The Best and Worst 529 College Savings Plans

As more parents save for their children's college education in tax-advantaged 529 plans, a new report aims to help them sort through the dozens of state plans by ranking some of the best and worst performers.

The report, released March 1 by Morningstar Inc., found that the best plans, including ones in Utah and Virginia, offer low costs and well-run underlying funds. Both states' plans have been on the Morningstar best-performance list since the investment research firm initiated its annual 529 survey in 2004.

Another factor that helps lift 529s to the top rankings is whether a plan includes enough investment options for investors to build a well-rounded portfolio. Also among the winning 529s are plans sponsored by Nebraska and Colorado. And new to the list this year is the Maryland College Investment Plan.

On the flip side, one of Alabama's broker-sold 529 plans turns up on Morningstar's worst list for the third year in a row, for what the firm calls the plan's high costs and lackluster set of options. Also on the worst list are Nebraska's AIM College Savings Plan, making a repeat appearance, and broker-sold offerings from Alaska, Missouri and West Virginia.

Congress gave a big boost to 529s last year by making permanent the plans' federal tax breaks, which had been set to expire at the end of 2010. Investments in the plans jumped in recent months, lifting total assets to over $90 billion at the end of 2006, according to Financial Research Corp.

With 529 plans, investors deposit after-tax income into an account that typically carries a range of investment options, usually mutual funds. Distributions aren't subject to federal income tax, as long as the money is used to pay for higher education. Competition among plans has prompted states and plan managers in recent years to cut fees and sweeten state tax breaks.

In selecting a 529 plan, investors should consider a number of factors. Foremost, you should check whether your own state's plan offers a tax deduction for contributions, which can raise the appeal of investing close to home. But the benefits of such a deduction can be reduced if a plan's total costs, including management fees and any broker commissions, are relatively high. What's more, a state tax deduction might be less meaningful if the state's tax rate is low.

Though nearly every state offers at least one 529 plan, many states have multiple plans, some of which are sold directly to investors and others that are only available through brokers, making it difficult for consumers to compare options. Information about comparing 529 plans can be found at savingforcollege.com and morningstar.com.

Among Morningstar's list of top plans is the Maryland College Investment Plan, run by T. Rowe Price Group Inc., which last year cut annual fees in the plans it manages for both Maryland and Alaska. Morningstar analyst Kerry O'Boyle says the Maryland plan has reasonably priced investments and a sound asset-allocation strategy. The plan also provides Maryland residents with a state tax deduction.

The Utah Educational Savings Plan, which is run by the state, remains a top choice due to a diverse lineup of portfolios and low annual expenses, which mostly range from 0.25 to 0.38 percent across its portfolios.

"There's lots of different age-based tracks to meet different types of risk tolerances," Mr. O'Boyle says.

The College Savings Plan of Nebraska, run by Union Bank & Trust Co., offers low-cost index funds from Vanguard Group as a core holding in its portfolios while giving investors the flexibility to supplement those funds with reasonably priced, actively managed offerings from American Century Investments, Fidelity Investments and Pacific Investment Management Co., or Pimco, he says.

Two highly rated broker-sold plans include Virginia's CollegeAmerica plan, run by Capital Research & Management Co.'s American Funds, and Colorado's Scholars Choice College Savings Program, run by Legg Mason Inc.'s CAM North America LLC business.

The appeal behind Virginia's plan -- the largest 529 plan in the country -- is its relatively low cost and steady, well-run underlying funds, Morningstar says. The investment lineup of the Colorado plan got a boost after Legg Mason, which bought Citigroup Inc.'s asset-management business, added a range of options last year.

Some 529s that were listed in previous years' surveys among the worst plans were dropped from the list when those states decided to shutter those plans.

Wyoming, for example, closed its high-priced Wyoming College Achievement Plan and merged it with one of Colorado's 529 savings plan. Last year, Arizona closed two of its plans to new enrollments.

This year, what some of the worst offenders on Morningstar's list -- including the Alabama Higher Education 529 Fund and Nebraska's AIM College Savings Plan -- have in common are high fees and mediocre funds, says Mr. O'Boyle.

Many investors in Alabama's age-based portfolios, which consist of a "mixed bag of lackluster funds," may pay annual fees of about 1.35 to 1.63 percent a year. By contrast, reasonably priced 529 plans should cost approximately 1 to 1.25 percent a year for broker-sold plans and less than 1 percent a year for direct-sold plans, he says.

Although Nebraska's AIM plan announced an overhaul of its age-based portfolios for March, investors are still paying above-average costs of about 1.35 to 1.61 percent for aggressively allocated, growth-leaning portfolios with some "weak and unproven underlying funds," Morningstar notes in the report.

Other high-priced plans include Alaska's John Hancock Freedom 529 Plan and West Virginia's Cornerstone SMART529 and Leaders Smart529 plans.

In figuring costs of a 529, investors should consider whether they can buy a plan directly from the state rather than going through a broker, which can add an extra layer of expenses.

There may be other perks to consider as well. Some states won't count the assets held in 529 plans in a decision whether to award state financial aid, says Andrea Feirstein, managing member of AKF Consulting LLC, a New York consultant to the 529 industry.

And while New Jersey residents won't get a state tax deduction for contributions to the plans, their children could be eligible for scholarships if they attend a state institution. "Don't focus just on the deduction, and don't be swayed by it if you live in a state with a low tax rate," says Feirstein.

Investors should also look at how the asset allocation in age-based portfolios shifts over time. Investors with a moderate risk tolerance, for example, should look for an allocation that is 100 percent stocks when the child is a newborn then gradually shift to a roughly equal split between stocks and bonds by the time the child is 10 to 12 years old, suggests Mr. O'Boyle.

By the time the beneficiary is ready to withdraw the money, a reasonable allocation should be about 20 percent equities, 40 percent fixed income and 40 percent cash, he says.

"Saving for college is different than saving for retirement where investors have 20 to 30 years to save," Mr. O'Boyle says. Since you only have 18 years to save for college and have less time to make up sudden losses, investors should look for more conservative asset-allocation strategies, he says.