VOL 59, ISSUE 5, MAY 1, 2005
Ivy-Covered Hall of Shame
by Kristin W. Davis
Our hall has three wings: The first holds five plans that clearly benefit financial companies more
than investors. The second singles out states with unfriendly tax rules. In the third, Congress gets a
rotten tomato for keeping investors in the dark about the tax status of withdrawals.
Last year wasn’t a very good one for 529 plans. They ran the gauntlet of regulators, who poked,
probed and peered at the state-sponsored college-savings programs. Congress held hearings on
whether fees are too high and whether financial advisers steer customers to inappropriate plans.
NASD examined 529-plan sales practices, and the Securities and Exchange Commission scrutinized
the plans’ many layers of expenses. As if that weren’t enough, the mutual fund market-timing scan-
dal tainted college-savings plans by association. It’s enough to make the 7.2 million people who
have invested in 529 plans wonder if they’ve done the right thing.
They have. As a whole, the plans continue to be a superb way to put college savings into appropri-
ate investments and take advantage of valuable tax breaks. But all that scrutiny wasn’t misplaced.
You’ll shoot yourself in the foot if you invest in one of the stinkers — a plan with egregiously high
fees and lousy investment choices.
To help protect you, we’re bestowing booby prizes on the worst offenders and corralling them in
Kiplinger’s 529 Plan Hall of Shame. Our hall has three wings: The first holds five plans that clearly
benefit financial companies and brokers more than investors. The second singles out states with
tax rules that are unfriendly to 529-plan investors. In the third, Congress gets a rotten tomato for
keeping investors in the dark about the tax status of withdrawals when it’s time to tap the accounts
for college expenses.
Fees, fees, fees
Morningstar senior analyst Dan McNeela told Congress last year that “too many 529 plans are pro-
hibitively expensive.” He’s right. Investors not only pay annual expenses for the funds they invest
in, they also pony up administrative and management fees to the state and to the financial compa-
ny that manages or distributes the plan. Now that 65% to 75% of the assets going into 529 plans
are funneled through brokers, most investors pay sales charges as well. And you may also be
charged an enrollment fee or a yearly account-maintenance fee.
Many plans have annual charges exceeding 2%. That means underlying investments have to earn
more than 5% to keep ahead of the fees and a modest 3% inflation rate.
To find the worst offenders, we used Morningstar’s 529 Advisor database of 83 college-savings
plans to screen for those with the highest expenses. Then we reviewed the overall investment
options and the performances of the plans that had investment selections with total annual fees of
2.5% or more. (Most plans have a range of charges based on the expense ratio of the investment
you choose and the share class you buy. The highest annual totals are usually for a plan’s Class C
shares, for which the broker earns an annual sales fee rather than a larger up-front commission.)
Plans that don’t report any performance data to Morningstar were excluded from the screen.
Among them is Wyoming’s 529 program, which Morningstar recently named one of the five worst.
Maine. Lee and Dyana Rossignol of Gorham, Maine, have held accounts for their four young chil-
dren in Maine’s NextGen College Investing Plan since shortly after it opened in 1999. But after
enduring five years of disappointing returns, they transferred the accounts this year to South
Dakota’s College Access plan. Maine’s plan “has done nothing for me,” Lee says, “and everything is
In fact, Maine’s fees are higher than most. Residents pay 0.5% per year (and nonresidents up to 1%
per year) on top of fund expenses, which range from 0.7% to 1.8%, for a total of up to 2.8%. In 35
of the plan’s investment selections, C shares carry annual expenses of 2% or more. Even the direct-
sold plan (with no broker’s commission) has total expenses that reach as high as 2%.
In return for those high fees, investors in NextGen have been rewarded with mediocre performance,
especially from its AIM and MFS funds. For their 8-year-old son, Mitchell, the Rossignols invested in
Merrill Lynch’s age-based portfolio, which adjusts its mix of assets to become more conservative as
a child gets older. That portfolio has returned a not-so-bad 5% per year over the past three years.
Overall, the Merrill Lynch funds have done better than other funds in the plan. AIM’s age-based
portfolio for the same group has had negative annual returns. For their 5-year-old triplets, Wilkins,
Madeline and Bridget, the Rossignols invested in an AIM fund and two Franklin Templeton funds,
which have returned a subpar 1% to 3% per year over the past five years.
“Fees are part of the equation, along with the value of the adviser, the investment choices and the
ability to move your money around,” says Charles Toth, director of education savings at Merrill
Lynch. With portfolios and stand-alone mutual funds from five fund families, including newly added
Oppenheimer funds, Toth argues that NextGen allows investors plentiful choices. Merrill Lynch has
also added a low-cost index fund for direct investors; however, it’s not available in broker-sold
But it’s mainly broker-sold accounts that have driven this expensive plan to become the nation’s
eighth-largest, with $2.9 billion in assets. Residents and nonresidents alike can do better.
Arizona. None of the three broker-sold plans that Arizona offers is attractive. The Waddell & Reed
InvestEd Plan is among the nation’s most expensive, with total fees running as high as 2.6% per
year. The company does not report complete investment returns to Morningstar, but annualized
three-year returns on the Waddell & Reed Web site range from 0.6% to 4.6% in the fund’s three
In the Securities Management & Research Family College Savings Plan, some funds carry expense
ratios exceeding 2.5%. There are no age-based portfolios. At the end of 2004, all eight portfolios
holding a fixed mix of stocks had below-average returns compared with their peer groups — some
by substantial margins.
Expenses are similar in the plan run by Pacific Funds, which offers a collection of uninspiring choic-
es save for a bond fund run by Pimco’s Bill Gross. The SM&R and Pacific Funds plans have direct-
sold versions with no sales fees (but still the high expense ratios). There’s no state-tax deduction,
so Arizona residents sacrifice nothing by looking elsewhere.
Pennsylvania. High fees plague the Keystone State’s TAP 529 Investment Plan as well. Expenses
for broker-sold shares range from 1.2% (plus an up-front load) to 2.6%. Performance in most of the
investment choices has been dismal. With the exception of some bond-heavy portfolios for older
children, nearly all of the age-based choices have underperformed their peers by significant mar-
gins. Among the fixed-investment portfolios, Calvert’s socially conscious funds have done well, but
those managed by Delaware Funds are duds. Steer clear.
Nebraska. Although state residents have three plans to choose from, the AIM College Savings plan
stands out for off-the-chart annual expenses — as high as 2.2% plus an up-front load for A shares,
and 2.8% for B shares — and poor returns. Every one of the age-based choices has lagged its peers
by one to two percentage points, and many of the fixed portfolios and individual fund choices have
Ohio. The state has vastly improved the plan it offers directly to investors (it added a slate of low-
cost Vanguard funds last year), but the broker-sold version, managed by Putnam, is still pricey, with
expenses ranging as high as 2.7%. Meanwhile, it has delivered only average performance — below-
average when you factor in sales fees. The plan is widely sold: It is the fourth-largest college-sav-
ings program, with $3.5 billion in assets.
Although many plans clearly need to improve, there’s good news about fees overall: Some plans
have trimmed their expenses, and states such as Ohio and Maine have added low-cost index funds
to their menu of investments. It’s also getting easier to compare one 529 plan’s costs with anoth-
er’s. Although 529 plans are not subject to the same disclosure rules as mutual funds, the industry
is voluntarily adopting the practice of showing total expenses as an annual dollar amount per
$10,000 invested. By year-end, you should be able to find that comparative information in nearly
all plan prospectuses.
Plans come clean
College plans haven’t been immune to scandal. Last July, the Utah Educational Savings Plan fired
its director, Dale Hatch, accusing him of breach of trust and misappropriation of funds. Hatch has
been charged with second-degree felony theft. He declines to comment.
Utah should have had better internal controls, but the state gets credit for cracking down after an
employee noticed suspicious transactions and for coming clean with investors about the breach.
Account holders of record in March were reimbursed for missing funds, which came to about 62
cents per $1,000 invested. And the plan’s new director has introduced record-keeping systems to
Kiplinger’s has consistently recommended Utah’s plan for its super-low expenses and for its sensi-
ble selection of age-based and fixed portfolios of Vanguard funds. Investors should feel comfort-
able keeping their money there.
What about 529 plans run by fund companies that have been embroiled in the industry’s market-
timing scandal? They, too, might have been contestants for entry into the Hall of Shame, but most
states have acted quickly to replace tainted fund families or to offer alternatives. When Richard
Strong and Strong Capital Management were cited for market-timing violations, Oregon and
Wisconsin both replaced Strong funds or added alternatives. “These are very good examples of
states exercising their fiduciary duty,” says Andrea Feirstein, a New York City consultant to 529 plans.
In about half the states and the District of Columbia, residents have an incentive to keep their
money close to home: a state-tax deduction for part or all of the money they invest in the state
plan. If your state’s plan is reasonably good, that tax break can be the sweetener that keeps you
from investing elsewhere. If your plan has steep annual expenses or underwhelming investment
choices, you can always forgo the tax break and enroll in an out-of-state plan.
But Hall of Shame citations go to Alabama, Illinois, Mississippi and Pennsylvania, which penalize
their residents for shopping around. If residents choose an out-of-state plan, they not only give up
the up-front tax deduction, but they must also pay state taxes on the earnings when they withdraw
the money for college expenses.
Illinois and Mississippi have attractive 529 plans, so their residents aren’t stuck with lemons.
Mississippi has a low-cost plan run by TIAA-CREF with solid choices. The Bright Start plan in Illinois,
run by Citigroup, also has reasonable expenses (just under 1%) and a good selection of Smith
Alabama’s and Pennsylvania’s plans, on the other hand, have high expenses and decent but not
stellar inevstments. (Morningstar chose Alabama as one of its five worst plans.)
Runner-up in this category is New York. Its Vanguard plan is a good one, but residents who enroll
and later change their minds pay dearly. Like some other states, New York recaptures the state-tax
deduction residents received on their contributions. But it also taxes the earnings portion of the
amount rolled into another state’s plan. That’s harsh.
Shame on Uncle Sam
Congress popularized 529 plans in 2001 when it blessed tax-free withdrawals for education. But
there’s a catch: The tax-free status “sunsets” in 2010 unless Congress acts before then to extend it.
With the deadline looming, millions of families with students younger than high school age may be
putting off saving because they’re uncertain about whether withdrawals will be tax-free.
States and the mutual fund industry have been lobbying hard to get the tax break extended, and
President Bush’s budget calls for making it permanent. But Congress keeps putting off legislative
action. “It’s a matter of competing for scarce tax resources rather than a lack of support for the
programs,” says David Pearlman, vice-chairman of the College Savings Foundation, which repre-
sents financial companies that manage 529 plans.