New Breed of 529 Plans Invests in ETFs

COLLEGE ISN'T GETTING any cheaper. And, sometimes it seems, neither is saving up for it.

We're talking about 529 plans. Thanks to their promise of tax-free earnings no matter what your income is, they should be a relatively cost-effective option. But to test that proposition, you'd have to add up a profusion of fees that would do any bursar's office proud. States, fund managers and plan administrators all get a cut in many cases. Thus, you can get socked with enrollment, management and admin fees, in addition to those levied by the underlying funds.

The good news is that costs are trending down, and competition from ETFs, which are usually much cheaper than mutual funds, could push them even lower.

iShares 529 from Barclays (BCS) is the first out of this gate after launching earlier in August. The lineup has three portfolio choices. You can pick according to when your child will start college, or by your level of investment daring (conservative, moderate, aggressive). You can also go a customized route. While it's too soon to judge on performance, the plan's cost and offerings are fair game.

First on cost. The good news is that iShares 529 is relatively cheap. If you go by enrollment year, annual fees range from 0.61% to 0.65%. If you go by risk level, it's 0.63%. Custom portfolios charge 0.5% to 1.1%. So far, so good.

But you can only buy iShares 529 from a fee-based financial advisor, adding to the cost. Alternatively, Vanguard and Fidelity 529 plans can be bought directly, and they're also cheap. Vanguard charges 0.5% for portfolios based on a child's age or risk tolerance. Fidelity's index-based offerings also charge 0.5%, or you can buy actively managed plans for 0.7% to 1.09%.

So iShares 529 is cheap, but not necessarily the cheapest. That's fine, but since the underlying funds are ETFs, couldn't it be cheaper?

This is where other fees come in. Underlying investment costs in the iShares 2024 College Portfolio, for example, are just 0.25%. But a program management fee of 0.35% and state administration fee of 0.05% bring the total to 0.65%. (Arkansas is the state sponsor.)

Tom Roberts, principal of A New Approach Financial Planning in Sarasota, Fla., considers iShares 529 "reasonably priced" overall, although he's a bit skeptical of the management fee. "With an ETF option it's about getting the cost down," he says. Yet Roberts does give iShares 529 credit for its menu of offerings, including a real estate portfolio, "which a lot of 529s don't have." The portfolio is based on iShares Cohen & Steers Realty (ICF). Roberts also likes the small-cap offering, based on iShares Russell 2000 (IWM). "A lot of small-cap funds have fairly high fees," he notes.

For investors who prefer to go it alone but still want iShares 529, too bad. Barclays doesn't plan to offer it directly, at least for now. As to cost, prices could fall as assets in the plans grow. "We price products to be competitive, but to be at the right value," says Christine Hudacko, a spokeswoman for Barclays. "We're always analyzing our pricing structures and at times we've been known to lower costs if we can pass the efficiencies on to investors."

Since 529s allow tax-free earnings and distributions for college costs, there's no added tax benefit to having ETFs in a 529 as opposed to mutual funds. But you do get the benefit of transparency. With ETFs, you can find out what each one is holding daily whereas actively managed mutual funds disclose holdings quarterly. And as always, your state's plan may offer special tax breaks so those are worth looking into first.

Also See:
The 529 College-Savings-Plan Estimator
Picking the Right 529 Plan
The College-Savings Superpage