529 College Savings Plans: The Good, the Bad and the Unranked

529 College Savings Plans: The Good, the Bad and the Unranked Morningstar (MORN) has published its annual analysis of America's best and worst 529 college savings plans. If you have kids -- and higher-education-related hopes for them -- here's what you need to know.

Good news first. According to Morningstar, the past few years have seen "meaningful improvements" in the quality of 529 plans available to parents seeking a tax-friendly way to save for their kids' educations. In fact, out of 64 plans that Morningstar reviewed, nearly half were good enough to win a "medal" from Morningstar, signifying the mutual funds-rater's opinion that they "serve college savers well over the long term." In the analysts' opinions, 27 of these plans "are likely to outperform their peers on a risk-adjusted basis over a full market cycle."

And the Bad News?

Unfortunately, the bad news is a bit worse than the good news would suggest. While a majority of the rated plans may be good deals, Morningstar actually left more than 25 percent of the nation's 529 plans unrated, thinking them for one reason or another to be too small to merit consideration.

As a result, fewer than one-third of the 86 plans available to parents today -- just 31 percent -- actually won high marks from Morningstar. Furthermore, six of the plans that did win medals from Morningstar were overlaps. That's good news for some people, but irrelevant to many.

You see, 529 plans are state-specific. And six of the plans Morningstar determined to be good values for residents of a state were located in states that already had good plans available. That's great for residents of Colorado, Illinois, Indiana, Nevada, South Carolina and Virginia, each of which have two approved plans to choose from. It's less good news for the rest of us.

Out of the 50 states (and one plan in the District of Columbia), 29 states (and the District) are left with no Morningstar-approved 529 option at all.

Result: You may have a 529 plan available in your state ... but you may wish you hadn't. Residents of those states are stuck choosing from the 33 plans Morningstar rated "neutral," the four earning "negative" ratings, or one of the 22 "too-small" plans deemed unworthy of consideration.

Back to the Good News

But enough doom and gloom. Let's quickly review the winners, beginning with the four 529 plans to which Morningstar assigned gold stars:
  • T. Rowe Price (TROW) College Savings Plan in Alaska
  • Vanguard 529 College Savings Plan in Nevada
  • Maryland College Investment Plan in Maryland
  • Utah Educational Savings Plan in Utah
Winners of the Silver included:
  • iShares 529 Plan in Arizona
  • Michigan Education Savings Program in Michigan
  • CollegeAdvantage 529 Savings Plan in Ohio
  • CollegeAmerica in Virginia
As for the runner-up Bronze category... well, that list is a bit longer. You can find it right here.

Best of the Best

What can we glean from Morningstar's ratings? Overall, plans managed by Upromise Investments scored the most "medals," being mentioned positively seven times in the report. TIAA Tuition Financing, part of the Teachers Insurance and Annuity Association of America, scored second best with four mentions. T. Rowe Price tied Columbia Management for third place, with two mentions apiece.

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As for what the analysts like about these plans, Morningstar tends to emphasize low fees, low dollar requirements to open a plan, and of course, "high quality strategies" as key determining factors in which plans made the cut.

Key to whether a plan made the list of "medalists" at all, though, is often its state of residence. According to Morningstar, a state's tax benefits can actually be dispositive. Morningstar gave a shout out to Georgia's Path2College 529 Plan, for example, based largely on the fact that Georgia gives taxpayers a "tax deduction on $2,000 of contributions annually." Alabama's $5,000 deduction probably helped win its CollegeCounts Direct 529 Fund a bronze medal berth as well.

Three states -- Indiana, Utah, and Vermont -- actually give income tax credits for 529 plan contributions, with the Hoosier state being most generous, crediting 20% of contributions made, up to a maximum tax credit of $1,000 in a given year.

Worst Choices

Finally, Morningstar pilloried four plans as "off the mark." Rhode Island's two 529 "CollegeBoundfund" plan options are said to "predominantly feature investments from AllianceBernstein (AB), which has struggled on the performance side." Minnesota's College Savings Plan, run by TIAA, is criticized for too-high fees. Meanwhile, Minnesota itself is criticized for "stinging" investors with a "2010 decision to withdraw a state grant for college savers."

Morningstar hits Kansas' Schwab 529 College Savings Plan on the high-fee issue as well. According to the analyst, "the expense ratios on the options are so high that they make it very unlikely that the plan will outperform over the long term."

Motley Fool contributor Rich Smith does not have an ownership interest in any company named above. He does, however (happily), have money in a Morningstar-approved 529 plan in his home state of Indiana. Motley Fool newsletter services recommend Morningstar.

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