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The New Gold Standard among 529 College Savings Plans?

Finally, investors have a reasonable pricing scheme from which to choose.

Kerry O'Boyle, 08/07/2007

We've taken Illinois to task in the past for the state of its 529 program, mainly for its unfair tax treatment for residents that opt to invest in an out-of-state plan. But an overhaul of its Bright Start College Savings Program, the details of which came in July, offers college savers everywhere hope.

Illinois awarded a seven-year contract to OppenheimerFunds in March to become the new program manager in a competitive bidding process to replace Legg Mason after its contract had expired. As promised, it's one of the most affordable options now available. Officially managed by OFI Private Investments, Inc.--a subsidiary of OppenheimerFunds--the plan offers the flexibility of investing in the cheapest age-based index portfolios in the industry alongside low-cost actively managed choices. It's available in both direct- and broker-sold options.

Did We Mention It's Cheap?
Ranging from 0.2% to 0.23% of assets annually plus a $10 yearly account fee, the total cost of the plan's age-based index option and three static index portfolios--all consisting of Vanguard funds--jumps immediately to the head of the class in the price-is-everything world of indexing. The fees are well below those of previous low-cost leader Utah (0.25% to 0.39%, plus up to a $25 account fee for nonresidents) and far cheaper than the 0.5% flat rate age-based portfolios recently touted by the Nevada Vanguard and California Fidelity plans.

The actively managed part of the plan consists of an age-based option and four static portfolios--including a principal protection fund. Its total annual asset-based costs are 0.56% to 0.6%. Only the direct-sold variant of the actively managed plan from South Dakota, which is limited to residents and employees of the program manager, is cheaper. At 0.81% to 0.86%, which includes a 0.25% broker-servicing fee, the advisor-sold variant is among the cheapest of its class as well.

Our longstanding criticism of 529 plans has been their high costs due to layer upon layer of fees. While we understand that this is a business for the managers and that states need to cover expenses, costs have seemed unduly high. Certainly, Illinois and Oppenheimer have done some interesting maneuvering to make this plan so cheap. For example, the state replaced its 0.03% administrative fee with the $10 account fee on the index options. Oppenheimer waived part of its program management fee on the index offerings as well, though a footnote stipulates that these waivers will cease as assets grow and the plan is able to invest in cheaper Vanguard institutional share classes of the underlying funds. Thus, any economies of scale derived from future growth in assets at the plan will be offset by a higher program management fee. The total costs will stay the same, investors just shouldn't expect it to get any cheaper.

Still, the bottom line for investors is that in terms of overall costs this plan is now dirt cheap relative to the rest of the 529 universe. It provides solid options for indexing fans and those who prefer active management. The asset-allocation schemes for the age-based options are measured, suitable for investors willing to tolerate moderate risk.

Not Perfect
Despite the great strides made, we do have a few quibbles with the Illinois plan. The equity portfolios--both index and actively managed--lean heavily toward large caps relative to the overall market. While maybe not a bad idea in the short run after a seven-year run-up in small- and mid-cap stocks, one can never be sure. We typically like to see these plans maintain well-diversified portfolios instead of trying to possibly time any market cycles. Some may also view the 15% international equity stake as light, though there's no clear consensus as to what is an appropriate amount of foreign exposure. Plus, the static portfolios are a bit lame, little more than copies of some of the options under the age-based plan that don't offer do-it-yourself portfolio builders much to work with.

Our biggest gripe, however, is with the thin lineup of underlying funds in the actively managed portfolios. Oppenheimer attempts to cover the entire U.S. equity market with just two funds: Oppenheimer Main Street Opportunity OMSYX and Oppenheimer Main Street Small Cap OPMYX. Both have solid track records and are cheap, but the same team using essentially the same quantitative strategy runs both. Should that approach falter, then a large chunk of the portfolio will falter as well.

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