New Math for College Savings
Charles Passy Published April 26, 2011
For millions of parents focusing on their
college-bound kids, it was the biggest
disappointment from the stock market
crash of 2008: the discovery that the
primary tool for saving for college, the
529 plan, was far from a sure thing.
Now, as college acceptance letters hit
mailboxes across the country—with
stark reminders of the increasing cost
of a higher education—many parents
are skipping the history lesson and
forging back into these same plans.
Indeed, the plans may be among the
hottest sellers in the investment
community. The state-sponsored
vehicles took in nearly $9 billion more
than they paid out in 2010, a 75
percent increase in assets from 2008,
according to Financial Research Corp.
The number of options keeps growing
too, with 96 state plans (some states
have more than one) and some 4,000-
plus investment options (each plan has
its own mix of everything from
certificates of deposit to stock-and-
bond portfolios). Fees have dropped as
well, in some cases by as much as 20
percent.
Not long ago parents were realizing
that college-savings plans carried a
host of risks—the average 529
investment option lost 24 percent in
2008—just as their kids were nearing
or attending college. But considering
the alternatives (near-zero interest
rates from banks, a volatile stock
market), many financial advisers are
nudging the nation's 24 million–plus
parents currently saving for college
toward 529s—and pointing to a newly
revised rating system to help guide
them. "This is not a simple choice,"
says Laura Pavlenko Lutton, editorial
director for mutual fund research at
Morningstar, which recently expanded
its rankings.
Buying a home-state plan, of course,
can offer some tax advantages, but
other states may still be more
attractive. Morningstar, for its part,
assesses 53 of the nation's largest or
most noteworthy plans and assigns
ratings of "top," "above average,"
"average," "below average" or "bottom"
to each. Under that system, based on
criteria that range from performance to
plan managers, the best include ones
from Alaska, Nevada, Ohio, Maryland
and Virginia, according to Morningstar.
Advisers caution against an
overreliance on ratings, whether they're
from Morningstar or
Savingforcollege.com, which rates
plans solely on performance. The
ratings sometimes change dramatically
from year to year. The results can also
be very different depending on who is
crunching the numbers. For example,
Savingforcollege.com ranks Rhode
Island's CollegeBoundfund plan 30th in
the nation, based on its performance
over the past five years. Under
Morningstar's more complex system,
which also examines fees and tax
incentives, the same plan is the only
one with a "bottom" ranking.
AllianceBernstein, which manages the
Ocean State's plan, takes issue with
the idea that its plan is subpar. "We've
got a well-respected program by all
measures," says Patricia Roberts, the
investment firm's senior 529 product
manager.
Many financial advisers say a big
consideration in selecting a 529 plan
should still be the home-state
advantage in states that offer tax
breaks, since the savings can reach
several hundred dollars a year. In New
York, for example, a married couple
filing jointly can deduct up to $10,000
annually from their state taxable
income for contributions to the state's
529 plan. And that's on top of the
federal benefits: Assets in all 529 plans
grow tax-free, and withdrawals used for
educational purposes are also exempt
from federal taxes. Parents should also
take into account the basics, such as a
plan's past performance and costs, and
whether the plan has investment
options that meet their needs and
tolerance for risk. A growing number of
529s feature federally insured choices
—essentially, certificates of deposit or
savings accounts backed by the FDIC
—for account holders still skittish about
the markets.
No matter what choice a parent makes
when it comes to picking a 529 plan or
other college-savings vehicle, experts
say, it beats doing nothing and hoping
that junior lands a four-year football
scholarship. With college expenses
increasing nearly 6 percent annually
above the rate of inflation, inaction
could be the costliest alternative of all.
Corrections & Amplifications
The version of this story that ran in
SmartMoney magazine incorrectly
listed the top five plans' assets in
millions; they should be in billions. Also,
Fidelity has plans in just five states.