College savings plans change in response to fund scandals

PERSONAL FINANCE

Your Money Eileen Ambrose

Scandals, complaints spur change in 529 savings plans

October 31, 2004|By EILEEN AMBROSE

THERE HAVE been enough scary headlines about state-sponsored college savings plans lately to give parents looking for an easy, tax-friendly way to save for a child's education reason to pause.

The mutual fund scandal that erupted a year ago involved some companies running state plans. Early this year, federal legislators began complaining of plan fees so high they threaten to wipe out tax benefits. Regulators are looking into the plans' disclosures and sales practices.

Now some states are making changes.

Some are lowering fees.

Maryland officials will vote on a proposal next month to lower its $90 enrollment fee - the highest in the country among plans sold directly to investors - to $75. Others dropped certain mutual funds and replaced them with lower-cost choices. And some states say they are improving disclosure so it will be easier for investors to comparison shop.

Some changes come from states passing on their savings as plans have grown and realized economies of scale. Some states are trying to make plans more competitive, experts said. But there's no question, they added, that others are responding to critics in Congress and to the mutual fund scandal.

"The states in some cases are reducing their own share of program management fees because they feel the pressure ... from Congress and the SEC," said Joseph Hurley, founder of Saving forcollege.com, an online resource on state plans.

Despite all the warranted scrutiny of fees and disclosure, plans are still worthwhile investments because of their tax benefits and flexibility, said Dan McNeela, a senior analyst with Morningstar Inc. in Chicago.

College savings plans, often called 529 plans for the section of the U.S. tax code that created them, allows people to invest, usually in mutual funds, on a tax-advantaged basis. Withdrawals are tax-free if the money is used for college, although the tax break ends in 2011 unless Congress extends it or makes it permanent.

Half the states also allow residents to deduct all or part of their contributions on their state income tax returns. All but one state - Washington - offer a college savings plan, and some have more than one. All but one state - Louisiana - allow nonresidents to invest in their plans. So families don't have to stick to a plan where they live or where they think their child will go to school.

Here are changes some states have made in the past year:

Oregon took the unusual step of firing its program manager, Strong Capital Management, in November after the fund company and its founder, Richard Strong, were implicated in the fund scandal.

The state sought a fund company with a clean record and quality, low-fee funds, said Michael Parker, executive director of the Oregon 529 College Savings Network. It hired OppenheimerFunds, whose actively managed funds charge fees of 1 percent or less of invested assets. In comparison, most of the Strong funds charged 1.25 percent.

In addition, the Oregon plan added low-cost index funds from the Vanguard Group, whose fees range from 0.33 percent for a total stock market index fund to 0.61 percent for an international index fund.

Wisconsin stuck with funds from Strong, a home-state firm, but moved swiftly to add alternatives. "It was a crisis," said Marty Olle, the plan's program manager. "We really wanted to do something quickly."

The state added four funds in December, two from Vanguard and one each from Baltimore's Legg Mason and Milwaukee-based Robert W. Baird. So far, $156 million has poured into the four funds, while assets in the Strong funds haven't much changed, Olle said.

Fees also have come down. In April, Wisconsin eliminated its $10 enrollment fee and cut its administrative fee from 0.15 percent to 0.10.

In one of Nevada's plans, money invested in Strong funds was shifted to Vanguard investments after the fund scandal.

In the Vanguard 529 Plan, another Nevada program, the expense ratios on six portfolios were lowered this month by 10 percent to 16 percent. Vanguard is passing along savings it realized from economies of scale as plan assets have grown, said John Heywood, who heads Vanguard's college saving programs.

Ohio added 15 Vanguard funds to its plan in response to a market survey early last year that showed investors wanted low-cost, passively managed index funds, said Jacqueline Williams, executive director of the College Advantage Savings Plan in Ohio.

The state also expects to add certificates of deposit and other savings products from an Ohio bank next year, Williams said.

Investors likely can expect more changes in other states.

Maryland officials are proposing to lower an enrollment fee that Hurley calls "off the charts" nationally.

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