Morningstar has upgraded its ratings for six 529 college savings plans and downgraded ratings for three in its latest annual report on these specialty tax-deferred savings plans.
The report covers 62 of the largest 529 plans — 20 sold by advisors and 42 sold directly to consumers — which altogether account for more than 95% of the $250 billion-plus assets in 529 accounts.
Assets in 529 plans grow tax free and can be withdrawn tax free, for federal purposes, so long as they’re used for qualified education expenses such as tuition. In addition, many states offer tax deductions or credits for 529 contributions, in some cases even for contributions in plans based outside those states.
Four of the six funds that Morningstar upgraded are advisor-sold. Two were upgraded from neutral to bronze, and two were upgraded from negative to neutral: CollegeAccess 529 from South Dakota and The Hartford SMART529 from West Virginia.
The other two upgrades are funds sold directly to consumers: the Bright Start College Savings, upgraded from bronze to gold (skipping the silver rating in between) and the CollegeCounts 529 Fund from Alabama, upgraded from bronze to silver:
Morningstar cited lower fees and improved portfolio construction as the primary reasons for the upgrades. Bright Start, for example, replaced its program manager OppenheimerFunds with Union Bank & Trust and revamped its offerings to include “strong underlying funds,” both passive and active, with index age-based funds charging 0.12% to 0.15%, among the lowest fees in the industry, according to Morningstar analyst Leo Acheson. Bright Start also eliminated a $10 maintenance fee.
One advisor-sold fund and two direct-to-consumer-sold funds were downgraded in the latest Morningstar ratings:
The advisor-sold Franklin Templeton 529 College Savings Plan from New Jersey was downgraded from neutral to negative, while the direct-sold CollegeInvest Direct Portfolio from Colorado was downgraded from bronze to neutral and New York’s 529 Program was downgraded from silver to bronze.
“We downgraded New Jersey’s Franklin Templeton 529 College Savings Plan as its fees have not remained competitive and the plan’s age-based portfolios introduce market-timing risk by making large, abrupt declines in equity exposure, whereas others have smoothed the transition from stocks to bonds,” wrote Acheson.
Noncompetitive fees were also the reason behind the Colorado plan downgrade, but that was not the case for the New York plan downgrade.
“Politics have influenced the plan’s investment process,” wrote Acheson about the downgrade of New York’s 529 direct-sold plan, managed by Vanguard. “Vanguard recommended increasing the exposure to international equities and international bonds within the age-based portfolios, but the plan could not because of the state limitation.” Acheson was referring to a New York state law that limits the amount of international equities, emerging markets debt and high-yield bonds in its 529 plan.
The Morningstar ratings are based on five factors: the design of investment options; assessment of the underlying money managers; the stewardship practices of the program manager and state overseer; whether investment options are a good value compared with those of its peers; and the plan’s risk-adjusted performance. In limited instances, Morningstar also takes into account the unique benefits of a plan including local tax breaks, grants and scholarships.
One development that has caught Morningstar’s attention is the way that plans reduce equity exposure over time within age-based funds. They can use a progressive approach that gradually trims stocks in favor of bonds or a static approach that makes relatively large asset-allocation shifts on individual days. Morningstar favors the smoother approach or a static approach using moderate steps of 10 percentage points or less. A static approach relying on big, abrupt changes in asset allocation introduces “meaningful market-timing risk,” as in the New Jerseyvplan writes Acheson.
It upgraded the BlackRock College Advantage 529 Plan from Ohio, in part, because beginning in November it will transition from a static asset allocation shift to a progressive one for its age-based funds. In addition, plans that use Vanguard and Union Bank & Trust as their investment manager have cut in half the size of their shifts inequity allocation — to 12.5 percentage points from 25 for Vanguard-managed plans and to 10 percentage points from 20 in Union Bank & Trust-managed plans.
Plans rated gold, silver or bronze, called medalists, are deemed to follow best practices for investments, choice of managers and asset allocation along with low fees and strong oversight. The other two ratings are neutral and negative.
Of the 62 funds that Morningstar rates, only four have a gold rating. In addition to the Bright Start fund, they are the Invest529 from Virginia, The Vanguard 529 Colleges Savings plan from Nevada and the Utah Education Savings Plan.
Ten plans have silver ratings, 20 bronze ratings and 26 are rated neutral. Only two plans have negative ratings, and both are advisor-sold funds. In addition to the Franklin Templeton plan, which was downgraded, the Ivy Funds InvestEd 529 from Arizona carries a negative rating.
— Check out Families Saving More for College but Underestimating Costs: Fidelity on ThinkAdvisor.