Interpreting 529 Plan Expenses

Interpreting 529 Plan Expenses

529 plans have many benefits, ranging from the fact that the owner, not the beneficiary controls the assets to the fact that earnings grow tax free from federal taxes and withdrawals for qualified education expenses are free from federal taxes through 2010. However, one reason many investors have not more readily utilized 529 plans is due to the extreme difficulty in understanding, calculating and comparing total plan expenses. Many of these plans? expenses and cost structures are not very transparent. Furthermore, for those plans whose expenses and total costs are not transparent, there is usually a reason! Although the various expenses involved in 529 plans can get confusing, we?ll attempt to lift the veil of secrecy. We will not, however, attempt to also analyze the potential tax benefits some states offer residents who invest in their own state's plan (although this is not an issue in Texas due to the fact that we do not have a state income tax), as this is a further complicating issue.

Many 529 plans structure their investment options as fund of funds. In reality this means what it says. A fund of funds is simply a grouping of mutual funds into a single mutual fund. An example of a fund of funds is an age-based allocation fund. These fund of funds often build in various administrative expenses as well as underlying fund expenses. In contrast, plans that offer single-fund investment options may offer a unique 529 plan share class, with the administrative fees included in fund operating expenses. Further complicating the analysis is the fact that various plans may use different names for the fees and expenses!

Fund Operating Expenses
Fund operating expenses are those expenses that many of investors are already familiar with. These are asset-based operating expenses of the plan's investment options. In a fund of funds, the total operating expenses would be a weighted average total of each individual fund's operating expenses plus any additional fund of funds overlay expenses. Overlay expenses would be the extra level of expenses tacked on to compensate the 529 plan for assembling and maintaining the fund of funds.

Administrative Program Fees
Those plans that do not offer a unique 529 plan share class typically do not include administrative expenses in fund operating expenses, instead breaking them out as various flat fees for various transactions, a general asset-based fee, or utilizing both methods. Administrative fees compensate the 529 plan program manager and state sponsor for administration and oversight of the plan. Administrative fees may include (although names may differ from plan to plan): (1) account setup or enrollment (most are under $50 with the highest current fee being $90); (2) annual maintenance (which usually range from $10 to $50 per year); (3) state sponsor; (4) beneficiary change; (5) transfer; (6) termination; and (7) rollover.

Sales Charge
529 Plans purchased through a broker or financial advisor, depending on the share class, typically charge an upfront or contingent deferred sales charge. Purchasing a plan directly from the state that sponsors the plan or from the plan's program manager generally costs less than purchasing a plan through a financial advisor. The plans are typically sold in A, B and C share classes. A shares typically carry an upfront commission charge of anywhere from 3% to 5.5%. Class A shares may also impose an asset-based sales charge but it is generally lower than the asset-based sales charge imposed by the other classes. A shares may also offer you discounts, called breakpoints, which may reduce the sales charge. B shares typically pay the financial advisor around 5% upfront, but instead of charging the investor immediately for the commission they might carry an ongoing sales charge of 1.00% for 5 or 6 years at which time the charge may fall back to approximately 0.25%. If the investor exits the plan before the reduction in the ongoing sales charge they may be charged a contingent deferred sales charge that may fall from 5% to 0% over time. Finally, C shares typically charge an ongoing sales charge of approximately 1.00% starting in year one. This charge is never reduced, and, if the plan is exited in the first year to year and one half, the investor may be charged a contingent deferred sales charge of 1.00%.

However, some plans do not have sales loads and may only be purchased directly from the state or through a Registered Investment Advisor. These plans utilize no load mutual funds (i.e. Vanguard, T. Rowe Price, etc.) or typical load funds without the load (i.e. American Funds F shares, PIMCO Funds D shares, etc.). Remember, not all plans have sales loads and you can determine a plan's sales charge by reviewing the fees and charges section of the offering document or prospectus.