Seven 529 Plans to Avoid

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Morningstar recently updated its ratings on the largest 529 education savings plans. Joining me today to discuss the plans that earned our lowest ratings is Adam Millson. Adam is an analyst with Morningstar's Global Multi-Asset Funds Research team.

Nice to see you, Adam.

Adam Millson: Nice to see you, Susan.

Dziubinski: We update our 529 plan ratings every October. How many plans did we rate this year, and how many earned our lowest rating, which is the Negative rating?

Millson: This year, we rated 62 plans in total. There were four upgraded plans, seven downgraded plans, and we initiated coverage on one plan this year.

Dziubinski: And then, what traits do the 529 plans with Negative ratings share?

Millson: Sure, absolutely. So, Negative-rated plans are obviously our lowest conviction out there. So, usually, they have one structural--major structural--flaw or flaws that we see. So, that can be excessively high fees, it can be very underresourced investment teams, that could be subpar oversight from the state or the investment manager, or that could also just be a poorly constructed glide path, outdated glide path. Many of these Negative-rated plans have these structural flaws, but they also tend to be those that are a step behind an industry that is very quickly moving and evolving for the betterment of investors.

Dziubinski: Adam, of the seven plans that earn Negative ratings, five are sold through financial advisors. So, is there some relationship between financial advisors and not-so-great 529 plans?

Millson: It's not a direct relationship, by any means. We do have two Bronze-rated advisor-sold plans. So, they can earn our medalist rating--one is offered by Ohio and the other by Virginia. So, not a direct relationship. But advisor-sold plans do tend to come at a higher fee, which is a key pillar of our ratings. And really, there's two key drivers to that. So, advisor-sold plans obviously cater to financial advisors who get commissions on the funds or plans that they put investors in. So, that's one piece of it. The second piece would be the construction of those portfolios that tend to be in advisor-sold plans. So, we tend to see more actively managed strategies going into the portfolios of advisor-sold plans, and because of that, the fees are higher than what you would see with index products that a lot of maybe direct-sold plans like to use. So, those are the two key reasons that drive the higher fees, which is an inherent piece of our assessment of plans.

Dziubinski: Adam, let's do a deep dive into just a couple of the plans that received Negative ratings from us this time. First, we downgraded Nevada's SSgA Upromise 529 Plan this year from Neutral to Negative. Why?

Millson: This Nevada plan, really two key reasons for the downgrade this year. First is the outdated glide path that it has. Although it is a progressive glide path, which we do see as an industry best practice or one of, and they were one of the first to roll that progressive glide path out, but at the same time, they've really fallen behind, and the glide-path construction itself we have concerns with, specifically the steep nature of the glide path kind of going into the enrollment year. That's a critical time for education savers and something that is behind what we would expect.

Secondly is the oversight of the plan. So, Nevada, unlike many states, actually has five plans that they're overseeing. Many states just have two plans. So, having five plans under the oversight, alongside stretched resources, is a concern. So, those two reasons are really why we saw the downgrade to Negative this year.

Dziubinski: And then, we did downgrade another plan to Negative this year from Neutral: New Mexico's Scholars Edge plan. And again, that one from Neutral and Negative. Why?

Millson: Yeah, absolutely. The big driver here was the departure of New Mexico State's Executive Oversight Board's director, that's Ted Miller. Ted Miller joined the state and the board in 2015, and he was an immediate impact to the plan, and he drove a lot of meaningful changes over the years to not only this plan but the direct-sold plan that the state offers as well. So, in 2019, he was a key piece to the overhaul of those plans where we had positive views of the changes that they were making. So, his abrupt retirement was a big loss for the state but also left the state underresourced. So, that's a concern. Then, also, the overall plan's fees are high compared to the overall universe. So, that is a detriment to education savers over the long haul as well.

Dziubinski: Then, lastly, let's say, you're an investor and you're in a subpar 529 plan. Is there anything you can do about that? Can you switch to a different plan? Are there penalties for doing that? What are your options?

Millson: Definitely. So, you can switch from plan to plan, and you have that option. And in most cases, there aren't tax implications tied to that. The IRS does allow one tax-free rollover per beneficiary every 12 months. So, you do have that option available to you. But if you do go over that limit, there can be penalties associated. So, if you're thinking about moving from a plan to a different plan, you just want to make sure that you're being cautious and understand that you're actually qualifying for that one tax-free rollover, and in that case, there's no implications. But again, if you go over that limit, then there can be penalties.

Dziubinski: Well, Adam, thank you for your time today and for walking us through some of these Negative-rated plans. We appreciate it.

Millson: Thank you for having me.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.