Morningstar found fees are dropping, but not all plans are bargains.
Here's the good news: Your 529 investment probably costs you less today than it did a few years ago. But 529 investments still tend to be more expensive than similar mutual funds, and some plans are steeply priced.
Morningstar has tracked the movements in 529 investments' fees since 2010. Then we found that 529 categories charged up to 40 basis points more on average than the analogous open-end fund peer group. That difference shrank to 31 basis points in 2011. The decline has continued, with all of the 529 categories below showing lower average expense ratios in 2013 than in 2011. (Note that the aggressive-allocation open-end fund category didn't exist in 2011.)
These fee reductions slightly narrowed the expense gap between 529 investments and their respective open-end mutual fund equivalents. The average large-blend 529 investment option continues to undercut the average open-end large-blend fund on price. As of January 2013, the typical large-blend 529 investment charged 1.05%, down from 1.13% in 2011, as more plans added indexed options to their 529 plans. Over the same period the average open-end investment expense ratio has risen to 1.27% in 2013 from 1.14% in 2011.
Index funds don't entirely explain the price reductions in the 529 industry, however. Several states aggressively negotiated for lower-cost investments in 2012 as their 529 program management contracts were up for renewal. South Carolina's direct-sold Future Scholar 529 program is a notable example. The Columbia-run plan dropped its prices to become one of the cheapest on the market; its average total expense ratio dropped to 0.13% in 2013 from 0.49% in 2011. The underlying investments were formerly a mix of active and passive management and are now entirely passively managed. Additionally, the direct-sold plan has no program management fees. Now the plan is even cheaper than New York's 529 Program and the Utah Educational Savings Plan, which are much larger plans by assets under management and historically had been the lowest-priced index options available to college savers.
In fact, several of the cheapest plans on the market in January 2013, such as Michigan Education Savings Program and EdVest 529 Plan, are plans that were formerly priced near or above industry peers and recently negotiated more-competitive fees for college savers by substituting index options and dropping program management fees. The table below shows each plan's average and asset-weighted total expense ratio.
So, how do you know if you're getting a good deal? While overall expense ratios tend to be higher for advisor-sold age-based options, the biggest amount of variation in expenses comes from direct-sold passive options. The cheapest direct-sold passive option charged 0.11% on average, while the most expensive charged a whopping 0.85%.
The underlying fund expenses for index-based options tend to be low, the difference in price across plans frequently comes from program management fees. Program management fees typically cover 529 plans' administrative and marketing costs, and larger plans can benefit from economies of scale to negotiate lower program management fees. For instance, New York's 529 Program (Direct) has more than $12 billion in assets under management and charges between 0.09% and 0.14% for program management fees, while North Dakota's $335 million College SAVE plan charges a 0.68% program management fee. Regardless of cause, higher expenses guarantee that indexed strategies will underperform their benchmarks, so it pays for investors to be especially price-sensitive for passively managed investments.
Blended options also vary dramatically in price, though this is less surprising given the range of active management in these investments. For instance, the T. Rowe Price College Savings Plan's age-based option is the most expensive of the direct-sold blend group, but it has one of the lowest allocations to index funds. Meanwhile, the age-based options at EdVest 529 Plan and Path2College 529 Plan cost less because they benefit from a hefty weighting to index funds.
The presence of multiple asset managers can also affect total expense ratios. Among direct-sold actively managed plans, those with open architecture have higher prices. The trend doesn't seem to occur among advisor-sold actively managed funds; both closed- and open-architecture plans occupy the top and bottom of the price spectrum.
Only college savers can decide their preferences for advisor-sold or direct-sold plans and whether to choose active management or passive management or a blend of both. Once these decisions are made, however, it pays to be price-conscious; Morningstar's research has demonstrated that more-expensive investments are less likely to outperform over the long term. If a more expensive plan comes along with generous state tax benefits, it may be a sensible option for some college savers. Otherwise, it may make sense to find the most cost-competitive plan available.