Should Your 529 Plan Be Direct-Sold or Advisor-Sold?
For most parents, two of the most frightening words in the world are "college tuition."
With college expenses spiraling ahead of inflation, the finish line moves further away, even for parents who diligently save. That's why state-sponsored 529 savings plans are popular. Depending on the state, they allow tax breaks for residents who funnel funds into dedicated accounts for tomorrow's college students.
But parents need a bit of an education themselves when it comes to setting up a 529 plan. Although it's easy, fast and cheap to open a basic 529 account, you can also open an account through a financial advisor.
Why bother?
You can open a mutual fund account directly, too, but you may choose to work with a financial advisor to have more investment options and consolidate your portfolio. The same rationale applies to 529 accounts. In fact, Morningstar's annual 529 research report, released in May, found that American families chose direct- and advisor-sold plans nearly equally. As of Dec. 31, 2013, advisor-sold plans had $98 billion in assets while direct-sold plans held nearly $102 billion, according to the report.
[See: 7 Ways Financial Advisors Save for Their Children's Education.]
Even with diligent saving, a 529 plan is likely to cover only part of your child's total college costs. The College Savings Plan Network reported in March 2014 that the average 529 balance was $19,584 as of Dec. 31, 2013 -- barely enough to cover one year's worth of in-state tuition and fees.
Before you plunge into the direct-sold versus advisor-sold thicket, review the basics, urges Mary Anne Busse, co-chair of the legal and regulatory affairs committee of the College Savings Plan Network, a national consortium of state-sponsored plans.
"Check your home state to see if there are particular benefits," Busse says. In Royal Oak, Michigan, where she operates her compliance advisory, Great Disclosure, residents can deduct up to $5,000 annually from their state income taxes, depending on how much they save in a Michigan 529 plan. Also, review your employee benefits to see if there's a payroll deduction option, which makes savings automatic and convenient.
But therein lies the argument for working with an advisor: You might find the tax benefits are more advantageous if you mix and match 529 plans. That's especially helpful when other elements of your portfolio are taken into consideration, Busse says.
[Read: How to Assess Customer Service Before Picking a 529 Plan.]
"A lot of people like to have all their investment options centralized under one advisor," says John Stergiou, head of managed accounts and 529 plans at New York-based Allianz Global Investors. "There are differences between investment options and the asset classes. Direct plans are more passive investments, often indexed. Advisor-sold plans are more active."
Advisors can also tap into a wider variety of investments than can be offered in a cookie-cutter direct plan. "We will utilize some index funds to help bring down costs, but we will also have exposure to alternative asset classes that don't exist in direct-sold plans."
"It's really about 'Does the advisor bring value to the whole portfolio management process?'" says Kathryn Spica, a mutual fund analyst with Morningstar who specializes in 529 plans.
Advisors love 529s because they bring in young, affluent families, 529 consultants say. Typically, parents open the accounts when their child starts kindergarten or first grade.
[Read: 529 Plans: The Best Way to Save For College.]
If you choose to go with an advisor, be sure to cover these points:
-- Check your employee benefits to see if you can tap into a free consultation with a financial advisor or a 529 consultant.
-- Understand the fee and compensation structure.
-- Ask what the minimum savings threshold is so you can detect whether an advisor works with people at your income level.
-- If you are opening several accounts, one for each of several beneficiaries, calculate the cumulative benefits and ask about any ceilings.
-- Explore ways to reduce fees, such as signing up for automatic contributions.
Bear in mind that you don't pay federal capital gains taxes on assets in the 529, Spica says. "You put in after-tax dollars, but the capital gains are not taxed, and there's no tax when you withdraw," she says.
The good news is that you don't need a doctorate to understand 529s. "Fee structures are analogous to mutual fund fees, and if you can understand those, you can understand the structures and lingo of most 529 plans," Busse says. Most 529 plans have age-based options with investments becoming more conservative the closer the child gets to high school graduation.
Stergiou says the age of your child or children can be a determining factor in how you structure a 529. It has been relatively easy for all types of funds to show healthy growth over the past few years. But if your children are already in junior high or high school, you'll need to look at a scope of options to ensure the money you invest will deliver the value you expect.
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