It’s no secret that the cost of college and higher education continues to get more expensive. According to the College Board, the average cost for the 2017-2018 school year was $20,770 for public schools. For those students looking at a private school, that number more than doubles.
Nonetheless, the need for higher education continues to grow. These days, many jobs require advanced schooling and skills. This requires many people to spend the major dollar amounts on higher education to get ahead and score future-proof jobs. Under that guise, many parents, grandparents, and other guardians have sought to find ways to help defer the rising cost for their children. One of the best ways continues to be the 529 Savings Plans.
Allowing investors to sock away a high amount of savings in various asset classes, 529 Savings Plans can be one of the best ways to meet higher education goals. However, the plans come in a variety of flavors and investment types. It’s important for investors to choose just the right one that matches their needs.
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529 Savings Plans: The Basics
Perhaps the best way to understand a 529 Savings Plan is to think of it like a 401k or IRA for education. Like those accounts, a 529 plan provides savers with the ability to grow their money tax-deferred and, if the proceeds are used for higher education expenses – such as tuition, housing, books, and required supplies – tax-free as well. The plans are sponsored by various states, and offer other tax benefits as well. Many plans will offer residents of that state the ability to lower their current state income tax bill by making a contribution to their state’s 529 Savings Plan.
There are other benefits as well; for example, with high contribution limits, they are not counted in many student aid and scholarship formulas, and are considered ‘completed gifts’ that remove assets from a taxable estate. Add in the flexibility to change beneficiaries with ease and it’s easy to see why assets in 529 Savings Plans have surged over the last few decades.
Gaining ownership of a plan is easy as well. Plans can either be bought directly from sponsoring states or through partnered broker intermediaries. Essentially, the difference is who you send your money to and how you log on to your account. For example, if you have a Fidelity 529 Plan, you’ll see it when you log onto your brokerage account versus logging on to the State of Ohio 529 Plan website. Some broker-sold funds come with sales loads and other commissions, so it’s important to look at your total costs when selecting a plan.
The Investment Selection
Whether it’s broker sold or purchased directly from the state, all 529 Savings Plans have roughly the same sort of menu of investments. Investors are basically buying units in a so-called master portfolio that owns the underlying assets. This can include stocks, bonds, and cash through mutual funds and/or exchange traded funds as the holdings. Here, these holdings can be both index or actively managed funds. Typically, these funds come in three flavors: Age-Based, Static, and Individual Portfolios.
Age-Based Portfolios: These are very similar to target-date retirement funds. Here a single portfolio owns a mixture of asset classes and slowly gets more conservative in its allocation toward its end date. Savers simply choose the year that the student will be attending college. For example, the BlackRock sponsored iShares 2024 College Portfolio Class F is designed for a student who will start attending college in the year 2024. With this option, investors get a diversified portfolio that is set-it-and-forget-it ready.
Static Portfolios: These are more traditional balanced funds in that their allocation doesn’t change. They own a mix of equities, bonds, and money-market that, as the name implies, is static. Investors choose the fund based on a target risk portfolio. For example, the Fidelity sponsored Moderate Growth Portfolio (Fidelity Funds) is set at a 70/30 split between stocks and bonds.
Individual Portfolios: Many 529 Savings Plans give investors the ability to build a custom mix of asset classes just as you would a regular portfolio. Individual Portfolios in 529 Savings Plans hold usually one asset class and include individual equity funds (domestic or foreign), bond funds, and real estate funds. So, the SSGA Upromise 529 Plan’s SPDR S&P 600 Small Cap Portfolio owns small-cap stocks, while the Vanguard 529 Total International Stock Index Portfolio owns foreign stocks.
Several 529 Savings Plans also have savings, checking, and certificate of deposit (CDs) account options. And just like your local bank, these options come with FDIC insurance, liquidity, and conservative returns.
As mentioned previously, you can also pick mutual funds in your 529 Savings Plans. Click here to learn more about mutual funds.
Things to Remember
It’s important to note that not all 529 Savings Plans offer the same investments. It depends on the sponsor. Many offer a broad menu of options, while some only provide a few choices for investors. This is something to consider when selecting a plan. Secondly, fees and state tax benefits need to be considered. It’s almost always better to choose your own state’s plan if they offer tax benefits on your income tax return.
And just like your retirement portfolio, the value of these sub-accounts can rise or fall as the market changes. By going this route, savers have the potential to increase the value of their account faster than estimated college costs. Still, you could see losses if the market takes a turn for the worse. That’s why diversification is important.
Also, it is important to realize that these are not ‘trading vehicles.’ Many 529 Savings Plans limit the amount of changes to investment selection to just once or twice a year. So, it’s important to think about your selection before clicking buy.
The Bottom Line
With more than $1.4 trillion in student debt outstanding, saving for college has never been more important. 529 Savings Plans go a long way in preventing and lessening that burden. These vehicles offer the chance for savers to own a variety of asset classes through underlying mutual fund/ETF portfolios. They can be customized for a variety of goals and offer a great way to save for college. It’s important to check under the hood and know what you are buying before you enter into a plan.
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