So you’ve made the first step and decided it’s time to start saving for college. 529s sound like the perfect investment. So you go online, do a bit more research and you get overwhelmed. 100+ plans. 1000+ investment portfolios. Direct-sold. Advisor-sold. Expense ratios. Asset allocations. Sales charges. You ask yourself, ‘How on earth am I going to navigate through this maze of plans?’
Picking the right plan is crucial. You want to be prepared when the college bills start rolling in. This means finding a plan with solid returns, low fees, incentives, etc. that’s also aligned with a level a risk that lets you sleep at night. That is why we built Gradvisor. Within minutes, our proprietary algorithm will find you the plan and investment portfolio projected to maximize your savings.
Here are some of the things we consider when making a recommendation.
Your College Savings Goal
The first thing you need to ask yourself once you decide to start saving for college is, ‘How much?’ And this is a question that will likely have different answers at different points in your life. It will likely be determined by your family’s current situation and will dictate the rest of your decision process. Some of my clients come to me with a very specific number or percentage of college costs in mind. Some are more restricted and just want to do what they can. The important thing is to be honest with yourself in making a goal and then stick to it. If your situation changes, so will your goal and your approach to saving.
Your State of Residence
Some states offer their residents incentives for opening 529 Plans. Currently, 34 states and the District of Columbia give their residents a tax benefit for contributions to the state’s 529 Plan. 6 “tax parity” states even allow a deduction for contribution to any state’s plan. Smaller incentives might also be available such as a waived account maintenance fee or lower minimum contributions.
These incentives should not be your only considerations when selecting a plan however. Remember, you can open up any state’s plan and each has it’s own attributes. Too often I see clients get caught up in the promise of a tax deduction. Try to determine how much you’ll actually be saving and balance that with the plan’s other attributes. At Gradvisor, we compute your yearly tax deduction depending on your state’s laws and how much you plan to contribute. In some cases, a better performing, out-of-state plan will actually result in more savings. I wrote more on this concept here.
Your Risk Tolerance
Before you evaluate the numbers of a plan, you need to evaluate yourself. I know that sounds existential, but it’s true. Life would be pretty simple if all we had to do was pick the plan with the highest return last year. But that plan might also come with the highest amount of volatility, meaning if the market has a bad year, you could see a lot more losses, something not everyone is comfortable with. It’s important to know how much risk you’re willing to take on as an investor and choose a portfolio that suits you.
Some are willing to take on more for risk for the possibility of higher earnings. Some would rather be more conservative and enjoy small, steady growth. At Gradvisor, we mathematically compute your risk tolerance using a series of questions so we can match you to a portfolio you feel comfortable with. We also place you into age-based investments. These portfolios automatically become more conservative as the beneficiary approaches college adding some built-in protection to your investment.
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Time Horizon
The length between starting your 529 Plan and when you will begin taking distributions is known as your time horizon. It will affect how much you should contribute, your portfolio selection and your risk tolerance. If your goal is to save $50,000 for college, you will obviously need higher monthly contributions for a beneficiary that is 13 as opposed to 5.
You will also need to determine what kind of portfolio will be suitable. Remember, in age-based investments, your portfolio becomes more conservative as the beneficiary gets closer to college. So an older child may be in a very conservative portfolio, which won’t have as much room for growth. If you child is already in high school, and you haven’t begun saving, you may decide you want to choose a riskier, static option to make up for lost time. But once again, all of this should be predicated on your risk tolerance.
Plan Performance and Fees
The problem with 529s being referred to as ‘savings plans’ is that some people don’t realize that this is actually an investment. And just like any other investment, each plan has different fees, performance, program managers, etc. All of these need to be weighed and balanced when making a final decision.
Fees. Every plan has a unique fee structure. If you’re going through a financial advisor, you may have to pay a 5% sales charge on all of your contributions, which can significantly eat into your earnings over time. There might also be deferred sales charges, which could force you to stay in a plan you want out of. These types of fees are more common in advisor-sold plans.
All plans also carry an expense ratio. These unavoidable charges can range from .17% to over 1%. They are paid yearly (based on your account balance) to cover administrative fees, operating expenses and all other asset-based costs incurred by the funds. Be mindful of how this can affect your savings, especially if you plan on making large contributions.
Program Managers. Although all 529 Plans are state-sponsored, some choose to contract with programs managers like TIAA-CREF, Vanguard, T. Rowe Price, etc. You should evaluate the strength and financial position of these managers, or choose one you are comfortable with. Some of my clients want a particular program manager they are familiar with, even if it means sacrificing some returns and fees. Peace of mind is an immeasurable statistic when it comes to investing.
Performance. This is obviously the crux when it comes to this whole process. It shouldn’t matter how familiar you are with the program manager or how low the fees are if the plan has poor returns. Obviously past performance is no indicator of future results, but I think a solid track record is better than a poor one. A plan with great returns can make up for higher fees and a lack of a tax deduction. But it’s all a balancing act. Sometimes my clients feel that its worth sacrificing higher returns to get a tax deduction or lower fees are because they are real and predictable. You can’t be sure of how a plan is going to perform.
I can’t stress enough how big of a difference a little bit of research can go when selecting a plan. Don’t get caught up in the rhetoric which tells you to open a plan simply because you get a tax deduction. You want a plan that can help you best achieve your goal, and that may not be your state’s plan. Every investor is different, but there is something out there for everyone.