Any proposal for addressing concerns regarding the potential misuse of 529 Plans should be administrable and not discourage the Congressionally-envisioned use of 529 Plans for enhancing college savings and expanding opportunities for a college education. Certain proposals included in the FY 2007 President's Budget (e.g., excise taxes or additional penalties on nonqualified distributions) would do far more to discourage appropriate saving through 529 Plans than to prevent potential abuses. For these reasons, we have opposed these proposals. Likewise, we have opposed proposals (i) to require program managers or distributors to assume significant new administrative burdens (e.g., coordinating recordkeeping and reporting across state plans) or (ii) to shift to program managers or distributors responsibilities best borne by taxpayers. If new rules are needed, we may recommend that some or all of these new rules apply only to accounts established after the effective date of such changes. We also urge you to consider differences between savings plans and prepaid plans when drafting proposed regulations. A broad application of the same provisions to all qualified tuition plans will not be appropriate in many circumstances. For example, a requirement that a plan report annually to the IRS market value account information may not be administrable by a prepaid plan, which does not pay earnings to account holders. A national cap on contributions may not be necessary for prepaid plans, or may require special rules if applied to such plans. Proposed regulations may require some clarifications to address issues specific to prepaid plans. Table of Contents
 529 Plan Enhancements to Encourage College Savings
Effective Date
Comments Regarding Specific Proposals
529 Plan Enhancements to Encourage College Savings
We continue to encourage the Treasury Department to issue guidance that expands and encourages the use of 529 Plans for college savings. We appreciate the helpful guidance, issued five years ago, providing that investment direction restrictions are not violated if the plan permits a change in investment strategy for a 529 Plan account once per calendar year and upon a change in the account's designated beneficiary.3 As we have discussed previously, we support guidance that would expand this relief, consistent with opportunities available to other investment vehicles, by permitting more frequent changes in investment strategy. We believe that 529 investors can be subject to greater risks than other types of investors because they do not have the same ability to adjust to changes in market conditions. Allowing more frequent investment changes may help 529 Plan investors take advantage of new investment offerings as they become available, rebalance their accounts to maintain a desired asset allocation or react to other types of changes in the market or personal circumstances. Proposed regulations should modify existing rules that impose generation skipping transfer taxes on a prior beneficiary when the account owner changes the beneficiary to someone two or more generations younger than the generation of the prior beneficiary. Since the prior beneficiary typically has no control over the decision to change beneficiaries, any tax liability associated with such a change should be imposed on the person who requests the change, typically the account owner. Proposed regulations should clarify the definition of the term "disabled." Current law permits 529 plan earnings to be withdrawn without penalty if the beneficiary is disabled; the definition of "disabled " in this context is unclear. Plans trying to advise account holders may look to definitions of "disabled" in other federal tax provisions or other federal regulations (e.g., rules related to Social Security administration). These rules typically define "disabled" in terms of employability or terminal or sustained illness to show eligibility for health or other benefits. These types of definitions do not translate easily to 529 Plan rules. Proposed regulations should define "disabled" in a manner that reasonably relates to the purposes of the penalty-free withdrawal exceptions. We also urge Treasury not to adopt rules that discourage the use of 529 plans for college savings. For example, proposed regulations should not impose age limits on beneficiaries. Many adults enter or return to college to gain additional skills, which they need to change careers or to remain competitive in their existing careers. We also suggest that regulations clarify that 529 Plans can be established by account owners who are not U.S. citizens on behalf of children who are U.S. citizens. These types of uses of 529 Plans are non-abusive and consistent with Congressional goals. Effective Date
The proposed regulations should provide an effective date that gives program managers sufficient time to implement the new rules and make required changes to their systems. Budget considerations also may impact the time needed to modify systems, since programs' annual budgets may not have sufficient funds allotted to cover unanticipated systems costs. We may have more specific comments regarding effective dates after proposed regulations are issued. Comments Regarding Specific Proposals
The remainder of this letter provides our specific comments on suggestions for 529 Plan guidance that recently were made to the Treasury Department. As always, we would be pleased to meet with you and others at the Department to discuss these comments further. (1) Limitation on Account Owner Changes. This proposal would limit the circumstances in which the account owner can be changed, e.g., (i) between spouses, (ii) pursuant to a valid court order, (iii) if the account owner is disabled or incapacitated, (iv) for scholarship accounts or state-sponsored matching grant programs, (v) for UGMA and UTMA accounts and (vi) from non-individual (e.g., corporate, scholarship or trust accounts) to individual account owners and vice versa. We generally support this proposal, provided that it is administered by requiring a certification from the account owner that any account owner changes will comply with disclosed limitations. Further, flexibility is needed in obtaining the certification, i.e., as part of the application process. Program managers and distributors should not be required to monitor compliance with this rule, since they often will not possess the necessary information to evaluate or ensure compliance. (2) Limit Beneficiary Changes to Once Per 12-Month Period. This proposal would limit the account owner's ability to change beneficiaries to once per 12-month period. We urge Treasury not to adopt this rule. Section 529(c)(3)(C) currently discourages beneficiary changes to non-family members by making such changes taxable events. The proposed 12-month limitation is not needed to prevent unintended use of 529 Plans, would require additional systems changes, and unnecessarily restricts an account owner's ability to change beneficiaries among family members. (3) Contributions from Non-Account Owners are Completed Gifts to Account Owners. This proposal would treat contributions to an account from a person other than the account owner as a completed gift to the account owner. While it is not clear that statutory authority exists for Treasury to include this proposal in regulations, if such authority does exist we strongly urge the inclusion of a de minimis exception. It is common for third parties to make small contributions to 529 Plan accounts on behalf of beneficiaries for birthdays or other events. It also is not unusual for grandparents who do not wish to assume the burden of managing a 529 Plan account to make gifts to accounts already established for their grandchildren. Any proposed gifting rule should include a de minimis exception to accommodate these types of contributions, which are not abusive and encourage education savings. If Treasury adopts this rule, the regulations may need to clarify the potential tax consequences to the account owner. Implementing this rule also may require program managers to make changes to systems and operational procedures. (4) All Rollovers Must be Plan-to-Plan. This proposal would eliminate indirect rollovers (distributions to the account owner followed within a specified time period by the account owner's contribution of all or part of the distributed amount to a new account). Instead, all rollovers would be required to be plan-to-plan transfers. This proposed rule does not appear necessary to prevent abuse and would be stricter than the rollover rules applicable to other savings vehicles. When amounts are distributed, the 529 Plan must report the distribution to the IRS and the account owner must certify that distributions have been used for qualified educational purposes. There are circumstances (e.g., termination of a program) when an account owner receives a distribution and needs time to investigate alternative savings programs. We urge Treasury to continue to provide 529 Plan account owners with the same 60-day period available to other savings vehicles to determine what to do with distribution proceeds. To the extent that the existing rules are insufficient, reporting of contributions to the Internal Revenue Service ("IRS") should provide the information needed to determine if unusual activity is occurring in accounts. We previously proposed that 529 Plans report contributions to the IRS on Form 5498. This is similar to the type of reporting currently done for Coverdell accounts and IRAs. (5) Uniform Cap on Account Contributions. This proposal would establish a national contribution cap (based on market value) per beneficiary across all 529 plans held nationwide. While we support considering a national contribution cap instead of more draconian rules such as excise taxes and penalties, this proposal, if adopted, should not impose inadministrable tracking and other requirements on program managers. For example, it would be impossible for program managers to track a national cap across state plans. We also recommend assuming a five-year instead of a four-year curriculum in calculating the cap; this calculation allows additional savings for certain types of undergraduate programs and/or some graduate education. Proposed regulations should be administrable and not impose enforcement obligations on program managers. Account owners will have information regarding their own investments; they cannot be expected to know about other accounts established for the same beneficiary. This proposal potentially raises a number of operational issues, depending on how a provision is ultimately drafted. We will provide more detailed comments if and when this proposal is included in regulations. (6) Contribution Reporting to the IRS. This proposal would require each 529 Plan to report annually to the IRS (market value) account information by account owner and beneficiary. We generally support this proposal. We may have additional comments regarding the definition of "market value" if 529 Plans are required to report annually the market value of accounts. We also may have comments regarding implementing this proposal, since it would impose additional costs on program managers and require systems changes. (7) Form 1099-Q Should Always Be Issued to the Account Owner. This proposal would require that the Form 1099-Q always be issued to the account owner, regardless of who receives an account distribution. While we generally support consistent reporting, there are certain situations where it is better to issue a Form 1099-Q to the beneficiary. For example, nonqualified distributions may be made to a beneficiary for expenses related to post-secondary education, such as off-campus room and board. Proceeds may be distributed to beneficiaries who don't need funds for education because they have received a scholarship. Beneficiaries should be responsible for documenting and paying tax on withdrawals later determined to be nonqualified in situations where the beneficiary received the distribution or controlled how it was used (e.g., withdrawing from a class prior to the end of a semester). It may not be appropriate to impose potential tax penalties and recordkeeping burdens on account owners in these types of situations. Issuing Form 1099-Q to account owners, who view proceeds as a completed gift to a beneficiary, may discourage investments in 529 Plans. If contribution reporting to account owners is required by regulations, we may urge the adoption of exceptions. (8) Remove Requirement for Aggregation of Distributions. This proposal would eliminate language in existing proposed regulations that appears to require programs to aggregate earnings across all savings accounts in the same state program. We generally agree with this proposal; aggregation is not needed to prevent abuse now that EGTRRA's tax-free treatment of qualified distributions has been made permanent. This rule also is costly to administer in states with multiple program managers. The rule should clarify that aggregation is permitted, but not required. (9) Clarify That Computers Are Required for College Enrollment or Attendance. This proposal would expand the definition of "qualified higher education expenses" to include computers even if the selected educational institution does not expressly require the purchase of a computer. We support this proposal and believe that "qualified higher education expenses" also should include expenses permitted by the rules governing Coverdell accounts, e.g., computer technology, Internet access, and transportation. The regulations should provide clear definitions so that program managers can administer these rules. (10) Confirm that 529 Plan Administrators Are Required to Obtain Account Owner and Beneficiary Social Security Numbers. This proposal would clarify that 529 Plans are required to obtain both account owner and beneficiary social security numbers. This rule, which is intended to address privacy concerns, should clarify that although social security information is required, 529 Plan administrators may obtain such information at times other than when an account is established. This clarification is necessary because many account owners open accounts for newborn children who do not yet have social security numbers. The regulations also should clarify that obtaining tax identification numbers is acceptable if the account owner is not an individual. ICI and SIFMA are committed to ensuring that 529 Plans are administered in a manner that complies with tax laws and promotes college savings. We look forward to seeing proposed regulations and working with Treasury to finalize guidance. Sincerely, Lisa Robinson
Associate Counsel
Investment Company Institute Liz Varley
Vice President for Retirement Policy
Securities Industry and Financial Markets Association cc: Susan Brown
Cathy Hughes
ENDNOTES1 ICI members include 8,781 open-end investment companies (mutual funds), 665 closed-end investment companies, 428 exchange-traded funds, and four sponsors of unit investment trusts. Mutual fund members of ICI have total assets of approximately $10.917 trillion (representing 98 percent of all assets of U.S. mutual funds); these funds serve approximately 93.9 million shareholders in more than 53.8 million households. 2 The Securities Industry and Financial Markets Association brings together the shared interests of more than 650 securities firms, banks and asset managers locally and globally through offices in New York, Washington DC, and London. Its associated firm, the Asia Securities Industry and Financial Markets Association, is based in Hong Kong. SIFMA's mission is to champion policies and practices that benefit investors and issuers, expand and perfect global capitals markets, and foster the development of new products and services. Fundamental to achieving this mission is earning, inspiring and upholding the public's trust in the industry and the markets. (More information about SIFMA is available at http://www.sifma.org.) 3 Notice 2001-55, 2001-2 C.B. 299.
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