Tax Parity Isnt as Important for Investors as Once Thought

FINANCIAL PROFESSIONAL CONTENT What is tax parity? There was a fierce debate in the first decade of 529 plans around "tax parity," which is when a state allows residents to claim a tax incentive for contributions to any state's 529 plan. Every state has its own unique tax laws and treatments, but the idea was to give investors a "level playing field" when selecting their 529 plan. Being able to get the same tax benefit regardless of the 529 plan you select makes it that much easier for the investor to compare and choose the best fitting plan. It also reduces the burden on advisors, who typically have to complete an additional disclosure form in order for their clients to use an out-of-state plan. But, is tax parity really worth it? How have those states that have enacted tax parity laws fared? Has tax parity been good for investors? For advisors? For the industry? And why have discussions died down in the industry? Which states offer tax parity? Of over 30 states (including D.C.) that have a state tax benefit available, only seven have passed legislation allowing residents the same benefit regardless of which 529 plan the investor selects. These states include: Arizona (enacted 2007) Kansas (enacted 2006) Maine (enacted 2006, though the benefit lapsed at the end of 2015) Missouri (enacted 2008) Montana (enacted 2013) Pennsylvania (enacted 2006) Minnesota (enacted 2017) States that offer no state tax incentive or cannot since they have no income tax, making them de facto tax parity states, include: Alaska Maine North Carolina California Massachusetts South Dakota Delaware Tennessee Florida Nevada Texas Hawaii New Hampshire Washington Kentucky New Jersey Wyoming Why don't more states offer tax parity to their residents? In theory, a state that offers tax parity to its residents is allowing the investor complete freedom of choice without the bias of a state benefit. 529 plans are typically run by sub-contractors; investment managers or administrators that service and support the state plan(s). These contracts expire at varying lengths depending on the state. When that contract expires, the state sponsor needs to attract strong bids to continue to improve the plan for its constituents. The lack of an in-state tax benefit ï ¿ ½ though one of many factors ï ¿ ½ makes expiring plan mandates less desirable to potential bidders. As we saw most recently with Rhode Island, an attractive state mandate will attract more providers and results in a lower-cost plan with better investment options for constituents. It also brings more revenue, better advertising terms, and other benefits to the state sponsor (which trickles-down to residents). Basically, a more appealing plan leads to increased competition during bids, and better plans overall. Rhode Island was primarily desirable for its huge asset base (over $6.8 billion in AUM at the end of 2015). But tax benefits are another arrow in the quiver of the state sponsor to draw bidders, just as assets, population, demographics, etc. all contribute to the state mandate's desirability. RELATED: How much is your state's 529 plan tax deduction really worth? How tax parity states have fared versus non-parity states Tax parity states have, on average, gained more in terms of assets than non-parity states (includes those with no benefit). The overall 529 market has greater assets and accounts in states with tax benefits than those without. According to CSPN data, there were nearly 8.5 million accounts in states that had tax benefits available only to residents using the in-state plan, versus 4.2 million accounts in parity states. Tax parity states also had accumulated less in terms of total assets. Anecdotally, there is also much greater participation in the state plan by state residents when a tax incentive is offered than without. This is, of course, proportionate to the amount of the benefit. It would be challenging to find an advisor in Indiana that wasn't aware their state offered a credit for contributions to its plan, for example. There can also be significant ramifications in terms of the ability of tax parity states to compete. In their May 2016 "College Savings Nation 2016" report, regarding the recently shuttered Missouri Advisor plan AKF Consulting stated, "We suspect that termination of the Missouri Advisor may reflect the challenges presented by parity tax treatment for new 529 players (Deutsche assumed its role in the Missouri Advisor in 2011). When state tax benefits are the same regardless of which plan an investor chooses, new program managers may struggle against more established 529 managers that advisors already promote." Why tax parity is less important now Tax parity was a major issue in the 529 space until a decision was handed down in the case of Department of Revenue of Kentucky v. Davis. Keeping in mind that 529 plans are considered municipal securities, it was decided that a state could exempt the interest on its bonds from the taxable income of state residents and still tax the interest earned on the bonds of other states. This makes it highly unlikely for any given group of states to all agree to allow tax parity. Further, there is sometimes a financial incentive for certain states to keep 529 assets in-house. States that offer a tax deduction or credit can offset some of their lost revenue with revenue from the state plan in those states that charge a fee. Some states use 529 revenues for other programs such as scholarships, matching grants, education programs, and more, so it is in their best interest to grow their own plan. So while tax parity is still a nice benefit for investors in those states that offer it to their constituents, non-tax parity states are not necessarily doing a major disservice to their own residents. RELATED: State tax calculator FINANCIAL PROFESSIONAL CONTENT What is tax parity? There was a fierce debate in the first decade of 529 plans around "tax parity," which is when a state allows residents to claim a tax incentive for contributions to any state's 529 plan. Every state has its own unique tax laws and treatments, but the idea was to give investors a "level playing field" when selecting their 529 plan. Being able to get the same tax benefit regardless of the 529 plan you select makes it that much easier for the investor to compare and choose the best fitting plan. It also reduces the burden on advisors, who typically have to complete an additional disclosure form in order for their clients to use an out-of-state plan. But, is tax parity really worth it? How have those states that have enacted tax parity laws fared? Has tax parity been good for investors? For advisors? For the industry? And why have discussions died down in the industry? Which states offer tax parity? Of over 30 states (including D.C.) that have a state tax benefit available, only seven have passed legislation allowing residents the same benefit regardless of which 529 plan the investor selects. These states include: Arizona (enacted 2007) Kansas (enacted 2006) Maine (enacted 2006, though the benefit lapsed at the end of 2015) Missouri (enacted 2008) Montana (enacted 2013) Pennsylvania (enacted 2006) Minnesota (enacted 2017) States that offer no state tax incentive or cannot since they have no income tax, making them de facto tax parity states, include: Alaska Maine North Carolina California Massachusetts South Dakota Delaware Tennessee Florida Nevada Texas Hawaii New Hampshire Washington Kentucky New Jersey Wyoming Why don't more states offer tax parity to their residents? In theory, a state that offers tax parity to its residents is allowing the investor complete freedom of choice without the bias of a state benefit. 529 plans are typically run by sub-contractors; investment managers or administrators that service and support the state plan(s). These contracts expire at varying lengths depending on the state. When that contract expires, the state sponsor needs to attract strong bids to continue to improve the plan for its constituents. The lack of an in-state tax benefit ï ¿ ½ though one of many factors ï ¿ ½ makes expiring plan mandates less desirable to potential bidders. As we saw most recently with Rhode Island, an attractive state mandate will attract more providers and results in a lower-cost plan with better investment options for constituents. It also brings more revenue, better advertising terms, and other benefits to the state sponsor (which trickles-down to residents). Basically, a more appealing plan leads to increased competition during bids, and better plans overall. Rhode Island was primarily desirable for its huge asset base (over $6.8 billion in AUM at the end of 2015). But tax benefits are another arrow in the quiver of the state sponsor to draw bidders, just as assets, population, demographics, etc. all contribute to the state mandate's desirability. RELATED: How much is your state's 529 plan tax deduction really worth? How tax parity states have fared versus non-parity states Tax parity states have, on average, gained more in terms of assets than non-parity states (includes those with no benefit). The overall 529 market has greater assets and accounts in states with tax benefits than those without. According to CSPN data, there were nearly 8.5 million accounts in states that had tax benefits available only to residents using the in-state plan, versus 4.2 million accounts in parity states. Tax parity states also had accumulated less in terms of total assets. Anecdotally, there is also much greater participation in the state plan by state residents when a tax incentive is offered than without. This is, of course, proportionate to the amount of the benefit. It would be challenging to find an advisor in Indiana that wasn't aware their state offered a credit for contributions to its plan, for example. There can also be significant ramifications in terms of the ability of tax parity states to compete. In their May 2016 "College Savings Nation 2016" report, regarding the recently shuttered Missouri Advisor plan AKF Consulting stated, "We suspect that termination of the Missouri Advisor may reflect the challenges presented by parity tax treatment for new 529 players (Deutsche assumed its role in the Missouri Advisor in 2011). When state tax benefits are the same regardless of which plan an investor chooses, new program managers may struggle against more established 529 managers that advisors already promote." Why tax parity is less important now Tax parity was a major issue in the 529 space until a decision was handed down in the case of Department of Revenue of Kentucky v. Davis. Keeping in mind that 529 plans are considered municipal securities, it was decided that a state could exempt the interest on its bonds from the taxable income of state residents and still tax the interest earned on the bonds of other states. This makes it highly unlikely for any given group of states to all agree to allow tax parity. Further, there is sometimes a financial incentive for certain states to keep 529 assets in-house. States that offer a tax deduction or credit can offset some of their lost revenue with revenue from the state plan in those states that charge a fee. Some states use 529 revenues for other programs such as scholarships, matching grants, education programs, and more, so it is in their best interest to grow their own plan. So while tax parity is still a nice benefit for investors in those states that offer it to their constituents, non-tax parity states are not necessarily doing a major disservice to their own residents. RELATED: State tax calculator