NEW YORK ( TheStreet ) -- For a decade, fund companies have been marketing 529 college savings plans. But the financial crisis took a big toll on the plans. In 2008, the average plan lost 24%, according to Morningstar. Reacting to the big losses, politicians charged that the plans were too risky. Some critics argued that the fees were excessive for plain-vanilla investments.
Since the financial meltdown began, plans have taken steps to improve. Many 529 plans have cut expenses. Some funds have lowered risks. "In the last 12 months, 529 plans have become more compelling investments," says Laura Pavlenko Lutton, a Morningstar analyst. Named for Section 529 of the Internal Revenue code, the plans have $119 billion in assets. The plans are designed for families who want to sock away money that can be used for college tuitions. Under the system, states sponsor plans and hire money managers to oversee the assets. Big players in the business include fund companies, such as Fidelity Investments, Franklin Resources ( BEN), and T. Rowe Price ( TROW). The 529 investments typically cost a bit more than comparable mutual funds, but savers like the plans because of the tax advantages. Earnings of the plan investments are not taxable -- provided the money is used to pay for education. The wave of cost cutting began in December 2009 when Fidelity shaved its total annual fees on some investment options from 0.80% to 0.60%. Vanguard reduced its costs from 0.44% to 0.25%. Many other companies joined the cost-cutting spree. Besides reducing expenses, some plans have sought to reach nervous parents by offering safer investment choices. TIAA-CREF rolled out conservative funds that have big allocations to fixed income. Plans sponsored by Massachusetts and other states offer FDIC-insured investments. Should you open a college savings account? That depends on whether you think your child will attend college. If the child does not enroll, you could owe Washington a 10% penalty on the money that has been put into a college fund. Still, many states offer considerable incentives for families to participate in the 529 plans.
Consider the Maryland plan, which is managed by T. Rowe Price. To cover the costs of running the plan, T. Rowe Price charges about 0.20% more than what an investor would normally pay for a portfolio of ordinary funds. So a saver who puts $2,500 into the 529 would face an additional cost of about $5 a year. But a Maryland tax payer could deduct the full $2,500 contribution from state taxable income, producing an annual savings of up to $200 in state income taxes. In addition, all earnings from the investment would not be taxed annually -- or when the fund is liquidated to pay for college. If you do decide to enroll, keep in mind that you need not sign up for your own state's plan. Savers from anywhere can sign up for plans sponsored by Alaska, Nevada and other states. Some of the most popular plan investments vary their asset allocations based on the age of the child. The portfolios start with big stock allocations and then shift to safe fixed-income choices as the student approaches college age. The fund companies figure that if a portfolio suffers a loss in the early years, then there is still time to recover. But there would be no time to rebound from losses that occur at later stages. Companies offer investment choices that range from aggressive solutions to more conservative portfolios. Vanguard Group manages some of the more cautious alternatives. In one choice, the portfolio starts with 50% of assets in stocks and 50% in bonds. By the time the child turns 11, the portfolio is entirely in fixed income. Some T. Rowe Price portfolios take a more aggressive stance. A portfolio for a newborn has 100% of assets in stocks. Even after the student begins freshman year, the portfolio still has 20% in stocks. T. Rowe Price argues that the big stock component is necessary to ensure that the savings can cover tuition costs. In recent years, tuition has been increasing at a rate of around 6% annually. Bond investments may not keep pace with inflation, T. Rowe Price figures. But if a family holds stocks for two decades, then the odds are good that investment returns will match rising tuition costs. Either aggressive or conservative strategies can work. But investors should shop carefully for plans that suit their temperaments -- and seem most likely to cover tuition bills.