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College funding is subject to unfair rules, expensive fees

By John F. Wasik
Bloomberg News

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When parents try to save for college expenses, they often go through a financial hazing.

Not only are they saddled with confusing and expensive state savings programs, they also have to endure countless pecuniary pledge nights to plan for financial aid.

The governmental bodies that regulate college funding are of little help, while costs continue to soar. Total charges (tuition and room and board) for public universities climbed 25 percent during the last four years to an average $11,354, according to The College Board, a research and testing organization. Private university fees increased 14 percent, averaging $27,516. During the last year, tuition and fees rose 10.5 percent and 6 percent at public and private colleges, respectively.

Clearly, financial aid and funding programs could be improved to put more assets to work, yet both are mired in needless complexity and expense.

Austan Goolsbee, a professor of economics at the University of Chicago's Graduate School of Business, is saving for college for his two children. To date, though, he has avoided 529 plans because of the high expenses and inflexibility.

"This really drives me nuts," Goolsbee said. "529 plans were designed to offer tax breaks for college savings and ended up being lucrative subsidies for financial providers."

Since states levy administrative fees on investors' assets placed in their plans, they have a huge monetary incentive to market their own 529s. They also may favor in-state brokers and managers who lobby for the business.

It's difficult to tell which plan is the best deal, though, since there's no clear, upfront disclosure of all fees or tax benefits. Not subject to federal mutual-fund or securities regulation, 529s have recently been the target of an investigation by the National Association of Securities Dealers, the federal regulator of securities dealers. The agency is reviewing broker sales practices. The College Savings Plan Network, a group of state treasurers who sponsor 529s, is promoting voluntary guidelines to improve disclosure.

Since fund choices are limited in 529s, college savers are often stuck in programs where expenses are higher than non-529 accounts.
 
For example, you could pay as much as a 5.75 percent commission — in addition to fund expenses of more than 1 percent annually, plus as much as 0.88 percent per year just in the state's administrative fee — on 529 plans sold through brokers. In contrast, you could easily find a Coverdell Education Savings Account with no sales charge and less than 0.50 percent in annual expenses. And you would have a choice of thousands of mutual funds.

The broker-sold fund expenses not only devour returns, they negate the financial benefit of state tax breaks, where offered.

"A lot of people don't even realize they don't have to invest in their state plans," says Goolsbee. "States have monopolies and marketing power. And the tax breaks disappear with the high [529 mutual-fund] fees."

"There are wildly varying expense levels within 529s," said Mercer Bullard, a law professor at the University of Mississippi, who has testified before Congress on the subject.

"I would yank these investment products out of the hands of the states, give everyone a state tax break and let residents choose from any plan," Bullard says.

Another area that has parents bewildered is the financial-aid arena. If you have saved money in a child's name or through a Uniform Gift to Minors account, you hurt your child's chances for getting financial aid.

Parental assets such as retirement accounts or home equity, though, aren't counted in federal financial-aid calculations (although they may be counted by some private colleges). So the process unfairly penalizes those who have saved in their children's names and often favors those with high balances in their retirement plans or who have significant home equity.

Susan Dynarski, a professor at Harvard's Kennedy School of Government, has long been critical of the aid process.

Say you have saved $1,000 in pretax income and placed it in an account in your child's name for 18 years. Dynarski found that you would lose $1,881 through income taxes and loss of financial aid versus having the money invested in your name.

"Such arbitrary policy variations undermine the goals of need-based aid," Dynarski says, "in that families with identical financial positions receive very different levels of aid, depending on whether they are savvy enough to steer their savings toward the right vehicles. It shouldn't matter what vehicle you put the money in."

In an attempt to make the aid process fairer, Dynarski would like to see all parental and student assets treated uniformly in the aid formula.

"Under such a system, the aid 'tax' rate on assets would be the same across savings vehicles," Dynarski says.

Until Congress and the states level — and open up — the playing field with college-funding options, you are on your own and will need sophisticated financial planning to maximize your chances for aid and provide the funding you need for college.

Try fee-only financial planners or advisers who don't sell college-savings products (see www.napfa.org) for advice.

In the meantime, informed investors like Goolsbee say they will invest in low-cost, out-of-state 529 plans and put as much as they can in 401(k)s and other retirement accounts, which aren't considered in most financial-aid formulae.