529 Plans


Educational Savings Plans were first established in 1996 as part of the Small Business Jobs Protection Act, and have since established themselves as one of the most effective ways to save for college.  529 plans permit significant investment contributions and offer tax-free investment growth, provided that withdrawals are used for qualified educational purposes.  There are two distinct types of Educational Savings Plans:  state savings plans and prepaid tuition plans. 48 states and the District of Columbia offer direct savings plans, and all 50 states have at least one Educational Savings Plan offering.

Finding the Right Plan

Many individuals tend to look only at their home-state 529 plans, which could be a mistake.  While some states offer a tax benefit for in-state contributions, such favorable tax treatment is often limited in scope or not available at all.  For most people, there are two critical factors that should be considered when searching for the right 529 plan:  the investment options and expenses.

Investment Options

Most 529 plans offer a wide range of investment options, usually a selection of mutual funds that invest in fixed-income and equity markets.  Many states include age-based target date funds, which provide for asset allocations that vary over time, becoming less risky and more stable as the target date approaches.  Target date funds are an apparently convenient one-size solution, but they are not an ideal fit for all investors.  Individuals have different needs and goals, risk capacities, and time horizons.  Target date funds do not consider any of these individual factors, instead applying generic rules to the underlying asset allocation process.  Investors should choose a 529 plan that offers a wide range of investment options and allows them to customize an asset allocation based on their particular circumstances.

Fees and Expenses

Fees and expenses are a drag on investment returns, and this fact applies to 529 plans as much as other investments.  There are a number of expenses that are specific to 529 plans.  In addition to underlying fund fees and expenses, 529 plans incur a plan administration fee, which is paid to the sponsor for establishing and managing the plan.  The fund management fees are paid to the investment advisor to manage the underlying fund assets.  Certain states offer broker-sold 529 plans, which provide for sales commissions to the originating broker.  The costs of such programs are significantly higher than direct-sold plans.  Because the costs of 529 plans vary widely, it is critical to understand and compare fees and expenses when evaluating your options.  Some plans may charge as much as 2.50% in annual fees and expenses, whereas the lowest cost direct plans are less than .50%.  Over a 20 year period, fees and expenses can dramatically impact cumulative investment returns.  

The Right Mix

Individual investors are often given little guidance on how to allocate their funds among the available investments in a 529 plan, yet asset allocation is the single most important aspect of an investment strategy because it is the primary driver of risk and return.  We advise our clients to select diversified, low-cost investments that offer exposure across a broad range of asset classes, investment styles, and strategies, consistent with their individual needs and goals. Researching, implementing, and monitoring the asset allocation in your 529 plan can make all the difference in ensuring that your portfolio meets your investment objectives. With education costs continuing to outpace the general rate of inflation, it is imperative that individuals make informed asset allocation decisions in their 529 plan accounts.

Need Help Estimating Costs and Your Savings Needs?

If you need help estimating the future costs of college, or the amount that you should start saving now, you may be interested in a college savings calculator that we have developed.  

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If you have questions about how to use the calculator, or about any of the assumptions that are embedded within it, please contact us.   The foregoing article is based, in part, upon a blog post by Robin Brinckerhoff on the North Capital weblog site.  Copyright 2011-12.  All Rights Reserved.

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