Assets in 529 College Savings Plans grew 4% to a record high of $227 billion in assets in 2015, led by flows into plans sold directly to individual investors, according to Morningstar’s annual study of college savings plans.

Those plans accounted for 80% of asset flows into 529 plans last year; advisor-sold plans accounts for just 20%. As a result, the market share of advisor-sold funds fell to 46.4% of 529 fund assets from 48.1% a year earlier. The share of direct-sold plans rose to 53.4% from 51.9%.

This trend favoring direct-sold funds is likely to accelerate as a result of the Department of Labor fiduciary rule. “It’s going to be much harder to justify the higher fees [of advisor-sold funds],” said Morningstar analyst Gretchen Rupp.

According to the Morningstar report, the average expense ratio at year-end 2015 was 0.47% for 529 plan funds sold directly to consumers and 1.33% for funds sold by advisors. The key reason for the difference: active management. Actively managed 529 funds accounted for 85% of the share of advisor-sold funds but only 16% of direct-to-consumer funds.

But the costs of advisor-sold funds vary widely based on the share class. A shares charge an average front load of 4.75%, while C shares have no front loads but generally a higher expense ratio than A shares. In addition there are also cheaper no-load shares sold by advisors. Advisors, especially fee-only advisors, also have the option of investing clients’ college savings funds in direct-sold 529 funds or they can counsel their clients to choose those funds, according to Rupp.

Overall, fees for 529 funds have fallen, to an asset-weighted average of 0.74% in 2015 from 0.79% in 2014, due to growing demand by investors for less expensive direct plans and low-cost index investments within plans, according to Morningstar.  The typical direct-sold plan charges 20 basis points on top of the cost of the underlying funds, while the typical advisor-sold plan charges an additional 70 basis points, said Morningstar. The advisor-sold plan, however, may allow for more investment choices, Rupp said.

Before advisors choose a particular 529 fund and share class, they should first decide whether to invest in a fund based in the state where their client resides, said Rupp. Although 529 plan assets grow tax free and withdrawals aren’t taxed so long as they’re used to pay for qualified educational expenses, only 27 states plus the District of Columbia offer a tax benefit for residents that invest in their state-administered 529 plan, typically some sort of tax deduction.

Six states – Arizona, Kansas, Maine, Missouri, Montana and Pennsylvania – offer residents a state tax benefit no matter what 529 plan they invest in, and 18 states don’t offer any tax benefit. In addition, state tax benefits may be capped at certain contribution levels, so it’s important for advisors to learn the details of these plans.

Once that’s decided, advisors and consumers should consider the following, though not necessarily in this order, according to Rupp:

  • Whether to use an advisor-sold fund or one sold directly to consumers, which advisors, too, can access on their client’s behalf or have the client do it
  • Whether to choose an actively managed fund or passive fund, or a fund that includes both types of portfolios, keeping in mind the tax implications of those choices, which will depend on the client’s state of residence
  • Whether to front-load contributions or space them out. Front-loaded funds allow more assets to grow tax-free over a longer period of time, but there could be contribution limits to qualify for tax benefits. “The tax deduction is key,” said Rupp.
  • Whether to choose an aged-based fund, which automatically adjusts allocations as the student approaches college enrollment and during their college years, or not. Age-based funds are among the most popular 529 funds, according to Morningstar.  

There are two main types of age-based funds: funds that switch from more aggressive (stock) portfolios gradually, which Morningstar calls “age-based progressive portfolios,” and funds that make the change more quickly, called “age-based static portfolios.” Morningstar prefers the former because it can avoid losses from a sudden allocation shift on a bad day in the market.

Morningstar also favors age-based 529 funds that have experienced asset allocators at the helm or use the expertise of the firm’s target-date fund team to design the 529 fund’s age-based tracks. The fund rating company rates advisor-sold age-based plans lower than direct-sold age-based plans because of the higher fees that advisor-sold plans build into their load and fee structures to compensate advisors. The latest Morningstar report does not provide new ratings for 529 College Savings plans but uses the annual ratings the company released last October. 

The report focuses on 529 savings plans, not prepaid tuition plans where families can lock in the tuition costs of a public or private college. Some states offer prepaid tuition plans for public colleges and universities, and the Private College 529 Plan does the same for 283 participating private colleges. If a student chooses not to attend any of those colleges, the assets can be rolled over into a traditional 529 plan.

Under the Private College 529 Plan, earnings are capped at 2% a year, as are any declines in fund performance, but families have the benefit of locking in tuition costs, which rose an average 2.4% annually over the past 10 years including a 3.6% jump between 2014 and 2015, according to the College Board. A recent survey from the Private College 529 Plan found that only 29% of families with kids under 18 are using any type of 529 plan to save for college versus 39% who are using a savings plan.

Nancy Farmer, president of the Private College 529 Plan, is concerned about this gap because in today’s low-rate environment savings plans usually earn less than 529 plans, which invest in securities, and they don’t have a tax benefit. “One of the greatest worries for families is not saving enough for college,” said Farmer. She suggests that financial advisors set up a college savings portfolio as they do a retirement savings portfolio and consider including both a prepaid tuition plan and traditional 529 plan in that college savings plan.

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