The benefits of a Section 529 collegesavings plan have been welldocumented. If you're lookingto save for your child's collegeeducation, the 529 state-sponsored collegesavings plan is a professionally managed,tax-deferred option. What hasn'tbeen as well documented are the feesassociated with some of these plans,which have the potential to erode or evennegate their tax advantages. According toa recent report, it's importantto do your homework if you're consideringa college savings plan.
Comparing the fees charged by 529plans is easier said than done. That'sbecause you not only have to read the fineprint, but you have to find it as well. Aprofessor of public policy at HarvardUniversity's John F. Kennedy School ofGovernment recently scrapped a study of529 plans because the fees were buried,unclear, or so varied in the way they wereworded that comparison was impossible.
As an example, the articlecites Maine's NextGen College InvestingPlan, which is the fifth-largest 529plan measured by assets. The plan offersdozens of investment options, includingnine that have three price tags each. Yourfee is also impacted by your method ofpurchase, directly or through a broker.
Broker practices are also a concern.According to the article, more than 90%of the dollars flowing into certain planscome from out-of-state residents. However,brokers may not be adequatelyinforming investors of the state incometax deductions they could be getting withtheir home state's plan. At present, 27plans offer state tax deductions, but onlyto residents who keep their dollars intheir home state.
This type of situation has led theNational Association of SecuritiesDealers to investigate the sales practicesof 16 brokerage firms that sell severalvarieties of 529 plans. In addition, theCollege Savings Plans Network (www.collegesavings.org), the trade group for529 plans, has written guidelines tostandardize disclosure, but only on avoluntary basis for brokerages.
As the article points out, it makes nosense to contribute to a 529 plan if thefees are going to eat away any tax savings.It could be that investing in a similarmutual fund is a better decision, buthow can you know?
Start by calculating the fee gap—thedifference between the total charges onthe 529 and the mutual fund. For example,if you're in the 28% federal taxbracket and the 529 plan you're consideringoffers a tax deduction, steer clearof the 529 plan if its price tag is 1.65percentage points a year or more abovethat deduction. If the 529 plan does notoffer a state tax deduction, use 1.3 percentagepoints as your guide.
Often, you're also going to comeout ahead by purchasing direct insteadof buying from a broker. As an example,the article refers to a plan calledColorado's Scholars Choice CollegeSavings Program. In the plan's prospectus,a table indicates that investors pay1.09% each year in fees by opting to gothe no-load route. In comparison,annual fees for the A shares are lower,ranging from 0.85% to 1.14%.However, you'll also be giving 3.5% ofyour contributions to a broker. In otherwords, $3.50 of every $100 you investgoes directly to a broker instead of intoyour 529 account.
Need to Know
There are other fees you should considerwhen comparing 529 plans. Thesame Colorado plan adds a 0.10%authority administration fee to cover thefund's expenses. There's also a 0.26% feeto cover marketing and record-keepingexpenses. According to the article,0.30% is considered reasonable.
If these fee percentages seem toosmall to be concerned about, rememberthat they do add up considerably overtime. According to the article, if you invest $10,000 when yourchild is born and assume annual returnsof 8% with average costs of 1.87%,you'll have $24,449 in 18 years.However, if your fees were only 0.65%,your plan would grow by an additional25%, or $35,534.
Some helpful Web sites to visit whendetermining a plan's fees are Savingforcollege.com and Morningstar.com. Beadvised, however, that because disclosureis not uniform, you may have to diga little deeper to find the informationyou seek.