Why Your Child's 529 Plan Should Be Direct

The 529 State Plan as a Vehicle for College Savings

With the cost of higher education rising steadily over the past few decades, more and more families are opting to use a 529 state plan to save up the necessary funds for tuition, room, board, and textbooks. In fact, during the year 2016, these types of savings accounts contained over 275 billion dollars in assets.

And while 529 state plans are a fantastic vehicle for many people, the benefits they offer can often be eaten up by the fees that financial professionals charge for administering them. For example, upfront commissions, which typically cost investors about 4.75 percent to manage, are often in addition to the internal expenses involved with the administration of 529 accounts.

The result is that far too little of the savings goes towards the student's actual expenses. This has led many families to pursue something called a direct sold 529 Plan, instead of the much costlier broker sold versions.

Unfortunately, from my experience, many parents aren’t aware of the differences between the direct and broker sold. They have purchased a broker sold plan without even knowing a much lower cost alternative exists.

What is 529 State Account?

A 529 account is intended to help families save for future college costs by allowing the investments to grow tax-free. They are offered in all 50 states, as well as by certain private universities.

The most popular type of 529 account is known as a college savings plan and functions in the following ways:

•             An account is set up for the student's college expenses.

•             The money in these accounts is invested in various funds (stock, bond, and money market), usually ones chosen by the account holder.

•             Interest earned by 529 plans is not subject to federal or (usually) states taxes, as long as the funds are used for eligible college expenses.

Keep in mind that these accounts are subject to a variety of fees even beyond the commissions charged by a broker.

Broker Sold Vs. Direct 529 State Plans

Broker sold plans are purchased through a financial services firm where you will have an advisor who can walk your through various investment options. A direct-sold plan (or consumer plan) is purchased directly from the state, often via a website (such as nysaves.org).

If you aren’t sure what plan you have check out Savingforcollge.com and click on your state.

Broker sold plans will be more expensive because you will be receiving the investment guidance and management from a professional vs a direct sold where you will be picking the investments on your own.

While I believe it makes sense for most people to pay for financial advice and handholding (I’m obviously biased) in this case I don’t. The problem is with the advent of age based options you will often end up in a similar type investment regardless if you work with and advisor or not, just paying much more if you went the broker sold route. The age based option investments make it easier for the consumer to choose and invest on their own.

What Is An Age Based Option?

An age-based option is a portfolio of investments (usually mutual funds) that is automatically rebalanced from a more aggressive mix early on in a child’s life to a more conservative one as college nears. You as the investor do not need to make any changes as they are done for you as your child ages.

The age-based option can do most of what an advisor did in the past (manually) in automated fashion at a fraction of the cost.

From the nysaves.org website:

For instance, if your child is 7 years old and you choose the moderate option, you'll start off in a portfolio with 62.5% stocks and 37.5% bonds and then transition to one with 75% bonds and 25% short-term reserves by the time he or she is ready for college.

Conclusion

Age based options via direct sold plans now make it much easier and cost efficient as you can eliminate or reduce many of the fees involved from commissions, maintenance fees, fund fees, and administrative expenses.

529 plans are designed to incentivize you to save toward higher education expenses, and they remain a good financial tool, just be wary of the many fees that can come along and hinder your growth.