An IRA Investment Firms Haven’t Learned to Love
Education individual retirement accounts have become the black sheep of the IRA family, and mutual fund companies are partly to blame.
Roth IRAs, which allow tax-free investment growth, are all the rage and, partly as a result, traditional IRAs, which still offer a tax deduction to people who qualify, have received more attention and a new lease on life.
But the new education IRAs are languishing. Fidelity Investments, the nation’s largest fund group, doesn’t even offer the accounts. Nor do some other large fund families, including Aim, Pimco, Heartland and Jones & Babson.
Even at the scores of fund companies that are making education IRAs available, consumer pamphlets and advertising dollars have been lacking. Companies are choosing to direct their promotional efforts elsewhere. If you consider the characteristics of education IRAs, it’s not hard to understand why.
“There’s not a whole lot going on with education IRAs,” said Michelle Smith, managing director of the Mutual Fund Education Alliance, a Kansas City, Mo., marketing organization that includes 39 low-cost fund groups as members.
Part of the problem is that certain wrinkles haven’t been ironed out of education IRAs.
For example, donors can invest up to $500 in a child’s account each year. But what happens if both sets of grandparents, investing independently, each put in the maximum amount? A 6% penalty would apply from such innocent mistakes, says tax researcher CCH Inc. in Riverwoods, Ill. This might be something, then, that a family should discuss in advance, rather than making, say, a surprise birthday gift.
They key benefits of education IRAs is tax-free growth if the money is used for college costs. (Note that money placed in one or more education IRAs doesn’t reduce your ability to put $2,000 a year into retirement-oriented IRAs.)
Many companies are waiting for Congress to revise provisions governing education IRAs. For example, both houses have passed legislation that would boost the yearly investment limit of $500 to either $2,000 or $2,500.
“We’re waiting rather than getting involved in a situation that might require us to change our paperwork and marketing materials,” said Phil Neugebauer, a spokesman for Pimco Advisors in Stamford, Conn.
Some fund companies probably won’t embrace education IRAs unless that $500-yearly ceiling is raised, because that amount is small potatoes--even for a company that levies a high management fee. With fees of 1.5% a year, say, this account would bring in just $7.50 annually.
“Financial institutions probably figure $500 a year isn’t enough to build up a significant amount of money, especially since you can only contribute to age 18,” said Mark Luscombe, a federal-tax analyst with CCH. “The most you can build up in one of these accounts, even if your investments do well, is maybe $25,000.”
Furthermore, an account would become taxable and subject to a 10% penalty by the time the child turned 30 if he or she hadn’t used it for college before then. The earnings’ tax-favored status can be maintained, however, if the beneficiary rolls the money over to a younger sibling’s education IRA.
In short, education IRAs will remain loss leaders for fund companies for at least the next few years unless Washington changes the rules. The White House isn’t keen on raising the $500 ceiling, said Luscombe, because such an increase has been tied to Republican proposals that would make education-IRA money available to all students, including those in grade and high schools, and would thus undercut support for public schools.
Given the shortcomings associated with education IRAs, it’s perhaps amazing that the accounts are as widespread as they are.
A few companies are even bending over backward to make education IRAs attractive. For example, Invesco Funds of Denver will establish a plan for a minimum $250 investment, or for those people willing to commit a minimum of $50 a month. In addition, the company is waiving its $10 IRA fee.
Similarly, you can open accounts through Strong Funds of Milwaukee without paying an annual IRA fee, although the minimum investment there is $500.
Vanguard, T. Rowe Price and Janus are some of the other fund companies offering education IRAs for a $500 minimum. Vanguard and T. Rowe Price impose a $10 maintenance fee, though, and Janus charges $12.
Invesco spokeswoman Laura Parsons acknowledges that her firm isn’t likely to turn a profit on education IRAs any time soon, given that Invesco needs about $3,000 in an account to break even. But she says this drawback must be balanced against the goodwill created among shareholders.
“It’s not profitable to get a lot of low-dollar accounts,” she said. “But a lot of our [high-dollar] customers want to set up accounts for their kids or grandkids.”
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Russ Wiles is a mutual fund columnist for The Times and co-author of “How Mutual Funds Work.” He can be reached at russ.wiles@pni.com
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A Brief Course in Education IRAs
Benefits:
* Investment earnings grow tax-deferred.
* Earnings are withdrawn tax-free if they’re used to pay for college costs, and the beneficiary has until age 30 to do so.
* Anyone, including nonrelatives, can invest money for a child.
Drawbacks:
* Investments from all sources are limited to $500 per child each year.
* Investments may not be made after the beneficiary reaches age 18.
* Contributions are not tax-deductible.
* Education IRAs are not available to high-income individuals.
* Money must be withdrawn by the time the beneficiary turns 30, and earnings will be taxable and subject to a 10% penalty to the beneficiary if he or she doesn’t go to college or transfer the account to a younger sibling.
