For investors under age 50, the goal of paying for their children’s college education often comes second to retirement saving. 529 plans are a tremendous vehicle to help reach college funding goals. Withdrawals are tax-free as long as they’re used to pay for bona fide education-related expenses such as tuition, books, and room and board. And with the changes in the tax code, 529s can also be used for primary education costs (e.g. private school tuition).

Many states offer two versions of their 529 plan. Direct 529 plans allow individuals to establish, fund, and choose investments from a menu of mutual funds on their own. Advisor (or “indirect”) 529 plans are available through brokers and other financial advisors. While the fund choices are different, the main distinction is that funds in advisor 529 plans charge a commission to compensate the selling advisor. We thought it would be worthwhile to compare these two choices. Let’s look at the cost differences, using the Indiana-sponsored plan as our example.

Direct vs. Advisor

The CollegeChoice 529 Direct Savings Plan offers 14 funds, including 7 Year of Enrollment Portfolios – portfolios which gradually get more conservative as the student approaches college age. Annual expense ratios range from 0.29% in the Stable Value Portfolio to 0.82% in the International Portfolio. Expenses among the Year of Enrollment funds range from 0.40% to 0.46%.

The CollegeChoice Advisor 529 Savings Plan option offers 21 funds, including 7 Year of Enrollment Portfolios. Expense ratios range from 0.32% (on the bank savings account) to 1.56% for Emerging Markets Equity Index Fund – C shares. Funds in the CollegeChoice Advisor plan fall into two categories. Class A shares generate a large commission for the advisor when the funds are purchased within the plan (3.75% to 5.25% in Indiana’s plan) and smaller commissions (0.25%) each year thereafter. Class C shares do not charge an up-front commission, but instead pay out a much higher (1.00%) commission annually to the broker. (These classes of mutual funds have the same commission structures when owned in regular brokerage accounts and IRAs as well.) The funds in the CollegeChoice Direct Savings Plan pay no commissions.

Are the Commissions Worth it?

Is it worth it to pay the extra commissions in the CollegeChoice 529 Advisor option? Let’s consider this from the perspective of fund choices. The answer is clearly “no” in the case of Year of Enrollment Portfolios. The underlying asset allocation and rebalancing is done for the advisor – they’re truly not doing any work that merits compensation.

What about advisors who recommend specific funds? It is possible for an advisor to add value above enrollment date funds by choosing a different asset allocation. On the other hand, Indiana’s Advisor plan offers a total of 14 additional funds from which to choose. Does that limited menu justify a commission?

Here’s a fun way to illustrate: imagine that you were looking for a birthday card and an advisor offered to help you choose the perfect one in exchange for a commission. Upon your arrival at the store, you notice a total of 14 cards on the shelf from which to choose. Would it really be worthwhile to pay somebody a commission to choose a card for you, or could you probably do it yourself with a little benevolent guidance?

Benevolent Guidance

Like retirement saving, the main thing to keep in mind when saving for college is to make sure that the money will be there when you need it. Because stocks can be very volatile (remember 2008-2009?) and bonds far less so, stocks must offer higher potential return to justify the fluctuations. Stocks do offer higher returns than bonds over many years, but when investing for college, it’s critical to remember that there is a specific point in roughly the next 18 years when you need the money to be available.

As we demonstrated in Debunking Investment Math Myths, by far the biggest impact on portfolio volatility is your decision about how much to allocate to stocks (or stock funds) vs. bonds (or bond funds). As a result, the volatility and return impacts of adding additional asset classes is minimal. In general small company stocks and emerging market stocks are likely to be more volatile than large company U.S. stocks. Long-term bonds are also likely to be more volatile than short-term bonds.

With those points made, we offer some guidelines for selecting funds in a direct 529 plan.

  • Portfolios based on enrollment dates are not a bad choice.
  • Basic strategy for maximizing return early and preserving value closer to enrollment:
    • when the child is 18 to 7 years from enrolling in college, invest in an equity index fund to maximize growth, and
    • when he/she is 7 to 0 years from enrolling, begin to gradually shift from an equity index fund to a short-term bond fund or stable value fund.
  • Keep in mind that plans change, and the beneficiary of 529 accounts (i.e. the student) can be easily changed if necessary.

Go Direct

With the information provided above, you can go direct and keep money otherwise destined for commissions reserved for tuition. What’s truly critical is to save regularly and stick with your investment discipline. And if you really want help from an advisor, hire one who will charge a flat fee to help you start down the right path.