Bloomberg Anywhere Remote Login Bloomberg Terminal Demo Request


Connecting decision makers to a dynamic network of information, people and ideas, Bloomberg quickly and accurately delivers business and financial information, news and insight around the world.


Financial Products

Enterprise Products


Customer Support

  • Americas

    +1 212 318 2000

  • Europe, Middle East, & Africa

    +44 20 7330 7500

  • Asia Pacific

    +65 6212 1000


Industry Products

Media Services

Follow Us

Bloomberg Customers


529s Just Might Make The Grade

Give parents (and grandparents) a program that allows them to invest money tax-free for their kids' (and grandkids') education, and you would think it would be a smashing success. Yet eight years after the so-called 529 college savings plans launched, there's just $82 billion in them. That may sound like a lot, but consider this: It's half the size of the Growth Fund of America (AGTHX), the nation's largest mutual fund.

But changes are under way that make the plans more attractive. For starters, last summer Congress made permanent the tax-free treatment of the plans' profits as long as the money is used for college. (The perk was previously scheduled to expire in 2010.) Some large investment companies that manage the state-sponsored plans are cutting their fees, too. Improvements in the plans' disclosures make it easier to shop for a good deal. "Now is a great time to invest," says Andrea Feirstein, founder of AKF Consulting, which specializes in 529 plans.

The investor-friendly changes have come about for a few reasons. In 2004, Congress held hearings on 529 fees that highlighted the varied and often confusing ways in which plans disclosed them. Now, virtually every 529 program publishes standardized fee tables that do the math for you, presenting total fees for each investment option, says Feirstein.

At the same time, competition among financial services firms to run these plans on behalf of the states has intensified, fueling a price war of sorts. In recent months more than 20 plans managed by such major players as American Century, T. Rowe Price (TROW), Vanguard, and Wells Fargo (WFC) have reduced or announced reductions in the fees they charge account holders--some by nearly 50%. Fidelity recently introduced index-fund investment options, at a cost of 0.50% each, in the plans it manages for Arizona, Delaware, Massachusetts, and New Hampshire, matching the bargain rates it's offering in California. "The big 529 providers are really getting aggressive in structuring low-cost programs," says Joe Hurley, founder of, a site which helps investors compare plans. The cost-cutting is important because high fees can substantially erode--and in some cases, even erase--the plans' tax-saving benefits.

The tax breaks can enhance investment returns, especially over time horizons of 10 or more years, says Sam Beardsley, director of the investment tax division at T. Rowe Price. For starters, earnings on the accounts grow free of federal and state income taxes, and once you withdraw them they're tax-free if used for college or some qualified form of higher education. In addition, residents of 27 states and the District of Columbia can deduct on their state tax returns at least a portion of what they contribute to their home state's plans. Pennsylvania, Kansas, and Maine provide up-front state tax deductions for contributions to any 529.

How much are these tax benefits worth? The answer depends largely on your tax bracket, as well as the investment mix in your account and your rate of return. If you're in the 25% federal tax bracket and invest for a newborn in an all-stock portfolio that earns 7% a year, the federal tax exemption will enhance returns by about 0.9% a year over 18 years, compared with saving without the tax exemption, Hurley calculates. If you live in a high-tax state such as California, the tax break is worth an additional 0.30% or so. That adds up to a total performance advantage of 1.20% a year for the college savings plan. (The value of the benefit rises for those in higher tax brackets and for portfolios that contain bonds, which would otherwise be taxed at a higher rate than stocks.)

California doesn't offer a state tax deduction or credit for putting money in a plan. But those breaks, where available, make the 529 even more attractive. For an estimate of how much your state's tax deduction will boost your annual returns, check the calculator at

Of course, these benefits won't mean much if you make poor investment choices or allow high fees to siphon off a big chunk of the tax savings. Make sure the investment you have in mind has a solid track record, compared with its benchmark. Then calculate the difference between what you'll pay for this investment in a 529, vs. a regular, taxable mutual fund.

Suppose you're a California resident. If you want to save for college using a Standard & Poor's 500-stock index fund, the cost for that in the California plan is 0.50%. That's five times the 0.10% cost of investing in Fidelity's Spartan 500 Index fund. Still, the 529 is well worth the extra 0.40%. Why? The tax benefits amount to 1.20% a year, so you still come out ahead.

As a general rule, if your home state offers a generous tax deduction, give it serious consideration, says Hurley. Otherwise, shop around. You may just find a better deal in another state's plan (table). If you're already in a plan, you can switch your child's account once a year, free of taxes and penalties.

To ascertain the cost of a specific investment, dig into plan disclosure documents. ( publishes links to plan Web sites, where you can download these documents.)

That's not as hard as it sounds. To get the bottom line on California's ScholarShare College Savings Plan, for example, simply flip to the fee tables in the disclosure documents (table, below). Like a growing number of plans, California's offers both actively managed funds and cheaper index funds. All you have to do is glance at the second-to-last column, titled "Total Annual Asset-Based Fees." In the case of the index funds, you'll see that each charges 0.50%.


If you want to see what goes into that fee, start with the first column, "Estimated Underlying Fund Expenses." This tells you the annual cost of investing in each mutual fund. In the case of the Spartan 500 Index fund, for example, the tab is 0.10%. The next column, "Program Manager Fee," tells you how much Fidelity receives for administration. It pockets 0.30% on the Spartan 500 Index fund. The "State Fees," of 0.10%, go to California to cover its expenses. California imposes no annual account maintenance fee. But if it did, it would be listed in the last column, and you'd want to add it in as well.

Sure, it takes a little time to shop for a plan. But when you're trying to amass enough to pay your newborn's tuition in 2025, those tenths of a percentage point can really add up.

By Anne Tergesen

blog comments powered by Disqus