Regulators Focus on College Savings
The darling of the college savings world -- the so-called 529 plan -- is coming under increasing scrutiny, as regulators fret that savers may have lost millions of dollars to high fees and inappropriate investments.
The plans, named after a U.S. Tax Code section, have become wildly popular in the last few years, amassing more than $51 billion in assets. They allow individuals to accumulate college money that will be free of federal and state income tax. They are sponsored by state governments but offered through mutual fund companies.
Amid the growing popularity of these plans, however, both the Securities and Exchange Commission and the NASD have started to scrutinize how 529 plans are marketed to the public. The NASD, the brokerage industry’s self-regulatory group, said last week that it was investigating 20 firms for potentially improper 529 sales.
Of particular concern to regulators is that investors get fewer disclosures when they buy 529 plans than they would if they were buying ordinary mutual funds.
Mutual funds are normally sold by way of a prospectus -- a lengthy legal document that spells out fees and expenses, historic returns and risks, among other things. The 529 plans are not required to send out prospectuses, and many are so new that they have little to say about historic returns. However, SEC officials say, the fees charged by some plans are sometimes so high that the costs can negate their substantial tax benefits.
In addition, data collected by regulators indicate that many investors may have been directed to funds that are inappropriate for their circumstances, said Mary Schapiro, vice chairwoman of the NASD, formerly the National Assn. of Securities Dealers.
The NASD, which launched its investigation of 529 sales this year, says the 20 broker-dealer firms it reviewed were consistently selling out-of-state plans, even though some tax benefits are available only to those who buy 529 plans sponsored by their home states.
California residents get no special state tax deductions for buying the state’s 529 plan -- the Golden State ScholarShare fund. Still, if California residents were encouraged to avoid the state’s low-fee fund in favor of a higher-cost fund sponsored by another state, it would raise red flags, the NASD said.
Indeed, although about 80 versions of 529 plans are offered nationwide, the probe has found that many brokerage firms sell just one 529 fund to all of their clients. It stretches credibility to think that one fund is appropriate for all, and yet brokers are bound to recommend only appropriate investments to their clients, Schapiro said.
“We have to understand the extent to which there was disclosure about the tax benefits. We also are looking at their sales material and advertising,” said Schapiro, who said the probe was continuing.
“The 529 concept is a great one,” she added. “There is no denying the great federal tax benefits. But investors have to think about what’s the right plan for them.”
Buying a 529 plan is far more complex than buying an ordinary mutual fund, said Joseph Hurley, author of “The Best Way to Save for College.” Unfortunately, some brokers are as ignorant as their clients about the risks and rewards of particular plans, he said.
The main selling point of all the plans is tax breaks. As long as 529 money is eventually used for qualified education expenses -- generally college tuition, fees, room and board -- all the money that accumulates in the account is free of federal and state income tax.
All the plans are sponsored by state governments but offered through mutual fund companies such as Vanguard, T. Rowe Price and Putnam. Every state sponsors at least one, and some offer several.
To encourage residents to choose a 529 plan in their home states, 25 states and the District of Columbia offer deductions or credits to their residents who contribute to the plans. That extra tax benefit boosts the effective investment return, Hurley said.
Other benefits of the 529: Money put in these plans remains in the control of the donor -- the child can’t take the college money and run to Europe. Assets in 529 accounts also are considered the donor’s asset for financial aid purposes, which can allow the child to qualify for comparatively more federal aid. The accounts offer some attractive estate planning benefits too.
Yet regulators complain that fees charged by some plans are so high that they can wipe out all the economic benefits of investing in a 529.
“The good news is that there’s no shortage of plans available,” Schapiro said. “But no two plans are the same. Fees and expenses vary greatly, and high fees and expenses can cut significantly into your returns, so you have to choose carefully.”
How can investors best choose among the different 529 options?
Hurley has a 50-question checklist, which includes such details as whether the name of the donor can be changed on the account if, for instance, a grandparent wants to transfer management of the account to the child’s parent. But, for most people, the pivotal issues boil down to a relative handful, he noted. Specifically:
Investment options. Each 529 plan will offer a limited number of investment options. Some, in fact, offer just one choice -- a portfolio that invests assets in stocks, bonds and cash based on the age of the beneficiary and whether he or she will need to access the money in a year or two or instead have time to take on a little more risk in hopes of greater returns. Others offer more choices, including the ability to mix investments individually.
There’s no right or wrong to these options, Hurley noted. Contributors simply need to consider what type of plan they prefer.
Fees. Much as with mutual funds, the fees charged on 529 plans vary dramatically, from a few cents per $100 invested to more than $2 per $100. Some also levy account setup fees and annual maintenance fees.
These costs are deducted from the investor’s return each year and can be particularly significant when viewed over time, Schapiro said. To help investors understand the weight of the fees and expenses, the NASD has recently launched an “expense analyzer” on its website at www.nasd.com.
Minimums and maximums. Every plan stipulates the maximum amount that can be saved in each beneficiary’s plan as well as the minimum amount that can be invested at any one time.
Those of modest means may want to look for plans that allow regular minimum investments as low as $15 to $25 a month. Well-heeled parents and grandparents, who would like to use the accounts for estate planning, should look for high lifetime maximums. Many of the plans allow contributions exceeding $250,000 per beneficiary.
Ratings. One good way to winnow the array of options is to check the ratings on Hurley’s website, www.savingforcollege .com. This free service rates 529 plans on investment options, tax benefits, fees and services, giving five “caps” to the plans Hurley considers the best and one or no caps to those with high fees and bad investment choices.
Hurley cautions that the ratings can’t be considered a predictor of future investment returns. They’re simply indicative of good and bad plan designs.
Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof @latimes.com. For past columns, visit latimes.com/kristof.
