Although 529 college savings plans continue to celebrate tremendous growth, the first 529 plan manager is dropping out, and industry experts predict more truancies to come.
The College Savings Foundation recently touted a 55% increase in 529 assets to a total of $45.1 billion in the third quarter from $29 billion a year earlier. Financial Research Corp. predicts college savings plan assets will surge nearly eight times by 2010 to $350 billion.
Amid all this exuberance, State Street Corp. is exiting the college savings plan business, looking instead to focus on its institutional investment core competencies of asset management, trade processing and other back-office services. The Boston-based company also plans to limit its investments in wealth management and develop business overseas, Ron Logue, State Street's chairman and chief executive officer, indicated in the firm's third-quarter earnings call. The firm reported its profits fell 12% year-over-year to $177 million.
The company never achieved the scale it needed in these college savings plans, and as a result, its 529 plan revenue has been "immaterial," said spokeswoman Hannah Grove. State Street's strength has always been the ability to provide efficiencies of scale, and for all of the growth in 529 assets, "there isn't the scale in the business that lends itself to our particular servicing model," she said.
Experts on 529s point to a number of other reasons why State Street, through its Schoolhouse Capital subsidiary, would leave the business, the first and foremost being a different model than other 529 plan managers. "The majority of 529 program managers, and certainly the top 10 plans, are also investment firms," said Bruce Harrington, director of 529 product development for MFS Investment Management. "But State Street set up a model where it was purely the recordkeeper, so it was depending on fee-sharing and transaction-based costs for revenue." These fees tend to be lower than asset management fees, according to industry experts. State Street is currently the recordkeeper for all of the five plan offerings in New Mexico and one of the four in Oregon.
Name recognition has also boosted business for many 529 plans, noted Luis Fleites, a senior analyst with Cerulli Associates, the Boston consulting firm. As a result, American Funds, Alliance Capital, TIAA-CREF, Vanguard Group and Fidelity Investments have handily attracted 529 assets, whereas Schoolhouse Capital was never a well-known brand, he said.
Indeed, Michael Ryan, a certified financial planner with the Professional Planning Group in Westerly, R.I., said he recommends Virginia's 529 plan to his clients because it's managed by American Funds. "I look for history and consistency, and their flagship fund, which goes back to the 1930s, year-in and year-out is in the top 20% of its peers," Ryan said.
As Fleites put it: "At the end of the day, State Street is more of an institutional player, and breaking into the retail world didn't happen quickly enough for them."
Related to reputation is the fact that the majority of 529 assets are accumulated through advisers or brokers, rather than directly sold, which has been Schoolhouse's model. "American Funds' success is quite easy to understand," Fleites said, "as it already has had tremendous success in the traditional mutual fund world and advisers are already comfortable with the American Funds' story." The most successful 529 providers have also been diligent and aggressive in supplying advisers with educational marketing materials, added Joseph Hurley, chief executive officer of savingforcollege.com of Pittsford, N.Y. He cited Manulife Financial as a company that has excelled in this area.
But there are other challenges that all 529 providers face that will inevitably cause others to fold, noted Bill Raynor a member of the board of the College Savings Foundation, a not-for-profit association of 529 plans in Washington. Unlike other investment products that can appeal to investors throughout the nation, many states allow investors to take tax deductions for contributions and even exemptions on withdrawals. This has created a very uneven playing field, noted Raynor, who is also director of education savings for AIM Investments of Houston.
Further complicating matters is the fact that these tax-free treatment provisions are scheduled to expire at the end of 2010. Unless Congress makes this permanent, it will stunt 529 plan growth, Raynor said.
Also, when states first began offering 529 plans, investment managers rushed to establish a presence, thinking there was a total of 50 "fishing licenses, and once you got there, it was a closed market of just one program per state," he said. The reality is that there are as many as four competing choices in some states and more than 70 investment managers throughout the nation. It goes without saying that managing 529 plans is labor intensive and costly, with the average account size only $6,500 according to the College Savings Plan Network.
Nonetheless, some think State Street is prematurely exiting the 529 business. "If you think back to when 401(k) plans were just starting, when people were just saving $25 a paycheck, it's only over time that 401(k)s have played such a huge role in the market," said Ryan, the certified financial planner. Ten or 15 years from now, 529s could be a force comparable to 401(k)s to reckon with, and State Street might even look to get back into the business, he predicted. "They pulled the plug a little early," he said.
Meanwhile, a quiet revolution is already said to be on the way. There are rumors that Merrill Lynch, through its Mercury Advisors unit, could be the next to bail out, from its 529 College Achievement Plan in Wyoming. Although Merrill declined comment for this story, Sharon Garland, deputy treasurer for Wyoming, recently said the plan has not been profitable for Merrill because of its small asset base. There are only 1,839 529 accounts in the state totaling $18.7 million, according to the College Savings Plan Network. Virginia has the most 529 plan assets in the nation, $6.8 billion, in 694,075 accounts.