Below is the text of a letter I sent to Washington, DC Mayor Muriel Bowser to reform the DC College Savings Plan to better serve the interest of DC families and college students. On August 1st, the DC CFO responded!!
Dear Mayor Bowser:
Your Administration would do college students and families saving for college a huge favor by directing the Chief Financial Officer to the reform the DC College Savings Plan (the DC Plan). Modest reforms to increase the variety of low-cost investment fund options and to lower annual fees would increase the Plan’s competitiveness with other state college savings plans and pay long-term dividends for our residents. A few very basic changes could easily generate $7,000 in additional college savings and make the DC plan a model for other states.
Because of the high costs embedded into the DC Plan, I advise my DC clients to invest only the amount in the DC Plan necessary to obtain the DC annual tax deduction ($4,000 per account holder). I advise them to avoid the DC Plan if they plan to invest their DC tax savings or have other monies to contribute toward college savings each year. Instead, I recommend they invest in the plans offered by New York, Nevada, or Utah. All three plans offer low-cost investment funds and have lower annual fees compared to the DC Plan and, as a result, their investment fund performance has been better.
As a CERTIFIED FINANCIAL PLANNER™ professional, it is my fiduciary duty to act solely in my client’s best interest when I offer personalized financial advice. I believe it is in my clients’ best interest not to invest more in the DC Plan beyond the DC annual tax deduction when other states’ plans offer a better selection of funds at a lower cost.
Over time, high fund expenses and annual fees lower earnings and dramatically diminish savings growth. By using readily available investment funds with low expense ratios and by lowering plan expenses, the DC Plan could provide a better value to DC residents. Doing so will likely increase the assets in the DC Plan given its strong marketing campaign and community outreach efforts. It will also increase the participation beyond the 61% of DC residents that have such savings.
I have three recommendations to improve the DC College Savings Plan.
Include Low-Cost Investment Fund Choices in DC Plan
The DC Plan offers 12 investment funds: five age-based funds whose asset allocation gradually becomes more conservative and seven static asset allocation funds for participants to mix and match. These streamlined choices are very appealing, provide amble diversification, and can reduce the hurdles to saving for college.
The five age-based funds, however, have very high expense ratios. The DC Plan’s expense ratios range from 0.55% (DC College Savings (17 & up) to a whopping 1.09% (DC College Savings (0-5)). Comparable target date retirement funds that have the same asset allocation strategy from Vanguard have expense ratios from 0.14% (Vanguard Target Retirement 2015 Fund (VTXVX)) to 0.15% (Vanguard Target Retirement 2035 Fund (VTTHX). The comparable Utah 529 Plan’s Age-Based Funds have 0.19% to 0.188% expense rates or about 0.90% lower than the DC College Savings (0-5) fund.
A 0.90% reduction in the fund’s expense ratio boosts the fund’s return by 0.90%. Assume a plan participant invests $4,000/year for 20 years. The 0.90% expense savings would result in an ending balance that is $7,224 more! A reduction of 0.90% in annual expenses would result in $1,875 in additional earnings for the typical DC Plan balance of $20,000 over a 10-year period.
The DC Plan static investment choices also have high fees that hurt investment fund returns. The most glaring example is DC State Street Equity 500 Index Fund with an expense ratio of 0.46%. This fund tracks the S&P 500. The same fund offered by Vanguard in the Utah 529 plan has an expense ratio of 0.19%. The fee differential is 0.27%.
The DC Plan participant that invests $4,000/year for 20 years will lose $2,086 in earnings using the DC State Street Equity 500 Index Fund. The DC Plan participant with an average balance of $20,000 for 10 years will lose $547 in earnings. These are real dollars that are lost due to completely avoidable fees.
Comparing the DC and Utah plan disclosures show that as of May 31, 2016 the five-year return for DC State Street Equity 500 Index Fund was 11.11% annually but for Utah’s similar fund it was 11.45% annually – an increase of 0.34%. The three-year return was 10.47% for the DC State Street Equity 500 Index Fund but 10.84% for the comparable Utah fund – a slightly bigger gap than the expense ratio.
The DC Plan contains three expensive static funds: Calvert Equity (1.22%), Calvert Small Cap (1.52%), and Calvert International Opportunities (1.66%). These ratios are 1.04% to 1.50% higher than comparable funds offered in the Nevada, New York, and Utah 529 Plans.
I recommend including low-cost age-based and static investment funds in the DC Plan.
2. Stop Advisor-Sold Sale of Front-Loaded Funds
The DC Plan offers two versions of the 12 investment funds: direct sold with no charge and advisor-sold version with a 4.75% charge. The 4.75% charge on the advisor-sold funds is deducted from contribution amount so the participant has lost money the day they make the contribution. Even the DC Plan literature shows how the returns for the advisor-sold plans are lower than their direct-sold counterparts. See Appendix B of Program Disclosure Booklet http://www.dccollegesavings.com/Documents/DC-529-Program-Disclosure-Booklet.pdf.
Advisor-sold plans are unnecessary in an investment environment in which most plan participants are likely to be familiar with 401k retirement plans (and comparable 457 and 403b plans). College savings plans are very similar. Retirement plans do not involve advisor-sold funds because they are unnecessary.
The DC Plan website also is full of easy to understand investment and planning information. It is unclear the value added by advisor-sold plans. Two versions of the same fund can only cause confusion for participants. Any confusion is likely to hurt the returns of unsuspecting participants because they may be steered into a higher-cost, lower-earning fund unknowingly.
I recommend eliminating advisor-sold plans in the DC College Savings Plan.
3. Eliminate Annual Fees
The DC Plan imposes a $25 enrollment fee and per fund annual fees of $15 (DC resident) and $30 (non-DC resident).
Annual fees are unnecessary and can be made up with a more efficient system and by increasing volume. The DC Plan fees are not competitive with other state plans. For example, the Utah plan has neither enrollment fee nor annual fund fees. Rather the Utah program or overhead fees are incorporated into the investment fund’s expense ratios. And as discussed above, these ratios are substantially lower than the comparable funds offered in the DC Plan. The Utah plan imposes fees only on those desiring paper copies of their statements.
I recommend that DC eliminate and/or lower its enrollment and annual fund fees.
In conclusion, the DC Plan could become a model for other states by retaining its streamlined investment fund offerings, but lowering their expense ratios and reducing annual expenses.
Thank you for your consideration.
/s Michael Wroblewski
Michael S. Wroblewski, CFP®
cc: Jeffrey S. DeWitt, Chief Financial Officer
The Honorable Jack Evans, Chair Committee on Finance and Revenue