Building A Bridge - Page 3 of 9

Building A Bridge

he explains.

All 50 states offer one or both types of 529 plans. Parents seeking the best deal on any given plan should compare one state’s offering to another. (See table.) They also should ask a series of questions:

  • Who is the fund manager?
  • Does the plan offer a variety of mutual funds, including fixed-income investments?
  • Does the plan impose any harsh restrictions? For example, New York penalizes investors who withdraw money if their accounts have not been open for at least three years.
  • Is it favorable toward nonresidents?
  • Can I buy the plan directly from the state or plan sponsor, or do I have to go through a broker-dealer?
  • Does my state offer additional tax advantages?
  • What happens if my state changes fund managers? For instance, last year, New York State dumped TIAA-CREF as the manager of its 529 plan and started a joint venture with UPromise and Vanguard.

Shannon Zimmerman, a fund analyst at Morningstar Inc., a Chicago-based firm that tracks more than 6,000 mutual funds, says you’ll especially want to keep four important factors in mind: the management team, the plan’s performance record, any fees involved, and your individual time frame and needs. “The fee structure of a 529 plan can be extremely complex,” says Zimmerman. It can include fees for enrollment, annual maintenance, management, and sales charges. Though they vary from state to state, Zimmerman says that, on average, fees for a reasonably priced plan should not top 1% of what you’re investing into the plan. He notes that TIAA-CREF, which manages a number of plans, and Vanguard offer some of the lowest fees.

But what difference do fees make? “Over the long haul they can make a huge di
fference,” says Zimmerman. For example, if you take into account the management fees and expense ratio of its underlying funds, the Wyoming College Achievement Plan charges an annual fee of 2.21% of its total assets. The Utah Educational State Plan, on the other hand, charges a fee of 0.37% in an age-based portfolio with an approximate 50/50 option of equity and fixed-income funds. With a 10% annual return on an initial investment of $10,000, in 18 years the Wyoming plan will be worth $38,584. In comparison, the Utah plan will be worth $52,327.

Winkfield counsels clients to not consider investing in a 529 plan if they’re “not on track for retirement.” Winkfield advised Walker, who had some debt and a small retirement account, to take out student loans for her daughter’s education and, instead of contributing $700 a month to a 529 plan, to invest $500 in a tax shelter, such as a universal life insurance policy earning a fixed interest rate comparable to what she’s paying out. Walker could use the remaining $200 to make accelerated monthly payments toward her current debt. “In 10 years, she can use the money for retirement, help her daughter repay student loans, or whatever she may need,” says Winkfield, who suggested a universal life insurance policy because of its cash accumulation and tax-favored withdrawal characteristics,