What to Consider When Shopping for a 529 Plan
Savers' goals aren't all the same.
Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Many families use 529 education savings plans as vehicles for college savings. What should investors consider when shopping around for a 529 plan? Joining me today to discuss the topic is Adam Millson. Adam is an analyst with Morningstar's Multi-Asset Funds Research team and the author of Morningstar's latest report on 529 education savings plans.
Thanks for being here today, Adam.
Adam Millson: Thanks for having me, Susan. Pleasure.
Dziubinski: Adam, let's start out by talking a little bit about what 529 education savings plans are and why they're so attractive for saving for college.
Millson: Absolutely. So, 529 education savings plans are tax-advantaged investment vehicles for savers so they can grow their assets over time to be used for qualified education expenses. What's unique about the 529 plan is that the contributions go in after tax, but those assets as they grow, they grow tax-free, and then, when you withdraw those assets for qualified education expenses, they're also tax-free. Almost all 50 states provide or sponsor a 529 plan, and investors can access those either directly or through a financial advisor.
Dziubinski: Now, you mentioned a little bit about taxes in your comments. And so, it seems like your first step when looking for a 529 plan would be to examine your plan in your own state, because there might be additional tax benefits if you stay in-state. What should you be looking for?
Millson: Right. Absolutely. So, the state tax benefit available to an in-state resident is a very important part of what an investor would want to look at when they're thinking about what plan is suitable for them. Those tax benefits can come in a couple of different options. So, it can be a deduction or it can be a credit, and they can be a very generous amount. So, when you're thinking about the benefit available to you, that's an important part to look at.
The other thing to think about is if your state is considered a tax-parity state. And what that means is that you can receive the tax benefit regardless of what plan you invest in. So, you can actually go out of state and not invest in your own state's plan to receive that tax benefit. So, that's a crucial piece of the pie as well. And as I mentioned, they can be pretty generous in the amount. So, it can overcome some of what might be a downside to a plan in your state--that tax benefit can really overcome that.
Dziubinski: In what situations, then, might it make sense to look outside of your state-sponsored plan?
Millson: Sure. So, not all states provide a state tax benefit. Roughly, half of the U.S. population actually reside in a state without a state tax benefit. So, that's the first--those investors that don't have one available, you're not tied to your in-state plan. So, you're free to shop around and look at all the offerings available across the country.
Second would be those people residing in a tax-parity state. Obviously, you're still getting the benefit, but you can go wherever you'd like and choose the plan that's best for you.
Morningstar also rates 529 plans. Obviously, there are plans out there that we have low-conviction views on that maybe have structural flaws that we think are reasons to look elsewhere. So, that might be, if your in-state plan isn't compelling or [doesn't] have the options that you're looking for, it might be another reason to go out of state. But as I mentioned, the tax benefit can be a very generous amount. So, it is something to consider. Even maybe our lower-conviction-view plans, where they might receive a Neutral rating, might still be worth investing in in your state if that tax benefit overcomes the price of the plan.
Dziubinski: Now, you did mention that Morningstar does rate 529 plans. What are some of the qualities that the best plans share that investors should be looking for?
Millson: We do rate 529 plans on four key pillars, so that's People, Process, Parent, and then the Price. And those four pillars inform our holistic view, which is the Morningstar Analyst Rating I mentioned, and that can range from Gold all the way to Negative. And our highest-conviction-view plans, those are Gold, Silver and Bronze, usually have strong characteristics or attributes across those pillars. On the People side, we're looking for a strong investment team, experienced and deep amount of individuals behind the plan. On the Process side, we're looking for well-constructed options. Is it thoughtful, research-based? We're also looking for a robust investment menu. Are you offering everything that an education saver would want or potentially think about investing in, and is that thoughtful? We're also looking obviously at the Price. Is it attractively priced? It's a key piece or an important piece to think about. And then, lastly, what does the stewardship of the state look like and the investment manager? Are they providing strong oversight of the plan and making improvements over time for the benefit of education savers?
Dziubinski: Adam, you mentioned the investment menu, and when you do select a 529 plan, you are asked to choose among the investments in this menu. How does a college saver think about how to allocate the assets within that 529 plan?
Millson: There can definitely be a variety of options to the robust investment menu. Really, at the high level, there's two areas you're looking at. So, the first would be the age-based options, and that's where you're getting an allocation between equity and bonds, and that allocation shifts over time as you become closer to your enrollment year into college, so a glide path. The other bucket would be static options. And as the name implies, those allocations remain static, so they don't move or shift their allocations over time. And the underlying options or portfolios in that bucket can be all equity options, and they could be ranging from growth- to maybe value-oriented. And it can go all the way down the spectrum to bond funds. So, you could see like a core-plus fund there as well. So, you have a lot of option there. Really, when you're thinking about it as an education saver, the age-based portfolios are more for hands-off investors, I would say. But on the static side, somebody that's more hands-on, maybe has more investment expertise, wants to be more involved, might like the static options better there. But it's not a one size fits all, so you can go either way.
The other thing to think about is: What's the goal? What are your savings being used for? Obviously, the list of qualified education expenses has expanded. So, maybe your time horizon is shorter than investing--or taking assets out when you're getting into college and through college. Maybe you're thinking about a shorter time horizon. And in that case, maybe a static option, if you're wanting to use those assets in five years, makes more sense than the longer investment experience you have with the age-based portfolios.
Dziubinski: Well, Adam, thank you for your time today and for these tips to help us figure out which 529 plan might be right for our circumstances. We appreciate your time.
Millson: Thanks for having me.
Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.