College savings plans' fees, marketing draw scrutiny


April 18, 2004|By EILEEN AMBROSE

THE popular college savings plans that have transformed the way parents save for education are facing scrutiny by Congress and regulators concerned about high fees and how the plans are marketed.

College savings plans, often called 529 plans for the section of the U.S. tax code that authorizes them, allow parents and others to basically invest in a group of mutual funds. The money grows tax-deferred and can be withdrawn free of federal taxes as long as it's used for college. (Tax-free withdrawals disappear in 2011, unless Congress extends the perk.)

States sponsor the plans and often encourage residents to invest at home by adding more perks and tax breaks. But plan rules, investments and fees vary from state to state, making it difficult for investors to comparison shop. And there's growing concern that confused investors might be taken advantage of.

The National Association of Securities Dealers is investigating more than a dozen investment firms that sell the plans, said Barry Goldsmith, NASD's executive vice president of enforcement. The NASD is looking into whether the firms steered investors away from home-state plans that offered tax advantages and sold them other plans with higher fees and commissions, Goldsmith said.

"Potentially, those investors are losing out on important benefits that come with investing in 529 college savings plans," said John Gannon, NASD's vice president of investor education.

A congressional committee raised similar concerns early this year, asking the Securities and Exchange Commission whether plan fees are so steep they actually erase the tax benefits intended to help parents.

In a response last month, the SEC said 529s generally don't come under federal securities laws. Disclosure of fees, investments and performance by plans can be so limited and uneven from plan to plan that it's difficult for parents to evaluate their options, the agency said.

And yes, the SEC concluded, 529 fees may offset some of the tax benefits of the plans, particularly those sold through brokers.

SEC Chairman William H. Donaldson also said his agency created a task force to look into the sale and structure of 529 plans.

Despite these troubling findings, there are low-cost college savings plans that can be attractive ways for parents to save for college, experts said.

Here are tips to finding the right plan for you:

Look homeward

First, check out your state's plan, because half the states offer tax breaks for residents, Gannon said. Some states, including Maryland, allow investors to deduct all or part of their contributions from their state income taxes, for example.

Several states offer a matching program for low-income residents, said Joseph Hurley, a 529 expert and founder of, a Web site that offers details on state plans. Rhode Island, for example, donates $2 for every $1 contributed by lower-income families, he said.

But if your state offers no perks and the plan isn't exceptional, experts said, by all means shop around.

Look for a plan that offers flexibility and quality investments to match your goals and stomach for risk, said Dan McNeela, a senior analyst with Morningstar Inc. who follows 529 plans.

"There is no right asset allocation for everyone," McNeela said. "Individual investors need to assess their risk tolerance."

Some plans maintain a fairly aggressive investment strategy right up until the child reaches college age, McNeela said. But parents might want to make sure they have the option to shift money into, say, a conservative stable-value fund when their child nears college or even earlier if they want to preserve gains, he said.

Check out fees

Think fees don't matter? The SEC compared plans in Utah and Nebraska, which use the same low-cost index fund. Invest $10,000 in each, earn 8 percent annually and, after 18 years, the Utah plan would yield $2,113 more because of its lower fees, the agency said.

The difference was even more substantial when comparing Utah's plan with the Rhode Island plan sold through a broker. This time, the investment options weren't the same.

After 18 years, the investor in the Rhode Island plan would have about $7,728 less because of its higher fees and 4.75 percent sales charge.

"There are fairly large discrepancies in the expenses of college savings plans," Gannon said. "In some instances, you can get the same underlying portfolio from a different state's plan for a lower cost."

There are all sorts of fees. At $90, Maryland's enrollment fee is likely the highest in the country, Hurley said. Most other states don't even have one, he said.

An annual account maintenance fee runs $25 to $50 a year, although some states waive that for automatic contributions or once accounts reach a certain level, Hurley said.

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