A Costly Lesson in College Savings

Last month, the Ohio Tuition Trust Authority, which oversees the plan, was named the lead plaintiff in a lawsuit to recover money from Putnam for alleged market timing deemed detrimental to long-term investors.

Strong Capital Management of Menomonee Falls, Wis., which has managed 529 funds in Wisconsin, Oregon and Nevada, and its founder and CEO also have settled federal allegations of abusive trading. The company has since agreed to be purchased by Wells Fargo (WFC Quote).

Political considerations might influence how 529 managers are chosen, says Mercer Bullard, an assistant professor of law at the University of Mississippi and president of a nonprofit, mutual fund shareholder advocacy group called Fund Democracy. At the congressional hearing, he cited the cases of Wisconsin, which chose state-based Strong, and Maryland, which selected Baltimore-based T. Rowe Price(TROW Quote), a fund family rated highly for its Alaska 529 plan.

The SEC recently noted that the states generally don't appear to disclose to investors in writing how they select managers for their 529 plans.

Most states follow a rigorous procurement process in choosing to partner with a financial institution for a 529 plan, according to Diana Cantor, executive director of the Virginia College Savings Plan and chairwoman of the College Savings Plans Network, the association of state 529 plans.

Bullard, however, has urged Congress to require the SEC to regulate 529s immediately, arguing that they have conflicts of interest that cannot be overcome. Already, he said, they have demonstrated their willingness to gouge out-of-state participants with high fees, commissions and lack of disclosure to the benefit of their own residents. Perks can include lower fees, state income tax breaks in many cases and even scholarship monies for needy student residents funded directly from plan fees.

Critics say that the uneven rules, tax deductions in some states but not others and tax penalties for switching states, can make some consumers captive to home-state plans. McNeela pointed to Wisconsin residents invested in the state's 529 plan, run by scandal-ridden Strong Capital, which saddled them with above-average costs and subpar management. They're forced either to wait for improvement or exit the plan and sacrifice their state tax deductions.

Fee Frenzy

Many plans charge a slew of fees. Their exact names may vary but they usually include a one-time enrollment fee, ongoing account-maintenance fees, administrative fees and management fees, and in many cases, broker fees or commissions.

While 1% or 2% in annual fees might seem minuscule to uninformed investors, McNeela of Morningstar says that when combined with brokers' commissions, they can consume as much as one-third of an investor's potential gains, assuming a 6% average annual return.

"In short, too many 529 plans are prohibitively expensive," McNeela told the subcommittee.

Growing concerns about high 529 fees are the reason Rep. Michael G. Oxley (R., Ohio), chairman of the U.S. House of Representatives Committee on Financial Services, convened the June 2 subcommittee hearing. In a Feb. 4 letter to William H. Donaldson, chairman of the SEC, Oxley questioned whether the many fees in some plans offset the tax benefits Congress granted to help families save for college.

Donaldson quickly set up a 529 task force. While the SEC does not regulate 529s directly because they are operated by the states, it does have control over the brokers, dealers and advisers who sell the underlying investments.

Responding to Oxley, the SEC confirmed what outside analysts already had concluded: that in some situations, a 529's high fees could in fact negate the tax benefit.