529 Plans Continue to Make the Grade With College Savers

As higher-education costs trend up, 529 college-savings plans remain a compelling choice for college savers. New research released today from Morningstar shows that college savers continue to send sizable new assets to the nation's 84 traditional 529 college-savings plans, even though returns and costs haven't always kept up with similar mutual funds.

Diversified Options Continue to Gain Assets
Assets in 529 plans continued to climb in 2013, reaching nearly $200 billion as of the end of 2013, an increase of 20% from the prior year. Both advisor-sold plans and direct-sold plans (which are used primarily by do-it-yourself investors as well as those working with fee-based advisors) saw an uptick in assets, with direct-sold plans maintaining a slight edge at $102 billion versus $98 billion for advisor-sold plans.  

The 529 industry's 2013 growth undoubtedly was helped by strong returns in the equity markets. The S&P 500 Index was up 32% for the period, while the Barclays Capital U.S. Aggregate Bond Index declined by about 2%. Most college savers choose age-based options, in which their assets are diversified between stocks and bonds, and assets shift from stocks to bonds as beneficiaries get closer to college enrollment. That structure puts many 529 college savers' nest eggs closer to the Barclays Capital U.S. Aggregate Bond Index's 2% loss than the S&P 500's 32% gain in 2013, but most age-based options' asset allocations still contain at least a sliver of exposure to stocks when beneficiaries are 19 years old.

College savers' preference for diversified investments also is reflected in flows to the plans' static options. Static 529 investment options do not alter their asset mix over time and often are invested in a single mutual fund or an unchanging collection of mutual funds. Among static 529 options, conservative allocation options took in approximately $890 million, the highest in terms of new asset flows by category in 2013. These investments typically have between 20% and 50% of assets in equities and between 50% and 80% in fixed-income and cash and have consistently been among the top recipients of new assets in recent years.

Net outflows were highest in two bond peer categories, U.S. government and intermediate bond. Withdrawals in these categories may reflect families tapping into their 529s for college expenses but also may reflect concerns about U.S. Treasury bonds' rising interest rates.

Largest Plans Reach Nationwide
State population certainly has an impact on asset size among direct-sold plans. For example, New York has the second-largest pool of assets at $17.6 billion, while relatively sparsely populated states like Vermont and Montana have relatively small asset pools.

Still, plans that market their investments outside their home state's borders have attracted significant assets. At more than $46 billion, Virginia's 529 plans continue to have the most assets under management by a wide margin. Virginia's College America 529 plan is the nation's largest, with just over $44 billion in assets under management, and is distributed nationally through advisors who use CollegeAmerica's program manager, American Funds, in their clients' portfolios. 

Similarly, Nevada and Utah have disproportionately large assets under management relative to their populations, but both are home to 529 plans that are marketed nationally. Both states are among the top 10 in terms of 529 plan assets under management.

Also unexpectedly large from an assets-under-management standpoint is New Hampshire at $11.9 billion. The direct-sold UNIQUE College Investing Plan and Fidelity Advisor 529 Plan market their Fidelity investment options nationwide. Meanwhile, Nevada sponsors four 529 plans, each of which is advertised nationally. The asset managers represented in Nevada's plans are Putnam, SSgA, USAA, and Vanguard, and they bring the state to number three in 529 assets at $12.8 billion.

Fees and Performance Continue to Underwhelm
Beyond asset growth, there are several notable trends within the 529 industry. Although 529 plans have been notoriously more expensive than their traditional open-end mutual fund counterparts, that gap continues to close. The average 529 category still costs 21 basis points more than the typical open-end mutual fund, although that is roughly half the difference from four years prior. However, some plans continue to charge select investors dollar-based maintenance fees, which can create a larger cost drag.

Heftier fees are one reason performance of 529 investment options in general continues to trail that of their traditional open-end mutual fund peers or blended benchmarks, although some structural features of 529 investment options can also affect results. Plan sponsors show a stronger preference for passive investments within 529 plans, as index mutual funds and exchange-traded funds have gained prominence. In addition, 529 investment options tend to have a stronger tilt toward international stocks than their typical mutual fund peer, which has been a drag in recent years.

Still, the tax benefits, at both the federal and state level, continue to provide an incentive for investors to consider select 529 plans as their preferred college savings vehicle. In addition, several plans have been at the forefront of providing high-quality, attractively priced investment options, worthy of a look from home-state as well as out-of-state investors.

For more on trends within the 529 industry, check out the full Morningstar's 2014 529 plan landscape study, available here. A video report exploring the report's findings regarding 529 fund performance versus traditional fund performance is available here. To find out how your 529 plan and its investment options rate with Morningstar's analysts, click here.