College savers need to be wary of high program costs and niggling account fees.
Favorable tax treatment, high contribution limits, and no income restrictions on owners of 529 college savings plans all add to the appeal of this vehicle to college savers. But despite a general industry trend toward lower fees the past couple of years, the overall costs of 529 plans remain high relative to retail options, and at a number of plans excessively so. (Costs are a key criterion in our annual study of "The Best and Worst 529 Savings Plans.") In an effort to better guide investors, we recently surveyed the fees on all the various 529 college savings plans to help prospective college savers avoid some of the pitfalls encountered with the many layers of fees typically involved and to attempt to provide some useful rules of thumb for identifying reasonably priced options.
When investors buy a mutual fund, they pay fees related to the cost of running and administering the fund. Fees for 529 plans, by contrast, are much more complex. Investors potentially face enrollment fees, account-maintenance fees, administrative fees, management fees, and distribution fees on top of the costs of the underlying investment options. Some of the costs are dollar-based, while others are calculated as a percentage of assets invested in the plan. Some plans charge a flat percentage rate, while others vary these asset-based costs depending on the option chosen. Some plans waive certain fees for different types of investors--typically residents, those with large account balances, or individuals using an automatic investment option. All of that doesn't even account for the differing portfolio structures among 529 plans, which range from single fund choices to static asset-allocation portfolios to age-based options, further adding to their complexity. As a result, making apples-to-apples comparisons of the fees associated with two plans, let alone coming up with industry averages, can be a daunting and arduous task.
The biggest critique of 529 costs has been just how many parties seem to be getting a piece of the pie. The states, program managers (typically fund companies), and third-party administrators all seem to be in line for a cut. Granted, these program-level fees cover real costs, but judging by the enormous variance in what plans charge for essentially similar services, some plans are doing it much more efficiently than others.
Although fee structures vary widely from plan to plan--and it's difficult to make line by line comparisons--it is often possible to get an overall sense of just where the fees are going by digging into each plan's program document. In our research, we found the best way to compare administrative costs between plans was to add the program manager and state fees together to see just how much is going to these middlemen altogether. This calculation excludes the underlying fund costs and distribution fees (the latter of which typically are only found on broker-sold plans and used to compensate brokers for service to their clients).
In looking at all the plans across the board, the results are instructive. Whereas several plans, including one of the largest--Rhode Island's CollegeBoundfund--don't charge any program or state fees at all, more than a dozen have middlemen fees of 0.5% or more. Especially egregious on this front is the 0.85% levied by Nebraska's TD Ameritrade College Savings Plan. All told, investors should look for costs below the median charge for such administrative type fees, which we calculated to be approximately 0.3%.
About two thirds of all 529 college savings plans have provisions to charge an annual account fee of some kind as well, often for smaller accounts that don't maintain a certain minimum balance (typically $25,000). Levied in dollars, not as a percentage of assets, these fees are typically $20 to $25 a year, though Maine's NextGen College Investing Plan stands out for its $50 rate. It's unclear, however, how many 529 investors actually pay such a charge. Often waived for residents and those using an automatic investment plan, such fees don't seem that pernicious on their own. But for small-account holders--those with less than $10,000, who have historically made up the majority of 529 owners--those fees are significant as a percentage of assets and can add up over time.
Such fees can also make it difficult to determine whether one plan is costlier than another. In fact, the only way an investor could reasonably expect to tell the difference is to prorate those costs out over the full 20-plus year investment time horizon. For example, Utah's Educational Savings Plan charges some of the lowest asset-based fees around for its age-based options (0.25% to 0.39%), but it levies an annual account fee of $5 per $1,000 invested, up to a maximum of $25 on nonresident accounts. The neighboring Nevada Vanguard 529 College Savings Plan, by contrast, charges a flat 0.5% for its age-based options and a $20 fee on only those accounts with less than $3,000. All else being equal (which, in terms of investment choices, they are not, by the way), which is the better deal for an investor from, say, California?
Generally speaking, it's still Utah--which is one of the reasons that it is perennially on top of our list of the best 529 plans. Assuming a conservative rate of return of 5% annually over a 22-year time horizon, it is basically a wash for a smaller investor starting out with $500 and investing $50 a month. But for those contributing more, say $2,000 a year, the Utah plan is clearly the better deal in terms of cost. The Nevada plan's higher asset-based fees over more than 20 years eat into returns more than Utah's fixed, albeit longer-running, account fees as the account grows larger. In the end, for most college savers the lower overall asset-based fees win out.