Americans' retirement plans haven't been the only thing ruined by the financial and market crisis. College savings plans have also been shattered, and it's caused parents-as well as the burgeoning 529 plan industry built around them-to reassess their strategies.
It may be due to a lack of faith in long-term equity investing. Or it could be that investors feel a secure retirement is more important than building a college nest egg. But what is clear is that Americans have pulled back somewhat in putting away money for college, as indicated by data that shows 529 plan sales and assets have declined since the bottom fell out of the market in the fall of 2008.
Average 529 plan contributions have also decreased and according to some 529 program managers have been weighted more toward conservative investment options.
At the same time, 529 plan providers have quickly adjusted to the changing market and attitudes-offering guaranteed, FDIC-insured bank accounts, for instance-while also fending off criticisms that their investment options were too risky going into the crisis. Of particular concern has been the industry's age-based account, which is by far the most popular 529 plan option in the nation. These accounts work much like target-date mutual funds and are designed to get more conservative as the child gets closer to graduating high school and going to college. Some analysts contend these plans took on too much equity risk even at late stages and that account holders suffered the consequences-losing, in some cases, 20% or more just a year or two before they needed the money.
"I think they got too aggressive," says Fred Amrein, principal of Amrein Financial in Wynnewood, Pa. "Everyone just got greedy."
These are setbacks for an investment product that many advisors considered underused before the crisis. The 529 industry has struggled to win wider acceptance for the plans for more than a decade.
"I think in general [the crisis] has slowed up contributions going into 529 plans," says Joseph Hurley, founder of Savingforcollege.com, a 529 plan information clearing house. "I think the impact is more from families that just don't have the confidence and cash flow they had before."
The sales drops in the fourth quarter of 2008 and the first quarter of 2009 were telling because those are the times of year when 529 plan sales usually peak. In the fourth quarter, at the height of the financial crisis, 529 plan gross sales were down 10% from the previous quarter, according to Financial Research Corp. Assets in 529 plans dropped 21% from a year earlier, going from $111.9 billion to $88.5 billion.
Gross sales were down 1% in the first quarter, while assets were down 22% from a year earlier, to $85.9 billion.
Investors in 529 plan accounts, meanwhile, have been throwing risk to the wind and moving money to the relative safety of CDs and other bank accounts. The programs themselves, meanwhile, have ramped up the number of low-risk options available to account holders, either in the form of FDIC-insured accounts or other forms of principal protection.
Some 529 plans have also seen their participants saving less. The Utah Educational Savings Plan, for example, recently looked at account trends from November 2008 to May 2009 and compared them with the same seven-month period the year before. That program found that the average account holder donated only $562 during the most recent period, after putting in $966 a year earlier.
The rate of new accounts in Utah's 529 program-one of the top rated in the nation-was down 44%, according to program director Lynne Ward. But even though average contributions were down, the plan found that there was no letup in the number of monthly contributions account holders were making. Ward noted that the program, which has no minimum deposit requirements, has families that are making contributions of as little as $10 per month. "People aren't saving as much, but they are still saving," Ward says. The program added FDIC-insured accounts to its options in February.
Studies by the College Savings Foundation indicate that 529 account holders were, like most equity investors, shaken by the market events of late last year and are now gradually moving back into the market. This is reflected in the percentage of 529 account holders participating in automatic savings accounts, says foundation Chairman Kevin McMullen: The percentage of automatic contributions dropped from 39% to 31% in the fourth quarter of 2008, but rose to 38% in the first quarter, he says.
"We are at least encouraged that families think saving for a college education is important," McMullen says. "The increase in the automatic savings plans is a very positive sign."
Some advisors, however, think the market collapse exposed some deep-rooted problems in the 529 plan industry and that systemic changes are needed. "We have kind of soured on 529 plans over the last few years," says Owen Malcolm, senior vice president and chief operating officer of Sanders Financial Management in Norcross, Ga. "Frankly, I'd say there has been very, very little interest in 529 plans from any of our clients."
The lack of interest is mainly due to performance, he says. "It's hard to preach the tax benefits of 529 plans when most folks haven't had gains."
Adding to the problem, Malcolm says, is that 529 plans continue to be a "mysterious" product for most investors, with wide variations in options, fees and flexibility from state to state.
The other problem, he says, is the lack of control 529 plans give to account holders. Until recently, participants were allowed to change asset allocations only once a year. That was recently changed to twice a year-a change that would be made permanent under proposed legislation in Congress.
Malcolm says many of his clients have moved money into the low-risk options now being touted by the 529 industry. But as college costs rise at a rate of 7% or more per year, he sees little benefit in throwing assets into a plan that offers a return of less than 2%. He calls these new options "lipstick on a pig."
The low return is one of the reasons that Hartford Insurance, the program manager for West Virginia's 529 plan, has not vigorously rolled out its own FDIC-insured options, says Jeff Coghan, Hartford's assistant vice president of college savings programs.
"Demand for conservative products is high on the one hand," he says. "On the other hand, we know that college costs have inflated at a rate of 6% a year or even more the last 25 to 30 years, and it's not going to get any better."
Coghan feels the tilt to conservative options is a natural reaction to the financial and economic crisis and that investors will eventually be more receptive to equities.
"I think they are concentrated on paying the bills and their own retirement," he says of investors. "The third priority might be saving for college. Probably, most financial advisors would say that's the order in which you should consider things."
Others express a similar sentiment, saying much of the pullback on college savings is simply due to people placing a higher priority on repairing their retirement funds.
"You can always get a loan for someone going to college, but you can't get a loan for retirement," notes John McAvoy of Waterstone Retirement Services in Canton, Mass.
While market conditions are certainly a key factor in how consumers approach 529 funds, the performance of supposedly conservative age-based options have shown the product's vulnerability, say advisors.
In its annual ratings of 529 plans, Morningstar put the failure of age-based plans at the core of the product's problems in 2008. The poor performance was partly due to the fact that many age-based plans held the Oppenheimer Core Bond Fund as the fixed-income component of their portfolios. The fund lost 35% in 2008 with its exposure to mortgage-backed securities.
Morningstar also came down hard on 529 plans that left investors too exposed to equities at the point the funds were needed to pay for college. For example, New Jersey's direct-sold 529 plan has one age-based option that can have as much as 35% invested in equities for beneficiaries already enrolled in college.
"The critical lesson for investors is to pay particular attention to the latter stages of a plan's age-based option, and be sure you are comfortable with the risk your plan is taking," Morningstar says in its rating report.
Jerry Verseput, president of Veripax Financial Management LLC in El Dorado Hills, Calif., notes that the mix of stocks and bonds can be significantly different depending on who manages the plan.
Because of the element of risk inherent with 529 plans, he advises clients to depend on 529 plans for only 50% to 70% of the total they will need for college expenses.
"This gives them flexibility if their kids decide to make different choices, and keeps a portion of their college savings under their direct control as opposed to turning it over to a 529 fund manager," he says.