Big growth is expected in 529 plans

Assets in Section 529 college savings plans are expected to grow to $145 billion in 2008 from $20 billion in 2002, according to a new study by Cerulli Associates Inc.

But most of the money is expected to stay in the proprietary investment options of firms managing the plans, the study says.

“There’s a bigger percentage in proprietary funds in 529 [plans] than in defined-contribution plans,” says Luis Fleites, an analyst with Boston-based Cerulli.

More than 76% of 529 assets are in single-manager rather than multimanager plans, Mr. Fleites says. A single-manager plan has one money manager that runs the 529 program for the state, which sponsors the plan. Forty-nine states now sponsor 529s, and 29 of them are single-manager plans

Biggest are singles

The five largest 529-plan providers offer only single-manager plans. Teachers Insurance and Annuity Association-College Retirement Equities Fund in New York is the top provider in terms of assets under management, running plans for 13 states with a total of $3.1 billion in assets.

Next is Alliance Capital Management LP in New York, with Rhode Island’s plan and $2.6 billion. Fidelity Investments of Boston, with $2.3 billion and three states, is third.

American Funds in Santa Ana, Calif., has one state (Virginia) and $2 billion in assets, and Putnam Investments LLC of Boston has $1.9 billion in a single state (Ohio).

“It’s still a pretty small market, and even looking to 2008 with [a projected] $145 billion of assets … compared to some $2 trillion in private DC [defined contribution], it’s not that significant,” Mr. Fleites says. “There are a lot of providers competing for a small asset base.”

Mr. Fleites expects 529-plan assets to grow because more plans will be created, and more families will be aware of the programs. Providers have committed to spend from a few hundred thousand dollars to more than $1 million annually to advertise the plans, he said.

Moreover, it should take five to 10 years before participants begin taking money from their plan accounts to pay for college, he added.

Single-manager providers may be enticed to add other money managers to their investment lineup, but these providers will continue to draw the dominant percentage of assets in the near term and are not expected to open their platforms right away.

The top managers have the dominant position, and until someone starts complaining, they won’t be adding other money managers, Mr. Fleites says.

However, TIAA-CREF may start shopping around, either to add an externally managed investment option or to include an investment by another manager in a style it does not currently offer as part of its age-based portfolios, says Timothy E. Lane, the company’s vice president of tuition financing.

“I would not be surprised if the [multimanager approach] is a trend that proliferates,” Mr. Lane says. This decision ultimately would be made by the states, he adds.

Mr. Lane says he doesn’t expect TIAA-CREF to add another manager within a year, because the company would have to develop a strategy for including one and explain why the strategy would benefit participants. “There’s no point in doing it just to be a multimanager,” he says.

Investment management fees average 0.93% of assets. Utah, which runs its own program, has the lowest costs for participants at between 0.25% and 0.35%. The Arizona plan, managed by Waddell & Reed Asset Management Group in Overland Park, Kan., offers the highest fees at between 2.22% and 2.71%.

Some 66% of all 529-plan accounts have less than $5,000, while 26% hold between $5,000 and $20,000. Six percent have $20,000 to $50,000, while 2% have balances exceeding $50,000. The average account balance is $6,457, Mr. Fleites says.

Tuition climbing

Private-tuition rates increased 5.8% to $18,273 for the 2002-2003 school year, and public-tuition rates rose 9.6% to $4,081 annually, according to the New York-based College Board.

Still, there is potential for growth. Only 4.2% of children younger than 18 are covered by 529 plans. Considering the College Board’s projections that a baby born in 2001 will need just shy of $250,000 to cover the total cost of a four-year private college, families soon will have to turn to some sort of savings vehicle.

Mr. Fleites considers 529 plans a very effective choice because of the tax deferral; also, distributions are now tax exempt under the federal tax relief law in 2001.

The problem is that parents historically have had other financial needs, such as mortgage payments and retirement savings, which take precedence over the desire to save for their children ‘s college education.

Although Mr. Fleites says he expects usage of 529 plans to increase, no more than 40% of families with college-bound children are expected to participate.

Ten state plans hold 90% of 529-plan assets and 84% of the accounts, the study showed. The 10 are Ohio, New York, New Hampshire, Maine, Massachusetts, Rhode Island, Pennsylvania, California, Illinois and Connecticut. Some 21 states have multiple providers, Mr. Fleites said; of those, New Mexico and Nevada each have five providers.

The most popular investment menu is one with age-based portfolios, with 60% of 529-assets invested in them.