Mutual Fund Scandals
and 529 College Savings Plans

The last quarter of 2003 saw a flurry of activity by state attorney generals seeking to unravel improprieties in the mutual fund marketplace. Since 529 College Savings Plans are often managed by mutual fund complexes, the scandal has trickled down to impact the investor saving funds in a 529 College Savings Plan.

The charges which are currently being investigated relate to market timing of mutual fund trades by hedge funds and late day trading by other mutual fund investors giving them an advantage over the average investor. As these allegations are investigated, the various state treasurers that entered into contracts with these mutual fund complexes managing their 529 Plans have raised concern.

As a direct result of these scandals, several states have taken steps to terminate contracts with an accused mutual fund company, or in the alternative have taken steps to add other mutual fund options to their existing program. Some others have begun to develop new programs within the state. While many states have a single provider for their state's 529 College Savings Plan the governing federal law does not require that there be only one provider. In fact, several states have multiple 529 Plan providers within the state.

Unlike the average mutual fund investor who upon hearing bad news might choose to liquidate a mutual fund position to escape the fall out of the scandal, the 529 College Savings Plan investor does not have that level of flexibility.

Remember that you can only switch your 529 Plan from one plan to another one time every 12 months. For this reason, if you have already made a switch in the past 12 months you cannot do so again without incurring a penalty tax.

One strategy that is available is to change the beneficiary on the current 529 College Savings Plan to another family member and then make the switch to a different 529 Plan. After switching to another 529 Plan, you can name the original beneficiary as the beneficiary on the account.

Experts in the industry have concluded that the effect of the mutual fund improprieties will have little to no effect on the average consumer investing in a 529 College Savings Plan. Since many of the accusations focus on market timing and inappropriate trades by hedge funds, it is expected that very few of the investments in a 529 College Savings Plan portfolio will be directly affected by the specific wrongdoing.

Nonetheless, the reputation of a number of mutual fund companies will be tarnished, and as such, investors may move assets to other fund companies. The trickle down effect may be that these accused fund companies have a difficult time administering their programs thereby increasing fees and expenses to keep the plans operating.

It is far too early to determine what the actual fall out from this scandal will be, however, the 529 College Savings Plan investor should not take quick steps to move assets out of a 529 Plan if moving the Plan will incur a penalty tax, ordinary income tax, or other state based penalty for moving the plan.

With the benefit of additional time, the industry will determine the extent of the wrongdoing and the steps to be taken to make investors whole. Since saving for college is a long-term proposition, we should be cautious to take short-term steps that may cause us more harm in the long run then good.

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