BOSTON — Rising college costs have become an election campaign issue. President Obama spoke at three campuses this week, vowing to keep student loans affordable. He's also threatened to cut federal aid for colleges that fail to keep tuition increases in check.
Obama is spotlighting the issue because he's aware how many voters fret about paying for a child's education without draining retirement savings. As a necessity, parents and their children should pay close attention to the costs they'll pay and the schools they select.
Yet many apparently are giving comparatively little thought to another piece of the equation, the cost of saving for college. How else to explain the large proportion of parents choosing college savings plans that charge steep investment fees, despite the widespread availability of affordable plans?
It's an important consideration, because those fees can significantly cut into investment returns and the accumulated savings.
Consider recent research on 529 college savings plans, named for the section number of the federal tax code from which they were created. These state-sponsored investment accounts permit withdrawals for college expenses to be made free of federal taxes.
The Coalition of Mutual Fund Investors found that plans sold through financial advisers or brokers charge more than twice as much in annual fees than plans that parents choose directly through states and manage on their own. The public-policy advocacy organization examined plans in 30 states and Washington D.C. that offer both "adviser-sold" and "direct-sold" 529s.
On average, the adviser-sold plans were 2.15 times as expensive. That calculation factors in annual expenses for mutual funds offered in those plans' investment menus, as well as program management and certain other fees.
The difference was larger when the fund investor organization also included initial sales charges and account maintenance fees that an investor would pay over 10 years – the time span many parents spend building up a 529 account. That comparison found adviser-sold plans cost 2.73 times as much, on average.
In dollar terms, the 10-year cost of a $10,000 investment was an average $1,944 for adviser-sold plans compared with $712 for direct-sold plans. "It seems to me that the cost disparity is more than the advice ought to be worth," says Niels Holch, director of CMFI.
The organization's findings are in line with the conclusions of Morningstar, which rates 529 plans. Last fall, it found that adviser-sold plans charged expense ratios of 1.47 percent on average, compared with 0.54 percent for direct-sold plans. Those are the ongoing expenses to cover operating costs, expressed as a percentage of assets in the mutual funds a 529 account invests in.
Despite that huge gap, many parents opt for the higher-cost plans. The $133 billion in total 529 assets is split about equally between adviser- and direct-sold plans.
"We find it very difficult to justify any kind of high-cost investment," says Laura Lutton, who oversees Morningstar's 529 ratings. "Those expenses are something that will drag on returns, year in and year out."
Of course, costs aren't the only consideration, and many families who choose to pay for advice may get their money's worth. An adviser can help select investments that match the family's appetite for risk, and help maintain an appropriate mix of stock and bond funds as college enrollment approaches. Then there are the complex rules to navigate about tax treatment and withdrawals. Investors also need to balance college-savings needs with other objectives, like saving for retirement or a home purchase.
Professional advice may be worth the higher cost, especially if a family already has a financial planner they trust, says Andrea Feirstein of AKF Consulting Group, an adviser to dozens of states offering 529 plans. But she says direct-sold plans may be a better option if you don't have that adviser relationship or are fairly new to investing.
Here are four other circumstances where the higher costs of adviser-sold plans may be justified:
1. YOU COULD MISS OUT ON TAX PERKS
Parents aren't limited to signing up for their own state's 529 plan, but two-thirds of the states extend state tax deductions or credits to residents enrolling in their 529s. Those state incentives may be sufficiently generous to offset the higher fees charged, if your state is one of the few offering only an adviser-sold plan.
2. YOU WANT TO TRY BEATING THE MARKET
A key reason that direct-sold plans are less expensive is that they're far more likely to include low-cost index funds. Adviser-sold plans are primarily limited to actively managed funds, which aim to outperform the market, rather than match an index. A wealth of research shows that most managed funds fail to consistently beat the market. Investors who choose an index approach should understand that they'll be giving up the chance to beat the market.
3. YOU'RE NOT A DIYer
If you're not the type to manage your investments, an adviser-sold plan may be a better option. That's especially true if you choose a plan that's not age-based. These increasingly popular 529 plan options are similar to target-date mutual funds geared toward retirement. Age-based 529s take a set-it-and-forget-it approach, automatically adjusting to fewer stock funds and more bonds to reduce risk as a teenager approaches college enrollment.
4. YOU'RE A PROCRASTINATOR
If you're chronically slow to plan for your financial future, an adviser can provide impetus to act. "The worst thing for somebody to do is nothing, when they should be saving for college" says Joe Hurley, founder of the website Savingforcollege.com. "If an adviser is what you need to get moving, then you may want to swallow the extra costs involved."
Link to Coalition for Mutual Fund Investors study on cost differences for direct-sold vs. adviser-sold plans
Link to Morningstar's latest annual report on 529 Plans