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Four Questions for Your Section 529 Plan
Check for New Investment Options
As Section 529 funds — accounts designed to help save for a college education — continue to gather assets, the number of plans continues to increase. More states are offering options with different investment advisers, and many states that don’t at least offer a choice between a no-load plan and a load plan sold by investment advisers.
The combined assets of Section 529 plans grew 8.5 percent year over year to $105.7 billion as of December 2006 (the most recent data available), according to the Investment Company Institute, a trade association for mutual fund companies. The average account of the 9.3 million overall had assets of $12,500. Of the $105.7 billion, assets in college savings plans totaled $90.1 billion, with the rest in prepaid tuition plans.
In a college savings account, you save for college and can spend those dollars on college-related expenses for the beneficiary (usually a child) as you see fit. Prepaid plans are set up so that you purchase units that entitle the beneficiary to a certain amount of future tuition at a specific state school. Only 15 states offer prepaid plans, and many of these are closed to new investors.
As with most other investment vehicles, the more options, the more confusion reigns among those meant to benefit from them. So if you’re already invested in a 529 plan and aren’t sure what you’ve gotten yourself into, or if you’re considering taking the plunge, asking these questions should help you sort through the issues.
What investment options have you selected for the beneficiary?
For many investors in college savings accounts, target-date funds based on the beneficiary’s entrance date into college are the best choices. Under this model, the fund’s investment options are more aggressive when the beneficiary is younger; as the target date approaches, the options become more conservative.
Investments typically center around stock funds in the early years, moving into bond funds and money market accounts as the beneficiary nears college matriculation. But sponsors of college savings accounts are offering more and more options, so make sure the one you’re invested in suits your risk profile. Although it makes sense to invest aggressively when the beneficiary is young, you don’t want to take on unnecessary risk as the first day of college looms. If you invest too aggressively at that time, you could find yourself short of the needed funds if the investments don’t work out.
If you’re concerned that your current option is too risky, consider switching to one in which the account transfers all or most of the assets into a money market fund the year before the beneficiary is scheduled to attend college. Conservative bond funds can also be an appropriate choice, especially when paired with a money market fund.
Have the investment options changed since you set up the account?
If you set up the account more than a few years ago, the plan administrator likely has added options for investments and investment advisers. In the past most states, which usually administer these plans, selected one investment adviser to run all the accounts. But more states are using several investment advisers in an effort to offer more choice to account owners.
So go to your plan’s website and see what’s available. There are likely more target-date fund options and perhaps more single-fund options. Aggressively managed single-fund options generally aren’t a good idea unless you prefer to actively manage your plan’s asset allocations and are prepared to keep tabs on how the funds are doing and regularly adjust the allocations.
You might be able to reduce costs by switching to one of the new options. Compare fees of your current investment vehicle with those of new ones, especially those from competing providers.
What are all the costs involved in the account, including the expense ratio, broker fees and administrative fees?
The expense ratio and other fees associated with your college savings accounts can take a big bite out of your returns if you aren’t careful. As an investor in a college savings plan, your goal should be to pay the lowest fees possible for the best investment returns.
Typical fees charged by Section 529 savings plans include:
• Administrative fees. Typically assessed yearly or quarterly, these cover the state’s costs involved in plan administration, such as mailing statements, staffing a toll-free customer service telephone line, operating a website and so on.
• Out-of-state account fees. Some states charge additional fees to account holders who live out of state. The fees are assessed quarterly or yearly.
• Enrollment fees.
• Distribution fees. These might be assessed when you take funds from a plan to pay for qualified college expenses.
• Sales charges. Otherwise known as loads, these are the fees you pay if you solicit the advice of a financial planner or broker. You generally pay an upfront charge that can run anywhere from 4 percent to 5.75 percent of the amount you invest. There’s also the 12b-1 fee, an ongoing charge added to the fund’s expense ratio. This typically runs .25 percent of your invested assets.
• Expense ratio. This fee, based on a percentage of the assets in your account, covers the investment manager’s operating costs. These include the expense of employing fund managers and analysts, administrative charges and the costs of running a trading desk.
• Brokerage fees. Fees incurred by fund managers when they trade securities in and out of the funds you invest in typically aren’t detailed in terms of a specific percentage. These costs vary depending on how much management trades, and they’re taken out of your assets on a percentage basis similar to how the expense ratio is handled.
In most cases, the best way to reduce your fees is to go with a fund option that features low-cost index funds. Index funds are designed to track various benchmarks and in the long term tend to outperform actively managed funds. The Financial Industry Regulatory Authority — formerly the National Association of Securities Dealers — offers an online tool to analyze the expenses of Section 529 savings plans. You can find it in FINRA’s Investor Information section.
What effect will your college savings accounts have on the financial aid process for the beneficiary?
If your child is nearing college age, financial aid is a huge issue. Many middle- and upper-middle-income parents mistakenly assume their children won’t qualify for much financial aid. More and more private schools are realizing that college costs have increased so much that most parents can’t afford them and are increasingly urging their children to attend state schools.
The result is that private schools are offering more financial aid to such students. That’s the good news. The bad news is that private colleges will count the money you’ve saved in a college savings account dollar for dollar against any financial aid it awards your child.
Private colleges vary in their treatment of college savings, but in most cases they aren’t nearly as generous in their assessment as are public schools that follow federal rules for assessing these accounts. These public colleges usually will deduct 5.64 percent of the savings account’s total balance from a student’s financial aid award.
Beware of strategies designed to circumvent a private school’s treatment of college savings assets. For example, you might decide to use the entire Section 529 savings account to pay the first year of college expenses so that the funds won’t be counted against your child in the future. Some colleges, however, apportion college savings funds equally over the four years of schooling and will count the funds even if they’ve already been spent.
For more information about financial aid, go to FinAid. The site also has calculators for estimating your expected family contribution to college, including the Expected Family Contribution Calculator and the Quick Expected Family Contribution Calculator. Click the Calculators link at the homepage.