529 Plan Fees Are Dropping

You don’t have to be a math major to see that saving for college is getting cheaper. The question for parents and students is whether it will stay that way.

As the recession has weighed on parents’ ability to sock away money for tuition, the fees on 529 college savings plans (tax-advantaged accounts operated by states or schools) have begun to decline around the country. Earlier this month, Vanguard and Upromise Investments lowered the “all-in costs” (including the annual expense ratio, enrollment fees, annual maintenance fees, and loads or commissions paid to financial advisors) on their direct-sold 529 plan in Colorado by 31%, following fee cuts earlier this year in Arkansas, Nevada, Iowa and New York.

Separately, Fidelity lowered its program management fees on its direct-sold plans in Arizona, California, Delaware, Massachusetts and New Hampshire. The fees were reduced by half for its index portfolios and by a third across its actively-managed portfolios. Fidelity also cut program fees by a third on its advisor-sold plans.

And in November, TIAA-CREF lowered the total annual asset-based fee on its Kentucky 529 plan by five basis points, after lowering fees on 529 plans in Vermont and Minnesota earlier this year.

Between Nov. 1 and Dec. 1, plan managers lowered total 529 fees from an average of 1.19% to 1.17% on advisor-sold plans and from 0.71% to 0.69% on direct-sold plans, according to the Financial Research Corporation (FRC).

And expect to see more fee reductions in the next few months.

Costs on these plans are falling for a few reasons, and the biggest one has little to do with the state of the economy: the nature of their contracts creates competition. When a contract for a state 529 plan expires, program managers compete against each other and may lower their fees to try to secure the new contract, says Joe Hurley, the founder of SavingforCollege.com, which tracks 529 plans.

The market also plays a role. “In a lower-return environment, fees come under more pressure,” says Greg Brown, the lead analyst for 529 plans at Morningstar.

And in this case, the market may have helped pull the bloom off the rose: 529 plans aren’t viewed as optimistically by many investors as they were before the downturn. In 2008 and early 2009, as the stock market tumbled, many families saw their plan balances drop significantly. That fall was so abrupt that it caused some states to pursue legal action against plan managers. On Tuesday, New Mexico became the second state to settle with OppenheimerFunds in a $67.3 million deal that resolves an investigation surrounding the alleged mismanagement of the state’s 529 program.

The net result: fees are coming down. Program managers can afford to lower fees when assets in 529 plans are growing, as they are now. During the third quarter of 2009, 529 plan assets totaled $111.1 billion, up from $85.9 billion from the first quarter of 2009, according to the FRC.

But how long can these lower fees last? Changes to the program management fee and state fee are typically set in stone after a state accepts a program manager’s 529 plan, says Bridget Bearden, a research analyst at the FRC.

“They would have to keep it for the term of the contract,” she says. But program managers can change the underlying fund expense ratio, she says. Those ratios are somewhat analogous to mutual fund expense ratios, which investment companies can raise or lower.

Although lower fees can help investors save more money, they’re not the only variable in a 529 plan. Parents should consider lower fees as an added incentive for a 529 plan, but they should not let such fees dictate their investment choices, says Tommy Grella, Jr., a certified financial planner in Methuen, Mass.

Here are four features investors should consider when choosing a 529 plan.

A tax perk to investing in most 529 plans is that the after-tax dollars contributed to the plan won’t get taxed when withdrawn to pay for college – and neither will the earnings.

And depending on the state investors live in, they may be eligible for deductions or credits when they invest in their own state’s 529 plans. For example, contributions of up to $5,000 per individual per year ($10,000 per married couple filing jointly) to a Connecticut 529 plan can get a state tax deduction. In Illinois, contributions to an Illinois 529 plan or prepaid tuition program of up to $10,000 per individual or $20,000 for a married couple filing jointly are deductible.

Arizona residents can qualify for a state tax deduction now by contributing to an Arizona 529 plan or one out of state. Through 2012, contributions of up to $750 per year for an individual taxpayer and $1,500 per year for a married couple filing jointly are deductible.

In California, residents don’t get a state tax deduction or credit with contributions made to 529 plans.