Investing

Is Your 529 Plan Robbing You Blind?

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Imagine you found one online retailer selling a plasma TV for $3,000, and another selling the exact same TV for $1000. No catches—a threefold difference in price. No one buys an expensive product when they’re selling the same one for a fraction of the price just a click away, right?

They do if the product is a 529 college savings plan.

There are over eighty 529 plans on the market, according to savingforcollege.com, one of the most comprehensive 529 plan resources on the web. Most of these plans are open to savers from any state. (Note: This column is only about investment plans, not the prepaid tuition plans offered by a few states.)

Worse than the profusion of plans is the fact that it’s so hard to figure out what they cost. “With mutual fund fees, there’s this wealth of information. It’s easy to compare fees,” says Laura Lutton of Morningstar, which ranked the best and worst 529s in October. “But it’s not that way on the 529 side.”

Fear not. Help is here.

The all-important expense ratio

Shopping for 529 plans isn’t like buying a couch. The price tag comes in the form of various fees and, most important, the expense ratio.

The expense ratio is easy to understand in principle: it’s just the percentage of your assets you’ll pay in administration fees, per year. So if you average $10,000 in your account this year and the expense ratio is 1%, you’ll pay $100.

That’s how I’d put it, at least, if I were trying to sell you an overpriced plan. We’ll only charge you 1%—big deal!

Actually, it’s a huge deal. Let’s do an experiment. Say you and I have a baby (I really love my readers). The day little Minty is born, we put $200 in her 529 plan, and we do the same every month until she turns 18 and enrolls at the University of Outer Space Robot Science. Furthermore, let’s say our investments do very well and we earn 6% per year before expenses. Let’s see how the expense ratio will affect our total savings.

Expense ratio

Total savings

0.25%

$75,833

0.91%

$70,787

1.85%

$64,295

Yes, that’s more than $10,000 difference, all because of less than two lousy (really lousy!) percentage points in extra expenses. Small differences in expenses have a huge effect on your balance because you’re not just missing out on that $100—you’re missing out on the opportunity to earn compound interest on it in the future. It’s the magic of compound interest, upside your head.

“Fees overall are still too high,” says Morningstar’s Lutton. “While there have been some great examples of cuts, I think there’s still room to go.”

The cuts came courtesy of some of the largest plans, which now charge about 0.25% for most of their investment options. These include Ohio, New York, California, Utah, and Nevada (of which I’m a member).

David Taylor, a MintLife reader and father of two, was paying about 0.91% for his 529, which is offered by TD Ameritrade in association with the state of Nebraska. Taylor lives in Texas, so he wasn’t benefiting from the Nebraska state tax deduction. “I signed up for a 529 so long ago, I don’t even remember if I compared expenses,” says Taylor. “I suspect that I went with TD Ameritrade because I was using them as my brokerage at the time.”

For Taylor, however, there’s good news and better news.

The good news is Nebraska is participating in the ongoing 529 plan price war. I spoke with the Nebraska state treasurer’s office, and they’re lowering their prices starting December 18. For the TD Ameritrade plan, the new minimum expense ratio will be closer to 0.5%. There’s also a plan available directly through the state where investors pay about 0.35%. Nebraska is also dropping its $20 annual account maintenance fee. “That was one thing that really irked me,” says Taylor.

The better news is that Taylor isn’t waiting; he’s moving his account to Utah, where he’ll pay even less than Nebraska’s new, lower prices.

What about that 1.85% ratio? It represents the most expensive advisor-sold plans, such as South Dakota’s CollegeAccess 529, rated most expensive by Morningstar. Many states offer advisor-sold plans, which are far more expensive than direct-sold plans that you open through the state’s website. Avoid them like you’d avoid a purse snatcher.

Move your money

Competition is driving down 529 fees and expenses—it’s just not doing it fast enough. If you have money in a 529 now or are planning to open one, take a moment to do two things that could save you thousands of dollars:

1. Check the master list of state tax deductions from FinAid.org. If your state offers a generous deduction, it’s often (but not always) worth taking it even if the plan charges higher expenses. “Every state would describe their tax benefits as generous,” says Lutton. Not all of them are. It’s especially important to check the list if you’ve moved to another state since opening your 529. You can also check the Morningstar report (page 28) to help figure out how much you’re actually saving by taking your state’s tax deduction.

2. Check the expenses and fees you’re paying in your current plan. If your expense ratio is higher than 0.3%, move your money to one of the low-fee plans:

And try not to think about how much of the money you save will be spent on pizza and beer.