The 529 plans by far have become the vehicle of choice to save for college funding. 529 plans provide investment vehicles for a designated beneficiary to encourage saving for future higher education. The plans offer tax advantages that vary between states and plans.
The average balance of 529 plans is only $9,700, according to a 2009 statistic from an article by ICI.org titled “529 plan program statistics.” As such, the biggest concern with these plans seems to be performance, while other concerns include restrictive investment rules and penalties on funds not used toward education. Morningstar recently highlighted 529 plans in the June/July 2011 edition of Morningstar Advisor. The edition was published to promote Morningstar’s new 529 platforms that include improved research capabilities. Of the 490 advisors polled by Morningstar, 40% felt the largest concern regarding 529 plans was the performance. However, Morningstar found that with the lower fees that plans have implemented, performance generally tracks the market.
Morningstar’s platform allows advisors to understand options in their home state and screen for a program manager, expenses (asset, enrollment and flat fees), state tax deduction restrictions and tax parity.
Morningstar has selected four “top” rated plans: Maryland College Investment Plan, The Vanguard 529 College Savings Plan (Nevada), College Advantage 529 Savings Plan (Ohio) and CollegeAmerica (Virginia). Advisors should be familiar with your state’s tax incentive levels. If a state has a “high” tax incentive level, this can mean a state tax deduction is $30,000 or more.
Most states have more than one type of plan, and those that do typically have age-based tracks. Age-based tracks are similar to target date funds for retirement, albeit a little more conservative. Known as a glide path, age-based tracks change the asset allocation based on the target date of using the funds. Age-based tracks change from one plan to the next. Morningstar determined that a 15-year old beneficiary could have 80% to 0% of his or her assets in stocks.
Investors have two options when investing in 529 plans: to choose their own allocation or to follow an age-based asset allocation. Morningstar believes that 40% to 50% of new assets are going into age-based asset allocations where the percentage in stocks declines over time. Given the short time period when a student would use the funds for college, this inherently makes sense.
But since the launch of the 529 plans in 2001, I believe the plans have suffered from experiencing two devastating market corrections in 2002 and 2008. That said, plans are usually invested by age or risk tolerance but can’t they include a valuation based plan as well?
The glide paths of age-based plans have reduced the exposure to stocks as a student nears matriculation to college. However, this does not account for the viability that the investment merits. In Intelligent Investor, Benjamin Graham advocated varying one’s asset allocation between 75% stocks and 25% bonds to 25% stocks and 75% bonds based on valuations. If a 529 plan did this, I believe the concerns about performance would diminish. While advisors may not have this option to choose from, they may be able to create it themselves even if plans have one asset allocation change a year.