It’s only fitting that the savings plan that helps families pay for college gets graded itself on how well it performs for investors.
Morningstar recently released its 2018 rankings of the best and worst 529 college-savings plans, and the report cards revealed vast differences in the quality of the programs. In all, the financial company analyzed and scored 62 plans nationwide, representing about 95 percent of the more than $300 billion invested.
With a 529, earnings are not subject to federal taxes as long as the withdrawals are used for qualified educational expenses. Additionally, many states offer tax deductions for residents who make contributions to a plan. You don't need to live in a particular state to invest in its 529. And your child isn't limited to going to a school in the state where you open an account.
As part of its analysis, Morningstar also took a look at how many people are using 529s. It's not as many as it should be considering the high cost of college and the heavy load of student debt that people are accumulating — $1.53 trillion overall, according to the Federal Reserve.
"We estimate that American families leave over $200 billion on the table by not using 529s for college savings,” according to Steve Wendel, head of behavioral science for Morningstar.
By using 529 plans, families could save 25 percent less and still have the same amount of money available when their child is ready for college, according to the Morningstar report.
Under Morningstar's rating system, plans could earn a gold, silver, bronze, neutral or negative rating. Plans earned top ratings for low fees, exceptional investment options, strong state oversight and a good asset-allocation approach for the popular age-based portfolios. These portfolios invest more aggressively when beneficiaries are younger, increasingly moving to more conservative options as the child gets closer to attending college.
Morningstar gave only four plans its highest rating (gold): Illinois' Bright Start College Savings, Virginia's Invest 529, Nevada's Vanguard 529 College Savings and Utah's Educational Savings Plan.
Nine plans in these states received a silver ranking: Illinois, Ohio, Virginia, Alabama, Maryland, Michigan, Missouri, California and Alaska. Eighteen plans got a bronze rating.
Twenty-six plans earned a neutral designation, which means they had room for improvement. But neutral doesn't necessarily mean stay away.
"Some neutral-rated programs may hold appeal for in-state residents because of meaningful added benefits, such as local tax breaks,” Morningstar said.
The five plans at the bottom of the list mostly got the lowest rating because they haven't followed the trend of reducing fees. The state plans with the lowest ratings are: North Dakota's College SAVE, Florida's 529 Savings Plan, New Jersey's Franklin Templeton 529 College Savings, Arkansas' GIFT College Investing Plan and Nebraska's TD Ameritrade 529 College Savings.
As an industry, many plans are lowering costs, and those that don’t are increasingly unattractive as an investment option, said Leo Acheson, associate director of Morningstar’s multi-asset and alternative strategies team.
The Arkansas and North Dakota plans were both given an “F” because of excessively high fees, even though they offered Vanguard's typically low-cost index funds, Acheson told me. In this area, the plans aren't keeping up with their peers.
"Prices depend somewhat on scale, or assets across the plan, and Arkansas and North Dakota are relatively small and therefore charge high program-management fees that erode Vanguard’s usual edge in price,” according to the Morningstar report by Acheson and associate analyst Stefan Sayre. “There’s little incentive for even in-state college savers to stay in the plans when similar fare is offered at a much more palatable price.”
As with any investment, it's important to pay attention to costs. Fees matter because they reduce your return. For direct-sold plans, age-based portfolios that use active investment management on average charge about 0.80 percent, Acheson said. But direct-sold plans utilizing low-cost index strategies would cost on average roughly 0.25 percent. Compare this with a plan sold through a financial adviser, where average fees for active age-based portfolios are about 1 percent.
“Hopefully the adviser would be adding value either through making certain recommendations within the plan or by encouraging greater savings,” Acheson said. “The adviser-sold plans do cost more.”
Another key factor Morningstar looks at is whether a state plan has strong oversight. Analysts look for states that stay on top of industry best practices or keep assessing the cost of their 529 plans. Some states take a hands-off approach and aren't as attentive to how plans are run, Acheson said.
You can find the full list of the rankings at Morningstar.com.
Choosing a 529 plan can be overwhelming, so use these ratings to help find the best fit for you and your student.