Our annual review of the 529 college-savings industry.
Editor's note: We've updated our best and worst "529 Travel Guide" map from the Summer 2008 issue of Morningstar Advisor magazine to reflect this year's picks. This map tracks every plan listed since 2004; the plans that have landed on the best lists are still deserving of investors' money, while some on the worst list have improved. Other plans have closed or are now defunct.
It's a dismal scenario: As college tuition continues to shoot up at an alarming rate, investors brave enough to open their 529 college-savings account statements have likely seen a precipitous drop in assets.
In the past, we've been able to laud the 529 industry for lowering fees, improving investment options, and closing down poorly structured plans. Unfortunately, the past year hasn't been so rosy in the college-savings universe. Several plans had maintained too-aggressive asset allocations for students nearing or in college, while other plans were hamstrung by their allegiances to floundering investment options.
A Major Player Stumbles
OppenheimerFunds is the poster child for how badly some 529 players went awry in 2008. Over the past few years, the company had firmly established itself in the 529 college-savings universe. The firm currently manages nine separate college-savings plans, both advisor- and direct-sold, in five states. Unfortunately, all of those plans had exposure to one of the worst bond-fund blowups in 2008. Oppenheimer Core Bond
In fact, one of those nine Oppenheimer-managed plans, Illinois' direct-sold Bright Start College Savings Plan, made our best list last year. The previously named "Active Portfolios" were caught up in Oppenheimer's fixed-income fiasco. The losses were so unprecedented that in mid-January 2009 Illinois' State Treasurer Alexi Giannoulias indicated that he was preparing to file a lawsuit against OppenheimerFunds. At the same time, the state also reacted by no longer offering the three troubled Oppenheimer fixed-income products, but existing shareholder money is still tied up in them. All told, the plan still holds plenty of appeal; its untainted "Index Portfolios" are still the cheapest nationally available Vanguard options.
The worst part for investors in these plans is that the Oppenheimer portfolios positioned closest to college were the ones holding the largest positions in these bond funds. Thus, even though fixed-income investments are typically considered more conservative than equities, the plans' bond options didn't provide the ballast that one might have expected--far from it. For example, Texas' direct-sold College Savings Plan's "Blended Age-Based 15 - 17 Years Portfolio," which had half its assets in Core Bond, fell nearly 30% in 2008, compared with less than half that amount at many peers in a similar age-band. A similar pattern of losses can be found in the same age band at nearly every Oppenheimer-managed 529 plan.
Risky Age-Based Options
Unfortunately, the Oppenheimer-managed plans weren't the only ones with problematic age-based options. Age-based options are designed to transition from mostly equities in a younger child's account to more conservative investments--bonds and cash--as the beneficiary approaches college. There's not a strong consensus on the exact amount of stocks, bonds, and cash to hold for a particular time horizon, but it's clear to us that some plans didn't move out of equities fast enough and were courting far too much risk given that they were geared toward students getting close to matriculation. After all, most students deplete their 529 assets in the space of four years, leaving little time to recover from a serious market downturn like 2008's.
The most striking example of an overly aggressive asset allocation comes from one of Utah's five age-based options. That plan's "S&P and Bonds" age-based option stashes 65% of assets in equities for a college-enrolled beneficiary. This is dangerously bold, in our opinion. It's important to note, however, that this best-in-class plan features four other age-based options with much more sensible structures.
An overly aggressive asset-allocation framework becomes a more serious issue when investors are offered only a single age-based choice. For example, Oregon's OppenheimerFunds 529 Plan has just one age-based option, and until March 30, 2009, the plan's "1-3 Years to College" portfolio had 40% devoted to equities, with more than 5% in foreign stocks. Additionally, New Jersey's direct-sold plan has just one age-based option that can have as much as 35% in equities--including up to 12% in international and 6% in smaller-cap fare--for a beneficiary already enrolled in college. The critical lesson for investors is to pay particular attention to the latter stages of a plan's age-based option, and be sure you are comfortable with the risk your plan is taking.
The terrible performance of some 529 plans in 2008 clearly illustrates that, now more than ever, investors can't afford to invest in anything but best-of-breed college-savings plans.
To arrive at our annual list of the best and worst 529 plans, we've combed piles of 100-plus page plan documents, talked with several plan sponsors and used our own tools to evaluate these plans. There's an enormous amount of data to review, but the critical features we focus on are asset-allocation schemes, fees, flexibility, and the overall quality of the underlying investments.
We like to see plans that have sensible allocations among stocks, bonds, and cash that are appropriate for the age of the beneficiary. We like to see plans that are not only well-diversified across the major asset classes, but are also exposed to such areas as foreign bonds, real estate investment trusts, and Treasury Inflation-Protected Securities for added diversification benefits.
Fees are another important item to consider. Morningstar and others have consistently found that costs are the best predictors of a mutual fund's long-term success, and one can safely extrapolate those findings to the 529 universe as well. Expenses are especially important for the growing number of index-centric plans, which have little else besides expenses to distinguish them.
Flexibility is also an essential ingredient to a 529 plan. In addition to multiple age-based options with differing levels of risk, we also like to see a few fixed-allocation offerings (that is, the level of stocks, bonds, or cash does not change over time) and a good selection of single-fund options for do-it-yourself investors or for advisors looking to tailor-make a portfolio for clients. Finally, the quality of the underlying investments is an important consideration. We look for funds that have experienced managers, a history of good stewardship, and sensible strategies.
Using those criteria, we've ferreted out what we believe to be the five best and five worst college-savings plans in the country. It's important to point out that, although we tend to put newcomers at the top, we don't rank plans within each list. This year's Best and Worst lists are a good deal different from last year's lists--with two newcomers on the Best list, and three on the Worst list.
The Best 529 College-Savings Plans
|Best 529 College-Savings Plans|
Ohio Tuition Trust Authority
|Indiana CollegeChoice 529 Direct Savings Plan||
|Utah Educational Savings Plan Trust||
|Virginia Education Savings Trust||
Virginia College Savings Plan Board
|Virginia CollegeAmerica 529 Savings Plan*||
Indiana CollegeChoice 529 Direct Savings Plan
This direct-sold plan is a newcomer to Morningstar's 529 Best list. Upromise Investments--a subsidiary of the popular Upromise rewards program--took over this plan from J.P. Morgan in the fall of 2008 and upgraded it to a best-in-class choice for investors. This plan keeps it simple, but it gets kudos in a number of areas. First, the plan is built with solid underlying funds from the likes of Vanguard, Dodge & Cox, and Western Asset. The underlying holdings cover all the major asset classes and even include exposure to Treasury Inflation-Protected Securities as a single-fund option. The plan also offers sensibly constructed age-based portfolios and six individual fund options for those who want to customize their portfolios. Fees are very reasonable, ranging from 0.35% for a total stock market index fund to 0.95% for a single-fund international portfolio, while costs for the age based options hover around a modest 0.51% to 0.53%. To top it off, Indiana residents receive a 20% tax credit, up to a maximum of $1,000 per year, on contributions.
The Utah Educational Savings Plan Trust
For those who want a tax-sheltered way to save for college using Vanguard index funds, this is the plan. Utah's 529 plan has long been a favorite of ours and remains a strong choice for its low costs, flexibility, and tried-and-true Vanguard index funds. The plan's fees are a rock-bottom 0.22% to 0.35%, making it one of the cheapest plans in the country. The plan offers plenty of flexibility with five distinct age-based choices, which gives investors a good deal of choice to match the options with a level of risk they are comfortable with. (Even the most risk-tolerant investors should steer clear of the aforementioned "S&P and Bonds" option, however, which has nearly two thirds of assets in equities for college-aged beneficiaries.) Investors also have the option of three individual funds and a few static options to augment the age-based options or build their own portfolios. We'll admit it's not an exciting option, but as this market has demonstrated, it's tough to argue with the merits of a passive, low-cost approach.
Virginia Education Savings Trust (direct-sold) and Virginia CollegeAmerica 529 Savings Plan (broker-sold)
The final two plans are the only carryovers from last year's Best list. The Education Savings Trust has a lot in common with Ohio's direct-sold plan. Similar to the Buckeye plan, Virginia not only sponsors the plan but it also manages it (instead of using a mutual fund firm). So it's not a big surprise to see plenty of diversification across different mutual fund families. The plan's age-based portfolios offer a compelling mix of solid actively managed and index offerings from such shops as Vanguard, Templeton, and Capital Research (advisor to the American Funds). We also like the plan's sensible mix of static-blend options and a smart selection of single fund options that not only cover the three core asset classes, but give investors access to real estate investment trusts and TIPS. The plan also offers residents generous state income tax breaks up to $4,000 of contributions per year--doubling last year's limit and still retaining the benefit that excess contributions can be deducted in later years. Finally, a nice price tag that ranges from 0.31% to 0.54% rounds out the appealing package here.
The state's other topnotch choice, the advisor-sold CollegeAmerica plan, remains a favorite for its large selection of mostly first-rate American Fund mutual funds that give investors access to a broad array of asset classes, including emerging markets, small-cap foreign stocks, and foreign fixed-income securities. Fees are attractive, too, as most of the plan's A-share options are below 1.00% in total annual fees.
The Worst 529 College-Savings Plans
Nebraska State Farm College Savings Plan (broker-sold)
Worst 529 College-Savings Plans Nebraska State Farm College Savings Plan*
New Jersey Best 529 College Savings Plan
Montana Pacific Life Funds 529 College Savings Plan
Ohio Putnam CollegeAdvantage*
Nebraska AIM College Savings Plan*
In November 2008, this plan overhauled its underlying holdings with Oppenheimer mutual funds, and the timing couldn't have been worse. Just as Oppenheimer Core Bond entered this plan as a prominent fixed-income holding, it imploded, dragging down shareholder assets in both the plan's age-based options and its fixed-allocation options. The plan also had exposure to Oppenheimer Limited-Term Government (run by the same management team), which didn't fall as hard in absolute terms but lagged virtually every peer in Morningstar's short government category. That's troubling, but more worrisome is that Nebraska hasn't done anything about it. In contrast, the eight other states that offered Oppenheimer-managed plans have made varying degrees of changes, mostly involving the replacement of Core Bond. We hope the state does something to address the troubled Oppenheimer fixed-income funds in this plan, but until it does we'd steer clear of it.
Nebraska State Farm College Savings Plan (broker-sold)
New Jersey Best 529 College Savings Plan
Names can be deceiving: Despite this plan's "best" moniker, it lands firmly in our Worst category. The first strike against this plan is its overly aggressive age-based option combined with a lack of flexibility. Even after a recent modification on April 1, 2009, the plan's single age-based option can still have up to 60% of assets in equities in the years just prior to enrollment and has up to 35% in equities when a beneficiary is enrolled in college. Another strike against the plan is its above-average fees. Total annual asset-based fees range from 1.04% to 1.23%, which are considerably higher than a number of other direct-sold plans offered in other states. There's also a lack of flexibility in this plan with just two single-fund options. Finally, New Jersey residents have no incentive to stay at home and invest in this plan because there are no state income tax deductions for contributions.
Montana Pacific Life Funds 529
This is one of the least flexible plans around. Investors are offered only five fixed-allocation portfolios and a money market option. There are no age-based options, which is troubling given how popular these options are. We also take issue with the lack of single-fund options. The plan's prospectus highlights a decent roster of individual-fund offerings, but all these options have been closed to new investors since early 2007. Fees are a problem, too, ranging from a reasonable 0.96% to a pricey 1.47% (excluding the plan's money market option). It's important to note that the plan's five fixed-allocation funds are held down by a fee waiver that is set to expire in June 2009. Pacific Life has in the past kept this fee waiver in place, but if removed, the fees on these funds would exceed 2%.
Ohio Putnam CollegeAdvantage (broker-sold)
At the polar opposite end of the spectrum from Ohio's laudable direct-sold plan, on our Best list, is this troubled college-savings plan. Similar to last year, we remain concerned about this plan mostly for its heavy exposure to Putnam funds. Putnam has been plagued by stewardship issues since late 2007 due to numerous manager departures and troubling executive turnover. As a result, the firm's funds get F's for the corporate culture section of their Stewardship Grades; no other firm's funds score that poorly for corporate culture. The state deserves credit for attempting to upgrade this plan last year by adding a handful of solid non-Putnam options, lowering fees a bit, and removing what plan administrators believed to be the worst Putnam options. However, the majority of the plan's underlying holdings are still Putnam funds. Until Ohio does more house-cleaning, we'd avoid it.
It's also worth mentioning that Ohio's Putnam plan may soon be overshadowed by a new option: The Ohio Tuition Trust Authority recently announced that BlackRock has been selected to run a new 529 plan in the Buckeye state. Although details remain scant--the state is still in contract negotiations with BlackRock--it's safe to say BlackRock would be a significant step up in quality from Putnam.
Nebraska AIM College Savings Plan (broker-sold)
Next to Ohio's Putnam plan, this is the only other holdover from last year's Worst list. Few changes have occurred here, and the same problems--high fees and a lack of flexibility--still plague this plan. Fees have come down a bit, but they are still high, ranging from a whopping 1.25% for a money market account to 1.61% for an aggressive portfolio, on top of broker charges. We also take issue with this plan's flexibility because it lacks single-fund options (outside of a money market fund), which is especially troubling given that advisors typically mix-and-match individual funds for their clients.