529 college plans grow in popularity

Published: Thursday, March 1, 2007 at 6:01 a.m.
Last Modified: Thursday, March 1, 2007 at 1:47 a.m.
Jeremy Blackburn considers himself a pretty good parent, but for three years after his son Ashton was born, he wouldn't touch any 529 plan, often touted as the best way to get a jump on college savings. Although millions of Americans were signing up, he thought 529s were a bad deal that could be worse by the time Ashton was ready to hit the dorms.
''It made more sense to me to have the money grow in other types of investments,'' says the 34-year-old insurance executive from Mansfield, Tex., who cobbled together a mix of investments to fund Ashton's college education.
Now he's had a change of heart. In August he wrote an $8,000 check to a 529 plan. Another $5,000 is headed for the account this year. In short, Blackburn has joined a growing group of parents giving 529 college-savings plans a fresh look.
These accounts are seeing the beginning of a renaissance. Financial Research Corp., a Boston consulting firm, projects that 529 savings plan assets will grow about 27 percent this year, to $112 billion. Behind the newfound interest in 529s are some surprising steps by the federal government and many states: They have made the plans better.
Named for a section of the federal tax code, 529 plans offer tax breaks for people who save for college. Some states offer an immediate break through an income-tax deduction, while Uncle Sam and some states offer relief on the back end - no tax on withdrawals.
As recently as a year ago, though, some parents hesitated to take the plunge, partly because the federal tax break on withdrawals was set to expire in 2010. That changed last year, when the Pension Protection Act made that break permanent.
What's more, many states have started slashing the plans' once-onerous fees - in some cases, by a third or more since 2004 - or adding tax deductions and other incentives for annual contributions to the accounts. The big players in the industry are gearing up for a growth spurt. A survey last fall by Fidelity Investments found that more than half of parents with children age 10 or younger were more likely to open 529 accounts because of the federal legislation. (Depending on the state, the plans allow parents or others to contribute up to $341,000 for each child.) To prod them along, states from California to Pennsylvania are running new ad campaigns to promote their plans. Maine even gives families with newborns a $50 grant to jump-start their account. ''It's never too early or too late to start,'' says Gov. John Baldacci.
With the total cost of college increasing at twice the rate of inflation, 529s couldn't be more important today. Still, many people find them pretty baffling.
The plans are sponsored by individual states, so each has its own set of managers, fees and rules. Parents don't have to stick with their home state, but many states offer benefits to do so. Some states have prepaid plans that enable you to pay today's tuition rates for a future education.
Some skeptics still think the plans have big drawbacks. Even in the lowest-cost 529s, the fees tend to be higher than what an average investor would pay on investments bought directly from a fund company. The state middleman and the extra administration involved in managing the money as a separate plan create costs that eat away at the investment gains. That said, the tax savings typically outweigh these added costs.
Another rap on 529s is that they limit flexibility; each plan has a set number of investment choices, and investors pay a 10 percent penalty if they make withdrawals for anything other than qualified education expenses.
''You have every adviser out there pushing them, and the message is that if you don't get a 529, then you are a bad parent,'' complains Sean Sebold, a financial planner in Chicago. ''But it eliminates options.''
Competition has knocked down some of the higher costs. According to Financial Research, the underlying annual expenses for funds in 529 plans have fallen 31 percent since 2004, to 0.74 percent. That's a yearly savings of $34 for every $10,000 invested. In the past few years, most plans have also dropped their enrollment fees, which could be as high as $90. And many plans now waive annual fees for in-state residents, accounts with high balances or savers who sign up for automatic contributions.
Fees, meanwhile, can vary by state - even for similar funds from the same investment firm. Expense ratios for Vanguard's age-based funds, with investments that become more conservative as the college years near, average 0.50 percent in Nevada. If you live in Little Rock, Ark., those Vanguard funds cost 0.85 percent, but they might be worth it because Arkansas residents get the income-tax deduction.
With all the complications, some 80 percent of 529 accounts are sold through brokers. But with upfront commissions as high as 5.75 percent, you can save a bundle by doing the research yourself and buying directly from the plan.
After all that, experts say parents still need to keep an eye on the account as junior grows up. Joe Hurley, founder of Savingforcollege.com, which tracks and compares 529 plans, says it might even make sense to switch programs as fees drop: ''The lowest-cost plan today won't be the lowest-cost plan tomorrow.''

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