The original intent of 529 plans was to providea convenient, reasonably priced, tax-efficientsavings vehicle for college educations. Underfederal rules, 529 plans allow any individual,at any income level, to put money away tax-free for theirchildren's college education. Despite this federal taxexemption, 529 savings plans are managed by individualstates, not the federal government. And in manyrespects, this is becoming an expensive problem.
Choices and Costs
A case in point is New York's 529 college savingsplan. A recent article in Money magazine notes that inNovember 2003, the $1.8-billion plan replaced longtimemoney manager TIAA-CREF with the trio of Vanguard,Fleet Bank's Columbia Management, and Upromise.While in some cases investors may see a broader menuof less expensive funds to select from, the potential problem,the article points out, is that ColumbiaManagement is expected to push its broker-sold funds,which carry higher expenses and sales charges.
Part of the problem is too many choices. In total,there are more than 70 separate 529 plans in the UnitedStates, and each has its own investments, rules, and pricingstructures. Most physician-investors don't have thetime or expertise necessary to make an educated choice.The fear of making the wrong decision has promptedmany to not choose any plan at all.
Confusion in choice aside, the most disconcertingdevelopment has been the rising cost of 529 savingsplans. The article points out that competition forinvestors' 529 dollars has intensified. This highly competitiveenvironment has led many states to enlist thehelp of brokers to market their plans, which is helping todrive up fund expenses.
Sales loads have nearly doubled in some cases,from an average of 3% up to 5.75%, and expenseratios are rising as well. Compare the funds inWyoming's broker-sold 529 plan, which carries totalexpense ratios ranging from 1.8% to 2.4%, to theexpense ratio for Utah's direct-sold plan, which rangesfrom 0% to 0.44%. When you add up the fees onsome 529 plans, it's easy to see how they can negatethe benefit of tax-deferred savings.
Making Your Move
Some experts believe that eventually the law ofsupply and demand will take hold and lead to lowerprices and better products. But what should you do inthe interim? First, keep in mind that not all 529 collegesavings plans are raising the roof on fees. The article points to three states in particularâ€”Iowa, Nevada, and Utahâ€”that offer different age-basedinvestment options, all with low fees. You cancheck for comprehensive data on these and other stateplans at www.savingforcollege.com.
If you do find that rising fees on your currentlyowned 529 plans are resulting in reduced earnings, don'tpanic. You are allowed to transfer your investment toanother state plan once a year. You may experience feesand extra state taxes for doing so, but those may pale incomparison to the rising fees of your current plan.
In addition, remember that you don't have to put allyour college savings dollars into 529 plans. There areoptions, such as Coverdell Educational Savings Accounts.While the contribution limit on a Coverdell islower than that of a 529 plan, the accounts offer the flexibilityof using savings for elementary and high schoolcosts in addition to college costs.
Also remember that 529 plans are currently treatedas parental assets when it comes to determining financialaid. However, that could change, as could the currenttax break. If Congress fails to renew it by 2010, earningswill be taxed at the student's rate.