California closes 529 plan as more advisers go direct

The California State Treasurer's decision last week to shut down its adviser-sold 529 plan is the latest evidence that the once popular option is losing ground, experts say.

For starters, these plans are already losing market share to their direct-sold counterparts -- giving up 9 percent market share in the past five years. And experts predict that this trend will pick up pace as regulation of the brokerage industry expands.

On October 12, the ScholarShares Investment Board, which runs California's 529 plan, announced it had decided to drop the plan because it was not able to find a manager that could deliver a competitive plan for our account holders, according to a statement by Joe DeAnda, a spokesman for California's treasurer office.

The change came as California switched providers from Fidelity Investments to TIAA-CREF. TIAA-CREF did not bid to run the plan.

We bid on the direct plan because that is where we feel we have the most expertise, said Doug Chittenden, senior vice president of institutional product management at TIAA-CREF. California's direct 529 plan has $3.9 billion in assets, compared to the adviser-sold plan, which has $283 million.

Currently, 30 states have both an adviser-sold and direct option, according to FRC. When 529 plans came to the forefront in 1997, adviser-sold plans -- which are sometimes available nationwide and are sold by brokers who receive a commission -- largely drove the growth of the market.

But that has changed. While adviser-sold plans accounted for 60 percent of 529 savings plan industry assets in 2006, they accounted for only 51 percent of assets as of the end of 2010, according to Financial Research Corporation.

VICTIM OF SUCCESS

To some extent, adviser-sold 529 plans are a victim of their own success, industry officials said. As the industry has raised awareness about how these programs work, more investors feel comfortable investing in them directly.

States also spend more of their marketing dollars promoting direct-sold plans, which may be another reason that market is growing, said Laura Lutton, a Morningstar Inc. analyst.

What's more, a growing number of advisers are telling clients to invest in their in-state direct-sold plans, forgoing any commission or fee.

Twenty-three percent of advisers recently surveyed by Financial Research Corp said they always recommend their in-state direct 529 plans for clients, while 49 percent said they sometimes do.

Direct-sold plans are less expensive than adviser-sold plans, said Paul Curley, a 529 analyst at FRC. The average fee for an adviser-sold plan is 1.14 percent. Direct plans, average 0.58 percent, according to FRC.

Robert Oliver, an Ann Arbor, Michigan-based fee-only adviser, always directs his clients to the in-state plan, which costs 0.35 percent and offers a tax break to residents. But he still meets prospective clients who have been sold out-of-state plans by other brokers, he said.

A lot of clients are being sold plans because the adviser gets a commission off of them, Oliver said.

REGULATORY CHANGES

Given the regulatory landscape, that is likely to change, Hurley said.

The securities industry expects the SEC to soon propose rules that would harmonize legal standards of care between brokers and registered investment advisers. That would mean that brokers could be required to act as fiduciaries, acting in the best interest of a client, a standard that RIAs already follow.

One change that would bring: Advisers selling out-of-state plans, when their clients can get a tax deduction for the in-state option, would have to provide even more disclosures about why they are choosing an out-of-state plan for the client, Hurley said.

But advisers won't be shut out entirely, experts say.

When we talk to account holders, the top three ways that investors learn about 529 plans is word of mouth, advisers and the Internet, said Joan Marshall, chair of the College Savings Plan Network and executive director of Maryland's college savings plan. A lot of people really want the assistance of advisers when making these decisions.