Can College Savings Be Saved?

Students are facing a crisis, as they struggle to afford the education they want and need. But while many focus on the impact of student-loan debt on young adults, few are looking at the other side of the coin -- namely, the incentives promoting college savings that in many cases aren't getting the job done.

The rising cost of college has set off a firestorm of debate. Skeptics argue that the rising tide of student-loan debt and ever-increasing tuition costs have reduced the economic benefit of going to college. And while proponents point to increased pay after earning a college or graduate degree, others -- including Fool contributor Brian Stoffel -- have questioned whether there aren't less expensive ways to get the knowledge and experience that will help young adults succeed and prosper in their careers.

But in the ideal situation, students wouldn't have boatloads of debt to deal with because their parents would have been able to set aside enough money to cover their college educations. One vehicle that was established precisely to encourage college savings, the 529 plan, has seen some trouble attracting savings from some quarters -- and even some of the industry professionals that earn handsome incomes from such plans are starting to lose interest.

With 529 plans holding billions in assets, it may seem surprising that some money managers are abandoning the market. But as TheWall Street Journal reported over the weekend, WellsFargo (NYS: WFC) chose not to keep managing Wisconsin's 529 plans (effective later this year), and Fidelity made a similar decision with its California plan.

Part of the problem comes from the trend toward lower-fee investments. With index-tracking exchange-traded funds charging fees that are far less than actively managed mutual funds, the higher-cost investment options that AllianceBernstein (NYS: AB) , Hartford Financial (NYS: HIG) , and other active-management firms have within some 529 plans come under greater pressure from the state board established to oversee the plans.

But one clear component of dissatisfaction with 529 plans has been the losses that investors have suffered during the market's volatile stretch since 2008. Unlike retirement savings, in which many investors have decades to recover from a loss, the time horizon for college savings is by definition shorter. A badly timed market downturn can spell disaster for college savers, and the threat of stock market losses has turned off potential investors from badly performing 529 plans.

That risk has prompted broader investment offerings from 529 plans, including bank CDs and other fixed-income options. Although Fifth Third (NAS: FITB) and some other banks have benefited from increased CD volume through those offerings, low rates aren't helping college savers.

Despite attempts to broaden their investment offerings, 529 plans suffer from the same problem as employer 401(k) retirement plans: a limited menu of options. Even considering that all 50 states offer at least one 529 plan of their own, none of them gives you more than a handful of investments to choose from.

The better solution would be to expand another, more flexible tax-advantaged vehicle that already exists. The Coverdell Education Savings Account acts like an IRA, letting you invest in just about anything you want. As long as you use the money for educational expenses, the income you earn is tax-free when you take it out. Yet despite allowing people to save hundreds of thousands of dollars in 529 plans, the annual limit for Coverdell ESAs is a piddling $2,000 -- and that number is slated to go down to just $500 next year if the bigger contribution limit isn't renewed.

529 plans were a good idea for college savings. But it's increasingly clear that in the tug of war between states trying to draw revenue from administrative fees and financial companies trying to maximize their own revenue, the entire purpose of the plans -- helping people save for a college education -- has been put on the back burner. Until policymakers remember that purpose, 529 plans may well continue to suffer a decline in interest from both savers and the financial community.

Investing for the long run demands special attention. The Motley Fool can help by pointing you in the right direction. Take a look at our special report on long-term investing to help you identify smart investments that can help you with all of your financial goals, from college savings to retirement. But please, don't wait -- click here to get your free report today!

At the time thisarticle was published Fool contributor Dan Caplinger is hedging his bets with a variety of savings vehicles, including Ohio's 529 plan. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Fifth Third Bancorp and Wells Fargo, and has created a covered strangle position in Wells Fargo. Motley Fool newsletter services have recommended buying shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy won't 86 you.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.