529 Plans: Lower Costs, Better Choices
529 Plans: Lower Costs, Better ChoicesBy JILIAN MINCERSeptember 9, 2007
Improvements to 529 college savings plans and changes in the tax laws have made these state-overseen programs the clear choice for most families saving for higher education.
In recent years, as the assets in 529 accounts have grown, many states have negotiated with investment providers for lower fees and better investment choices. The plans also received a boost from the Pension Protection Act of 2006, which made permanent the federal tax benefits of 529s -- but did not extend some benefits of Coverdell education savings accounts.
At the same time, more families using custodial accounts to save for college are facing higher taxes with a recent expansion of the "kiddie tax."
(See the accompanying story1 for more on Coverdells and custodial accounts.)
Tax-Free Savings
The 529 plans, named for the section of the Internal Revenue Code under which they were created, were first established in the 1990s. They took off in popularity after a 2001 tax law provided that money withdrawn from the plans to pay higher-education expenses would be free of federal income tax. Without last year's pension legislation, that federal tax provision would have expired by 2011.
MORE ON COLLEGE SAVINGS
• Parents looking beyond 529 plans to save for a child's college costs may need a refresher course, amid tax-law changes that may have dented the appeal of custodial and Coverdell accounts. Here's what you need to know2.
• A little cash goes a long way when savers have time -- and a hospitable stock market -- on their side. That's why it's important to start early3.
"The Pension Protection Act eliminated a lot of uncertainty," says Jackie Williams, executive director of the Ohio Tuition Trust Authority and chairwoman of the College Savings Plans Network, an association of state 529 plans.
Families, many of whom were using other savings vehicles, have jumped into the 529 market in the last year.
"We're seeing people put money into 529 accounts rather than [custodial] accounts," says John Heywood, a principal at Vanguard Group, which has 20 529 plans in 19 states.
Reflecting those inflows and also investment gains, assets are likely to reach nearly $112 billion at the end of this year, estimates Financial Research Corp. in Boston -- up from $90.7 billion at the end of last year and $68.4 billion at year-end 2005.
Mutual funds are the primary investment options offered within 529 plans.
During the last few years, states "have taken to heart" earlier criticism of their 529 offerings, says Kerry O'Boyle, an analyst for Chicago investment research firm Morningstar. States have eliminated some of the high-priced plans and replaced more expensive investment providers with lower-cost options.
"Typically what you're seeing is better investments, because of increased pressure from states," says Brian Boswell, an analyst at Financial Research. "The plans have evolved to the point where they're much higher quality than even two or three years ago."
Indicative of a price war, within the last year Fidelity Investments introduced aged-based portfolios in California with annual expenses of just 0.5% of assets a year. The underlying holdings are all index funds. Indexing giant Vanguard Group followed with fee cuts to its Nevada plan, bringing half of the investment choices to that same 0.5% expense level.
Fees Dip Even Lower
In March, OppenheimerFunds became the new program manager in Illinois, introducing even lower fees. That state's Bright Start program, offered directly to investors, has index portfolios with fees ranging from 0.2% to 0.23% and actively managed portfolios ranging from 0.38% to 0.63%.
(Most 529 plans now offer age-based investments, which automatically become more conservatively invested as the child gets older.)
Meanwhile, some states have added or plan to add federally insured bank products to their 529 lineup. For conservative investors, these offer guaranteed returns, but may deliver lower returns over time than stock-market investments. Investments in the Ohio CD program, which is available through Fifth Third Bancorp, more than tripled in the last year to over $66 million. Other states that have or are working on CD options include Virginia and Arizona.
Picking a Plan
Almost every state offers a 529 plan and some offer more than one.
Joe Hurley, founder of Savingforcollege.com, an independent Web site that provides information about 529 plans, says families should first consider their own state's plans. That's because more than 30 states offer tax or other benefits to residents who invest in an in-state plan.
(States including Maine, Kansas and Pennsylvania have begun to pass on those benefits to residents who invest in out-of-state 529 plans.)
Take Time to Compare
Investors should then compare the home-state plan to other offerings. In some cases, they may decide to go with a better performing plan with lower costs from out of state.
That's what Illinois resident Mark Merlet did early this year, before that state's new program was introduced. He compared a number of plans for his two young sons and chose a T. Rowe Price Group plan in Alaska because its performance and fees were better than the plan that was then available in Illinois.
In going with the Alaska plan, Mr. Merlet gave up a substantial deduction on his Illinois return. He says he would consider opening an Illinois account in the future, now that his home state's program has lower fees.
Consumers also need to decide whether they want a direct-sold program or one distributed through brokers, which would typically have higher fees. Many states offer both varieties.
Attention, Grandparents
It's not just parents who are opening up 529 accounts for their kids. Mr. Heywood of Vanguard says grandparents also are using 529 plans, for estate planning and to ensure that money is set aside for grandchildren in a separate account available for college expenses. He says about a quarter to a third of the assets are funded by grandparents.
Some older people are making very large 529 contributions for their grandkids. Under tax rules, you can give up to $12,000 this year to another individual without any federal tax consequences. A couple can together give $24,000 to one recipient.
But under the rules for 529 plans, you can give up to five years' contributions at once -- up to $60,000 per beneficiary or $120,000 per beneficiary from a married couple -- without generating a taxable gift, assuming that no other gift is made to the same person during the five-year period.
Don't Put It Off
Saving for college, even if you start early, is intimidating. "Sometimes families decide there's no way I'll meet that goal so I won't try," says Ms. Williams of the College Savings Plans Network.
Instead, she says, "we're trying to get people to invest and save in a systematic fashion."
There are a number of online sites to help consumers compare 529 plans.
Two of the most popular ones are Savingforcollege.com4 and www.CollegeSavings.org5, which is coordinated by the College Savings Plans Network.
Write to Jilian Mincer at jilian.mincer@dowjones.com6
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