Two Alabama legislators have introduced a bill to make one of state’s two 529 college savings plans — which has been rated among the worst in the country — more attractive to Alabamians.
The bill, introduced Monday, would exempt qualified withdrawals from the state’s income tax.
Anthony Leigh, the deputy state treasurer in charge of 529 plans, acknowledged Wednesday that the Alabama Higher Education 529 Fund falls short of those offered in other states.
Last week Morningstar Inc. rated that plan among the five worst. “While not having seen the results or methodology,” Mr. Leigh said, “we understand that one of the drawbacks is that we still do not have a state tax exemption for qualified withdrawals.”
Morningstar also said the lineup of Van Kampen Investments mutual funds offered through the plan are expensive and lackluster. Mr. Leigh declined talk about the funds.
The Alabama Higher Education 529 plan was launched in June 2002. Like plans offered in every other state, it enables participants to contribute to an individual account, choose from several investment options, and later use the money in the account to pay for a child’s college expenses.
The legislation, introduced by state Rep. Richard Lindsey of Centre and state Sen. Zeb Little of Cullman, would provide the same tax-free treatment to the criticized plan that is currently extended to the state’s other 529, the Alabama Prepaid Affordable College Tuition Program.
Interest earned in the program Morningstar criticized “is already tax-free on the federal level,” state Treasurer Kay Ivey said in a press release Monday. “Eliminating the state income tax on the earnings will make the program even more attractive for Alabama residents.”
Morningstar said subpar tax breaks, high fees, and lack of investment flexibility and choice in some states’ 529 plans should prompt their residents to look at the best plans that other states sponsor.
“There can be differences in how withdrawals are viewed in state income tax,” said Dan McNeela, a senior analyst at Morningstar, “and other plans could offer more flexibility in investment options.”
This year’s Morningstar ranking, its second, also put some plans sponsored by Arizona, Maine, and Wyoming on the “worst” list for high fees and by Tennessee for lack of a meaningful tax break. Calls to the state treasurers’ offices in Arizona, Wyoming, Maine, and Tennessee were not returned by press time.
Joe Hurley, the president of Savingforcollege.com, whose Web site provides information on 529 plans, said the best of them depend on “the quality of underlying investments, investor-friendliness, fees and expenses, flexibility in investment structure, and state tax exemptions.
But though “fees are certainly one way to compare programs on an objective basis,” he said, it is hard to compare the options in different plans, which vary.
Furthermore, “the overall opinion is that the best plan for one person may not be the best for another,” Mr. Hurley said.
Mr. McNeela of Morningstar said costs are not the main reason consumers pick one 529 instead of another. “It’s difficult to focus on fees, because the disclosure of fee information isn’t that good at this point,” he said. “Investors would need to dig to get a handle on all the fees.”
Many of the state plans his company ranked best and worst last year got the same grades this time round, he said. These included plans in Arizona and Wyoming among the worst and Alaska, Utah, Michigan, and Virginia among the best.
Maine, Tennessee, and Alabama showed up for the first time among the states with the worst plans.
The Securities and Exchange Commission announced last March that it was creating a task force to examine 529 plans with an eye to disclosure and costs.
It said it would look at fees, investment performance, tax considerations, investment options and managers, risk, and limitations or penalties connected with transfers and distributions.
Mr. Hurley said fee disclosure and increased scrutiny could drive some 529 plan providers from the industry.
The first provider to leave the 529 business was State Street Corp. Last October, in its third-quarter earnings statement, the Boston company said it would quit because it had too little 529 business to provide economies scale and thereby justify its investment.
The company had only one 529 plan, conducted by its Schoolhouse Capital unit and sponsored by New Mexico.
