about how you'll send your kids off to college? You're not alone.
According to a recent
survey, 44 percent of parents say they are not prepared to pay
for their children's college education, though 65 percent fully
expect their kids to attend.
Even scarier: 16 percent of parents plan to dip into their retirement
funds to help out their kids, and another 7 percent plan to finance
at least a portion of education with credit cards. Eeesh.
We have the perfect savings tool for college funding available
to us -- 529 plans, those state-sponsored savings programs that
allow you to sock away thousands of dollars a year in a tax-deferred
account for your kid's (or grandkid's) higher education.
Well, OK, they're not quite perfect. Some might call them seriously
flawed. In recent months, 529 plans have been under severe scrutiny
by a task force of the Securities and Exchange Commission, both
houses of Congress and the National Association of Securities Dealers.
Their shortcomings came to light recently as a result.
A mini primer
There are two types of 529 plans -- the tuition prepayment plans,
where you pay ahead for tuition costs that are applicable to the
public universities in your state. These more-restrictive plans
came on the scene in the 1980s and are now waning in popularity
as the newer 529 savings plans, introduced in 1997, take a foothold
in the marketplace. So far 529 savings plans have attracted $45
billion of assets nationwide.
The pros of the savings plans: Earnings grow tax-free, and when
it's time to matriculate, you can take the money out without paying
federal taxes, as long as the money is used for qualified education
On top of that, the earnings may be free of state taxes, and you
may also get handsome state income tax deductions for contributions
made along the way.
Each state has at least one type of 529 plan, some have both types,
and a few even offer several different versions of the savings plans.
Drawbacks of 529 savings plans
They are not regulated under federal securities laws, so they lack
the transparency of other securities. As a result, disclosure about
all the various fees involved with these plans has been inconsistent
and spotty at best, making it all but impossible for people to make
apples-to-apples comparisons between plans.
Some states offer 529 plans with fees that are indefensibly high.
That in itself may not be so alarming. Just as there are good mutual
funds and bad funds, there are good 529 plans and bad plans. But
so far folks do not seem to be able to discern between the two,
because they're being herded into high-cost plans that have little
Two accounting professors at the University of North Carolina at
Wilmington studied 77 different 529 savings plans over two years,
and found that the plans with the highest fees tend to have a disproportionate
share of investors as well as assets. At the same time, they discovered
that the 529 plans in states offering handsome tax deductions have
"Investors are choosing out-of-state plans with higher fees
and forgoing significant state tax benefits," the professors
in their study. "We find no support for the theory that
investors choose plans based on low fees and state tax subsidies."
It's not that people are stupid. It's that advisers are steering
their clients into 529 plans that pay good commissions, even though
the plans may be completely inappropriate for their clients.
Separately, the National Association of Securities Dealers has
been conducting its own investigation of more than a dozen broker-dealer
firms that have sold 529 plans to investors.
In a hearing before the U.S. Senate Committee on Government Affairs
last fall, Mary L. Schapiro, NASD vice chairman in charge of regulatory
policy and oversight, shared this shocking finding:
"We were troubled to discover that more than 90 percent of
the sales by some firms were to out-of-state residents, despite
the fact that about half of the states give a state tax deduction
to their citizens for contributions to the home state's 529 plan."
In fact, she continued, "Regardless of the number of 529 plans
sold, the vast majority of sales were made to residents outside
of the state that sponsored the 529 plan."
This is seriously disturbing, because people who invest in a different
state's plan could get taxed or hit with a fee when they begin withdrawing
money from the plan, either by the outside state or their own state
-- possibly both. Naturally, investors in plans outside their home
state don't get their own state's tax breaks either.
On the other side of the issue, critics say the states have designed
protectionist policies in an effort to keep their residents in their
home-state's plan. The states serve as interloping middlemen, they
argue, who often charge high fees that negate any tax breaks.
Fee disclosures may improve
In December, the National Association of State Treasurers and its
affiliate, the College
Savings Plans Network, released disclosure guidelines that the
529 savings plans are expected to embrace. If they are widely adopted,
people will be able to more easily compare the various state plans
and make intelligent decisions -- with or without a broker's "help."
The guidelines suggest that the following costs be broken out:
- estimated underlying fund expenses
- program manager fee
- state fee
- miscellaneous fees
- annual distribution fee
- total annual asset-based fees
- maximum front-end or back-end sales charges
- annual account maintenance fee
Not all of these costs apply to every plan. Those that are direct-sold,
for example, won't have front- or back-end loads. Right now, it's
relatively easy to research some, though not all, of these expenses
on Web sites such as Savingforcollege.com
or Morningstar's college savings investing center. Currently, prospective
investors may or may not see a complete breakdown of fees in a particular
plan's program documents, since some plans only provide a general
expense ratio rather than an itemization of costs.
Don't kid yourself. The states have come up with these long overdue
guidelines less out of a sense of duty to the public and more
to protect their territory. 529 plans were their creation, after
all. But the guidelines are an attempt by the states to stave off
interference by federal regulators and show that the states are
quite capable of policing themselves. Too bad they didn't come up
with this sooner.
keys to choosing a 529 plan
Longtime financial journalist Barbara Mlotek Whelehan earned
a certificate of specialization in financial planning.