By Kaye A. Thomas
Current as of December 17, 2014
Beginning in 2015 you can change your 529 account investments twice a year.
You can change your IRA investments any time you want. If you have a 401k account, chances are you have similar freedom, although employers are permitted to impose some restrictions on frequency of changes. Yet the college savings plans known as 529 accounts impose strict limits on how often you can change your investments. Initially, no changes at all were permitted. Then the IRS said once a year would be okay. As of 2015 you can rearrange the portfolio twice a year.
The peculiar restrictions on changing investments in 529 accounts derive from the peculiar history of these accounts. Unlike IRAs, Coverdell accounts and HSAs, 529 accounts were not initially created by Congress. They came in through the back door, so to speak, through a creative interpretation of law in which contributed funds were considered owned by the state that sponsored the program, rather than by the person who made the contribution or the named beneficiary. States don’t pay tax on their investment earnings, so this approach allowed the program to treat investment earnings as nontaxable. Giving contributors complete control over how the money was invested would have weakened the argument that the state should be treated as the owner of the funds. Congress decided to create a section of the tax law to govern these accounts after they were already in existence, and built the investment restriction into the law.
The initial version of the law prohibited any investment direction by a contributor to, or beneficiary under, a 529 account. This rule, freezing in cement whatever choices you made when setting up the account, was so awkward that the IRS decided to offer relief, issuing a notice in 2001 that permitted one change in investments per year. (They also permit a change in investments any time you change the account’s beneficiary.) In 2009, in the midst of the turmoil created by the stock market meltdown, the IRS said that for that year only, two changes would be permitted.
Neither of these permissions granted by the IRS were in any way authorized by the statute, which continued to have a flat-out prohibition on investment direction by contributors or beneficiaries.
Change as of 2015
In the last gasp of the 2014 lame duck session, Congress passed a law that included the creation of ABLE accounts for disabled beneficiaries. Although not restricted to educational purposes, ABLE accounts are similar to 529 accounts in various ways. Seemingly as an afterthought, a provision changing the investment direction rule for 529 accounts was tucked into the legislation. As of 2015, the rule permits a change in investments “no more than 2 times in any calendar year.” Presumably the IRS will continue to treat a change of beneficiary as a distinct occasion for permitting a change in investments.
Comment: While some account owners may wish for a further loosening of this restriction, you’re more likely to doing harm than good if you make changes more than twice a year.