After examining the investment choices a 529 plan offers, consider fees only as the second most important factor. • Don’t get hung up on a difference of 0.1 or 0.2 percentage point between one program’s fees and another’s. Having the full set of asset classes in a broad-ranging plan can give you a larger gain than a more limited plan, thereby outweighing slightly higher fees.
• Parts 1 and 2 of this column appeared on Dec. 6 and 10, 2018.
In Part 2 of this column, we saw that many college savings programs — called “529 plans” in the US and various other names elsewhere — have a limited selection of asset classes. A choice of at least nine widely varied asset classes, including emerging-market equities, real estate, and commodities, can help you position your account so it produces the fastest gains during the years before your young student plans to enter college.
Two 529 plans stand out with particularly extensive sets of asset classes to help you construct a diversified portfolio:
- The Upromise 529 Plan is one of the few in the US to base its portfolios on exchange-traded funds (ETFs) rather than mutual funds. All of the ETFs are from Upromise’s parent, State Street Global Advisers. But State Street’s hugely liquid ETFs — including the original S&P 500 tracking ETF (SPY), US and ex-US REIT ETFs (RWR and RWX), and others — can, in some cases, produce a portfolio with lower fees than a program that’s based on mutual funds.
- CollegeCounts is one of the few 529 plans to offer a commodity index fund as an investment option. The fund tracks the Bloomberg Commodity Index. A commodities index isn’t something that always goes up, to say the least. But when global equities are crashing, a commodity fund can be a better bet. This assumes an investor understands how to use the principle of momentum, tilting toward assets that are in uptrends and away from those in downtrends. (For the formula, see my Muscular Portfolios summary.)
Gains should be your primary goal, not tax credits
When selecting a 529 fund to invest in, the breadth of investment choices and the frugality of annual fees are your two most important concerns. Picking a 529 plan that happens to be administered by an agency in your state or province is usually the least important. That’s because the tax benefits you might get from a 529 plan in your jurisdiction are far outweighed by the gains you can earn on a diversified portfolio, perhaps enhanced by a smart use of momentum for your fund choices.
The website Saving for College publishes a map showing the possible tax credits in each of the 50 US states. The site assumes that a couple earns $100,000 in taxable income and makes $100 monthly contributions to a 529 plan for each of their two children. The tax credits the couple might receive would be as follows:
- Seven states have no income tax, therefore offering no tax credit: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
- Nine states that do have income taxes don’t give tax credits for contributions to 529 plans: California, Delaware, Hawai’i, Kentucky, North Carolina, New Jersey, and Tennessee.
- Of the other 34 states and the District of Columbia, only one provides a tax credit worth more than $200 to the couple. It’s Indiana, where the parents can take $360 off their state tax return. In other states, the savings is as small as $36 or $37 (Rhode Island and North Dakota). And even the credits in those states require that the family itemizes its federal taxes. Itemizers will drop to only 10% of tax filers rather than 30% previously, due to the tax-cut bill passed by Congress in 2017, according to a study by the Tax Policy Center, a nonpartisan group.
The few dollars in the tax credits that are available to you will very likely be a fraction of the improved gains you can make in a 529 plan that has a wide range of investment options and relatively low annual fees. Unless you live in a state that has a very generous tax advantage, there’s no need to limit your search to 529 plans that happen to be administered in a location near you. Instead, choose whichever plan offers you the best package, wherever it may be based.
Fees vary, based on the costs of alternative funds
As noted above, Upromise offers emerging-market equities and REITs, while CollegeCounts offers those choices as well as a commodity index fund. Few 529 plans make all of these asset classes available to account holders.
We saw in Part 1 of this column that 529 plans generally prohibit investors from purchasing individual stocks. That confines investors’s choices to each plan’s particular set of funds.
Additional choices can help you eke out greater gains over time, as we’ll see later. But the diversification comes at a cost. CollegeCounts’s commodity fund, for example, charges a hefty 1.43% annual fee. That’s partly because commodity index funds must pay for trades in the futures market (as opposed to buying actual tankers of oil, tons of copper, etc.).
If you limit yourself to the cheapest funds within a 529 plan, your annual fees (including the administrator’s maintenance fees) can be well under 1% per year. When you tilt your portfolio toward some of the alternative funds, though, you may find that your annual fee exceeds 1%. In the following list, you can see the range of possibilities in three 529 plans that, from top to bottom, offer fewer choices and greater choices, based on Saving for College figures. (The state that administers each fund is shown, but remember that most 529 plans are available to investors no matter where they live within the country.)
- 0.15% to 0.44% — Vanguard 529 College Savings Plan (Nevada, no annual maintenance fee)
- 0.28% to 0.89% — Upromise 529 Plan (plus $20 annual fee, except for Nevada residents)
- 0.42% to 1.65% — CollegeCounts Class F (plus $12 annual fee, except for Alabama residents)
Note: Each plan typically charges a much lower fee if an account is fully invested in a low-risk asset, such as cash or an ultra-short-term fixed-income fund. (Such an all-cash allocation is common after a student has entered college, and the owner of the account wants no chance of the balance declining due to market corrections.)
A benefit of Upromise that can offset its fees is a unique credit card that rebates about 1.44% of your charges. The refund is automatically deposited into a linked 529 account. That’s by no means the highest cash-back rewards card that’s out there. For one example, Citi offers 2% cash back. But the Upromise Mastercard doesn’t require you to claim the rebate and then manually contribute it to the 529 plan. If that painless approach to saving appeals to you, ValuePenguin provides the details in a review.
The “Class F” descriptor on the CollegeCounts 529 plan requires some explanation. Most 529 plans are based on mutual funds, which may charge higher or lower fees depending on how the funds are sold. Front-end and back-end fees compensate brokers who recommend that investors purchase certain funds. In brief, according to FIGuide:
- Class A mutual funds charge a front-end load to buy in, which can be as high as 5.75%. In addition, annual 12b-1 fees may help pay additional incentives to brokers.
- Class B funds charge higher annual fees than Class A, but no front-end load. However, a Class B fund charges a back-end “redemption fee” if investors sell shares during a deferred sales charge period. That lock-in can be as long as seven years.
- Class C funds have no front-end load but charge up a fee of up to 1% if investors sell shares within the first one year.
- Class D and Class F funds charge no front-end or back-end loads. That keeps investors’s costs down. But these funds do have annual fees and may also levy a 12b-1 fee, which pays incentives to brokerage firms that include the funds on their rosters.
CollegeCounts, like many other 529 plans, uses Class A, C, and F funds. The A and C funds wind up costing investors higher fees in general. The Class F fund is more economical. Check on which mutual funds in a 529 plan have which fees before you invest.
Tilting toward asset classes that have stronger momentum
Selecting a 529 plan that has low fees and a wide selection of asset classes is a good start. But enhancing your gains means occasionally tilting your portfolio toward those asset classes that are in uptrends and away from those that are in downtrends.
As a rule, 529 plans are not ideal for taking advantage of trends. Muscular Portfolios use a momentum rule to make gradual shifts about nine time a year. In the US, 529 plans allow only two portfolios changes per year. However, you can reallocate more frequently by changing a plan’s beneficiary or owning more than one 529 account, as described in Part 2 of this column.
If you’re happy with the type of age-based portfolio that’s typically offered in 529 plans — holding mostly stocks in the first few years and mostly bonds in the last few — go ahead and invest that way and accept the returns you get.
However, if you want to maximize the gain you can achieve in a tax-deferred 529 plan, we’ll see in the final part of this column how to use simple rules to give a portfolio higher returns with the least additional effort.
• Part 4 appears on Dec. 13, 2018.
With great knowledge comes great responsibility.
—Brian Livingston
CEO, Muscular Portfolios
Send story ideas to MaxGaines “at” BrianLivingston.com
