Friday, June 15, 2007

529 College Savings Plan Alert

You've probably heard of the 529 College Savings Plan. It's a program, usually sponsored by a state, that allows you to open an account and save on a tax advantaged basis for college expenses. There are dozens of 529 Plans to choose from, and no two plans are alike. A parent, grandparent, aunt or uncle trying to walk through the thicket of 529 plans could easily become confused and feel lost. They might naturally look for help.

Many 529 plans are sold by stock brokers. It may seem easier to ask a financial professional which of the confusing array of 529 plans is best. That certainly takes less time than wading through the details of even a couple of 529 plans. But stock brokers don't work for free. They work for commissions, and if they persuade you to open an account with a particular 529 Plan, you can be pretty certain they get a commission from it. If fact, they may have disclosed that commission to you. (If they didn't, ask.)

But there's a cloud on the horizon. The SEC (U.S. Securities and Exchange Commission), which regulates stock brokers, posted a "compliance alert" on its website on June 14, 2007: ( The alert says that the SEC staff has uncovered problems with the way that brokerage firms supervise the sale of 529 plans. (You have to scroll about two-thirds of the way through the alert to get to the part about 529 plans.)

Brokerage firms have a legal duty to supervise their sales people (i.e., their brokers). The SEC staff has learned that many brokerage firms lack adequate processes and procedures to supervise the sale of 529 plans. That's not good, because 529 plans are hot ticket items these days, with the cost of college educations rising faster than the rate of inflation.

The SEC reported that one problem was a lack of evidence that brokerage firms were reviewing 529 sales to see that they were suitable for the customers. Brokers are supposed to recommend only investments and financial products that are "suitable" for their customers. Suitability is one of the crucial protections you, as an investor, have. Brokers should focus on your individual needs and wants. For example, if you and your spouse are in your 20's and have a one-year old child, the type of investments you'd use for college savings would probably be more heavily weighted towards stocks and their potential for long term growth, because the child has 17 years to go before college and the stock market may offer good returns over a long period of time like that. But if you and your spouse are north of the big 5-0 and the baby of the family is entering college in two years, you'd want to ratchet down the risk levels of your college savings so that you'd have less chance of losing entire tuition payments in the stock market because a big hedge fund has a tummy ache. If the brokerage firms aren't adequately supervising for suitability, there's a greater risk you might end up with a 529 plan that isn't right for you.

The SEC's compliance alert also revealed that, at many brokerage firms, 529 plan transactions were not entered into the firm's computer records. Why does recordkeeping matter? Because it is one of the keys to effective supervision. If a supervisor can't learn about a sale to a customer, how can the supervisors supervise? A supervisor could be responsible for numerous brokers and can't watch all of them every minute. So the supervisor has to rely on records much of the time. Without good recordkeeping, there may not be effective supervision and that heightens the risk of unsuitable sales of 529 plans.

The SEC also expressed concern that many brokerage firms didn't train supervisors or brokers adequately about the suitability of 529 plans the firms were recommending. This makes us furrow our brows more deeply.

Does the compliance alert mean that a 529 plan account that you opened through a stock broker is wrong for you? Not necessarily. Does it mean that your stock broker cheated you? Not necessarily. But it means that circumstances may have made it easier for a naughty stock broker to deal unfairly with you. Review your plan closely and see if it really suits your needs and wants. Think about whether you're comfortable with the risk levels of the investments in the plan. Look at the fees and expenses of the plan. Are they 2% or 3% a year? If so, that's pretty steep. Less expensive 529 plans are readily available. The plans with high fees and expenses may also be the ones that pay brokers generous commissions. If you have an expensive plan, you'd have to consider whether the broker might have put you in that plan in order to get a juicy commission.

If you're going to talk to a broker about 529 plans, be careful. Do your homework first. Learn as much as you can about these plans before you talk to the broker. Sure, the broker is supposed to be the expert. But the broker is also a salesperson. Would you rely on a salesperson at a car dealership to choose the best vehicle for you? No. You'd study up on cars first and have an idea of what you really want. Buying a 529 plan, which can involve a lot of money, deserves your time and attention, before you meet with the salesperson.

For more information about saving for college, please go to our earlier blog at

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