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Give 529 account the old college try

Life and Money

So you're convinced that college is going to cost $200,000 a year by the time your kids get there.

And you're thinking (between gasps of shock and horror) that maybe you should check out these tax-favored college savings plans - called 529 plans - you've heard about.

Well, I've got some good news, some bad news and some new news for you.

The new news is that the state of Oregon is now giving you an even better break from state taxes to invest in one of the state's own 529 college savings plans.

The good news is that those plans - Oregon's and others throughout the 49 other states - are getting better for investors.

The bad news is that many of the plans had to come a long way to get to slightly better than mediocre, in terms of value to investors. And many of them still have a ways to go.

The idea of the 529 plans (since all things revolve around the Internal Revenue Service, they're named for the section of IRS code that spells out their tax advantages) is to allow families to set aside funds for future college costs, and get some nice tax benefits.

You don't pay taxes on the investment income your account makes, and distributions from the fund - when you and your kid finally have to pay that $200,000 a year - come out federally tax free. And they can pay for college costs at any public or private institution, not just colleges or universities within your state.

Last year, Oregon added a nice new incentive for its plans. Beginning in the 2008 tax year, you can get a state tax deduction equal to what you contribute to one of Oregon's 529 plans - up to $2,000 for single filers and $4,000 for joint filers.

But there's nothing that says an Oregonian can't contribute to a fund sponsored by the state of Idaho, or any other state. And when you're considering 529 plans, look at all state plans - without giving blind devotion to possible state tax deductions, says Marta Norton, a fund analyst with Morningstar Inc., an independent investment research firm based in Chicago.

Her firm recently analyzed returns in an Ohio 529 plan that used a bunch of mediocre mutual funds and a Virginia plan that used much better funds. The five-year return on $5,000 was $9,768 with the Virginia plan compared to $8,261 with the Ohio plan.

If you were an Ohioan with a state tax break, 'you still might have earned more from the out-of-state plan,' she says.

Norton's firm just completed its annual analysis of all 529 plans in the nation and listed the five best and five worst.

The firm uses a range of criteria in its analysis, but often present in the worst plans were poorly performing mutual funds that either are sold through expensive brokers or have high fund expenses built into them.

For instance, management fees in some of the worst 529 plans were often 1.4 percent or more of annual assets, compared to 0.11 percent or so for some of the best plans.

To a novice, Norton says, 1.4 percent doesn't sound like much. But over time, and every year, it is.

The high fees - which can go to broker commissions, to managers of the mutual fund and to a state for administering the plan - were common in the early days of 529 plans and are still too common now, Norton says.

'If you look back in the history of 529s, they were just sky-high,' she says. 'I think competition has brought fees down to a more responsible level.

'On the whole, they're migrating in a better direction. But there's still work to be done.'

None of Oregon's three funds made either Morningstar's best list or worst list; Morningstar was mostly complimentary toward two of the funds, and relatively disparaging of the third.

Here's Morningstar's Oregon view:

• The Oregon College Savings Plan. This plan, directly sold by the state (which means it's cheaper than plans sold through brokers) uses Oppenheimer and Vanguard mutual funds and has 'ultra low fees,' ranging from 0.26 percent of assets for some Vanguard funds to 0.87 percent for some Oppenheimer funds.

'Overall, this plan is a strong choice for residents and a potential alternative for nonresidents with costly home-state plans,' Morningstar's analysis said.

• Oregon Oppenheimer Funds 529 Plan. Morningstar notes that the plan is very similar to the Oregon College Savings Plan except that it's sold through brokers and does not include the low-expense Vanguard mutual funds.

The fees for this fund are higher than those in the Oregon College Savings Plan, 'but it's still reasonably priced relative to other broker-sold 529 plans,' Morningstar's analysis said.

• Oregon MFS 529 Savings Plan. Mutual fund firm MFS not only was implicated in some questionable activities among mutual fund companies a few years ago, 'but the shop has a reputation for high fees and lackluster performance,' Morningstar's analysis said. 'That's certainly the case here.'

Information on Morningstar's analysis can be found at www.morningstar.com/529/529Table.html . Information on Oregon's 529 plans can be found at www.oregon529network.com, or by calling 503-373-1903.

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