Complaints mounting over college savings accounts
Tighter controls on plans proposed
John Trainor thought he was being savvy when he opened a pair of college savings accounts for his two young sons in 1999. But disappointed with their poor returns, Trainor has nearly stopped putting money into the plan and now counts on other investments to cover expected tuition costs.
''I'd almost have been better off sticking it in a mattress," said Trainor, a schoolteacher who lives in Lunenburg.
In the decade since they were created by Congress, so-called 529 college savings plans have soared in popularity. By the end of last year, Americans had $80.3 billion invested in 8.1 million accounts.
But as the first generation of students and parents to take advantage of the plans reaches college, complaints are mounting about poor returns, high fees, and confusion generated by the 80-odd different savings programs offered by state agencies around the country.
''Now that the plans have been through a few market cycles, you can assess the plans that aren't really doing that well, and that a lot are quite expensive," said Lauren Gadkowski, a financial planner who recently moved her practice from Boston to Covington, La.
As a result, the regulatory organization set up by Congress to oversee all state and local bonds, the Municipal Securities Rulemaking Board, has proposed several changes, the most controversial of which would be requiring brokers who sell the plans to make sure they are suitable for the buyer. Industry representatives worry the idea would require brokers to track too many different plans. The board also wants brokers to make customers aware of all the tax benefits of their in-state plans and to prohibit transactions designed only to boost commissions.
Hoping to forestall at least some of the changes, the College Savings Plan Network, a group representing all 50 states, will offer a new Web service by the end of the year to make it easier to comparison shop. ''We feel it will go a long way to addressing the concerns," said Diana Cantor, a Virginia official and past chair of the network.
The 529 savings plans, first begun by a handful of pioneering states like Michigan in the early 1990s, offer several major advantages over other types of college savings plans. Contributions up to $12,000 a year are not subject to federal gift taxes; withdrawals also are exempt from taxation, as long as they are used for costs, such as tuition, room, and board, anywhere in the country. Parents retain control of the fund, unlike other plans that turn the assets over to the child at age 21, whether they use it for education or not. Some states, such as Rhode Island, will match up to $500 annually for low-income residents. In 1994, Michigan won a lawsuit allowing its savings plan to remain free from federal taxes, and other states rushed in to create similar accounts.
One reason for the confusion is that while parents receive marketing material for the plans run by their home states, the best deals are often far from home. In Reading, Daniel Fantasia, said he wound up opening accounts in South Dakota's 529 plan for his two young children, on the advice of financial planner Jack Bevilacqua of Peabody.
''He really helped us navigate the system," Fantasia said. Bevilacqua says he can't track every plan, but at least tries to stay away from those that ranking services such as Morningstar Inc. and Savingforcollege.com show had the worst grades -- like those offered by Arizona and Alabama.
Recent market performance also demonstrates the risks of relying on the stock market for savings. While stocks historically have outperformed other investments over the long term -- the stock market has gained, on average, about 10 percent a year since 1926 -- saving for college is typically over a shorter time, anywhere from 5 to 15 years. And over the shorter haul, the market can be quite fickle. Over the last few years, for example, the market has actually lost ground; on Dec. 31, 2005, the Standard & Poor's 500 stock index, a common measure of the market, was 15 percent below its closing on Dec. 31, 1999. In other periods, however, stock market appreciation can be significant.
The plans can be set up for a child either with the help of a financial adviser, for a price, or bought directly through some state agencies such as the Virginia College Savings Plan. Some plans are available only through a mutual fund company: Massachusetts' U.Fund, for instance, is sold and run by Fidelity Investments.
U.Fund investors have a menu of choices, ranging from aggressive to conservative. The simplest choice is to pick a portfolio designed around the year the child will graduate from high school. Such a fund will be more aggressive in its early years, investing primarily in stocks, and become more conservative as the child nears college age to lessen the risk that the fund will fall dramatically as the time approaches to spend the money.
Fees vary widely, but they average around $25 to set up and $25 a year to maintain, plus charges from the mutual funds in which the 529 plans invest. A U.Fund plan for a child born in 1991 with $10,000 in it costs $114 a year, for example. Meanwhile, a plan aimed at the same-aged child that Putnam Investments runs for the state of Ohio would cost $100.98 a year.
David J. Pearlman, a Fidelity vice president, said that the poor returns in some cases are a natural risk of investing in stocks. But he predicts steps like the industry's website will satisfy overseers such as the securities rulemaking board. In effect, the board is saying ''if industry will improve the disclosure, then it won't put the hit on the industry," Pearlman said.
Ross Kerber can be reached at kerber@globe.com. 