Satisfaction. A four-syllable word that can be used to describe a variety of situations. We know the Stones can’t get any and that a Snickers really does. Merriam Webster’s Dictionary defines it as “the fulfillment of a need or want.” But when it comes to experiences around personal finance, satisfaction is not a word that typically comes to mind.
Except for one financial experience.
For many parents, just the decision to fund a 529 plan for a young child is a satisfying financial experience. And for the privileged group who can fully fund their child’s education through a 529 plan, it is a feeling of immense pride and satisfaction in having planned so well. Not surprising, Fidelity’s 2016 College Savings Indicator Study found a 62% increase in parents using 529 plans, from 2007 to 2016.
Would that feeling of satisfaction still exist if savers found that fees for their chosen plan was costing them a half semester’s tuition or more?
Plan choice can be a minefield. Conceptually, 529 plans are simple, elegant and accessible. But a basic choice can cost you up to a semester of tuition in fees.
Here’s what you need to know to avoid this.
It’s all about the kind of plan
There are two types of 529 plans: Advisor-Sold Plans and Direct Plans. An Advisor-Sold plan requires you to work with an advisor for access. The advisor houses it on their custodial platform and handles the asset allocation. Typically, the advisor is compensated from the fee structure.
With Direct Plans, the account holder invests directly with the investment provider, with no middleman – and the investor has responsibility for the asset allocation and the investment decisions.
In order to simplify this, many plans offer what is called ‘age-based’ funds. Similar to Target Date retirement funds in 401(k) plans, “age-based” funds use the child’s age to drive asset allocation. When the child is young, the allocation tilts toward equities. As the child gets closer to college, the allocation becomes more conservative. The plan custodian uses a robo-like approach to the allocation – and the parent is not involved in investment.
It’s all about the fees!
Many parents make uninformed decisions about the type of plan they go into, without understanding the difference between the two options. The plans have different fee structures and it’s important that you understand the costs before making a decision.
Advisor-Sold plans often have complex fee structures. The most common plan holds a basket of mutual funds that are ‘front end loaded,’ i.e. you pay a percentage up front simply to enter the fund. Thereafter, you pay annual mutual fund fees which can be in the .50% – 1% range.
While Direct Plans typically don’t have a front-end load, they do have annual underlying mutual fund fees.
Obviously, fees matter. But you have to look under the hood and do some calculations to really understand the potential impact.
Example: Addie and Isla are twins and their parents decide they’re going to fund each daughter’s 529 plan with $10,000 annually, from birth. For Addie, they invest in an Advisor-Sold plan, while Isla’s is a Direct Plan.
Addie’s Plan – $10,000 annual investment in a commonly used American Funds Advisor Sold 529 Plan, with a front-end load of 4.25. Underlying fund costs are 0.80% annually and we assume the fund grows at a rate of 6% annually. After 18 years and $180,000 of contributions, Addie has $302,097 in the plan for college. The fees they paid include $7,650 in front end loads and $20,147 in underlying fee costs. The grand total of fees paid is $27,797.
Isla’s plan – $10,000 annual investment in a Direct Plan such as the Vanguard Nevada 529 Plan. Underlying costs are 0.16%, with no front-end loads. After 18 years, with annualized growth of 6%, Isla has $340,646 in the plan from the $180,000 in contributions. At a grand total of $4,408 in fees, she paid $23,389 less in fees than Addie.
The fee disparity… the less you take out at account opening, the more you have to grow.
Even the playing field
So why would anyone even consider using an Advisor-Sold plan? Most Americans know they should fund a 529 plan but they’re not sure how to go about it. An investment advisor is the person who helps them connect the dots from an idea to actually funding.
Ultimately, it’s about asking the right questions. If you decide to work with an advisor, you need to understand the fee structure and what you would get in exchange for those fees. If the fee structure doesn’t work for you, consider going direct. You might find that doing an age-based plan with a low fee structure provides greater benefit over time.
If an advisor claims their plan outperforms the Direct Sold plan, voice a challenge and ask to see performance numbers. Or do some due diligence on your own. Both Morningstar and SavingForCollege.com do annual reviews on 529 plans covering fees and performance.
Informed investors make better 529 plan decisions. The 2017 Morningstar Study found that Direct-Sold plans continue to grow and take market share away from Advisor-Sold Plans. In fact, Direct-Sold plans now have a greater than 53% market share. Don’t be afraid to ask questions and to feel confident going with a Direct-Sold plan. It could save you half a semester of tuition – and that is some good math!