Why 529 Plans Are a Smart Way to Invest for College
What if someone offered you an opportunity to save money for your child's college education, with no tax consequences until you withdrew the money? In addition, depending where you live, your state might also offer tax breaks and other incentives to participate.
To sweeten the pot even more, you could use the money not only for a traditional four-year degree for your child, but for vocational programs and graduate school, or even for yourself or another family member if your child does not pursue higher education.
Turns out, that investment vehicle does exist. It's the 529 college savings plan, named after the section of Internal Revenue Service code that established the plans in 1996.
Although 529 plans have been available for nearly two decades, most Americans don't know about or understand them well, according to a May survey by investment management firm Edward Jones.
"Two in three Americans could not identify a 529 as a college savings tool, yet for many, the need or desire to help their kids with college is one of their most significant priorities, from a financial perspective," says Stephen Seifert, a principal with Edward Jones in St. Louis.
"So there is almost a disconnect. We know it's a significant need. The cost of college is increasing at a rate greater than inflation, so families are grappling with how to address this. Yet one of the most beneficial tools for doing so is unrecognized by two out of three. It's a missed opportunity, given that it is such an important need for so many families today," Seifert says.
To determine whether the plans are increasing in popularity, new account openings are a more useful metric than asset growth. Despite current awareness of a volatile stock market, most stock investors, including those in 529 plans, enjoyed solid gains between 2009 and 2014. Though stocks took a tumble this year, most of those longer-term gains are still intact. That means a simple asset-growth calculation isn't the best way to gauge increases in plan usage.
The College Savings Plan Network, a consortium of officials representing state 529 plans and vendors, such as investment firms, tracks plan growth, both in terms of total assets and number of accounts. For the five years that ended Dec. 31, assets grew at a rate of 12.9 percent. However, that number includes asset appreciation as well as new accounts.
A more useful number is the number of new accounts, which, according to CSPN data, have grown by about 470,000 annually since 2010, or about 5 percent on average each year.
Andrea Feirstein, managing director at AKF Consulting Group in New York, is encouraged by the increase but says it's instructive to look at where the growth is coming from. Feirstein, who provides consulting services to dozens of state college-savings plans, says CSPN data shows that direct-sold plans are driving the national growth, in terms of assets and number of accounts.
For example, the number of new accounts grew at a total rate of 5 percent in 2014. Direct-sold plans grew at a rate of 7.2 percent, while the number of advisor-sold plans grew by just 1.7 percent. Asset growth in direct-sold plans also outpaced the advisor sales channel.
"So the question you have to ask is whether the different growth rates in the direct-sold plans, versus the advisor-sold plans, reflect greater visibility of the college savings issue overall, and thus more families are finding the plans on their own, or whether advisors are just tapering their efforts and focus on 529s," Feirstein says.
Peg Creonte, senior vice president of business development at Ascensus College Savings in Newton, Massachusetts, says her firm has identified a slight increase in new accounts. Ascensus, which administers direct-sold and advisor-sold 529 savings plans for several states, also has recorded higher annual contributions recently.
Ascensus released its 529 College Savings Plan Survey in May. The survey tracked data such as account balances, amounts of contributions and how account owners made contributions. "The report shows that most people contributed to 529 plan accounts on a regular basis throughout the year, often through automatic transfers from bank accounts or payroll direct deposits," Creonte says.
According to the survey, approximately 60 percent of all contributions were in amounts of $100 or less, and about 75 percent were for $200 or less. Payroll direct deposit averaged $75 per pay period, while contributions through automatic investment plans averaged $169.
Feirstein says the CSPN data indicates that growth in new accounts has picked up since the financial crisis that lasted between 2007 and 2009, which she sees as a positive sign. Even if it's better marketing by direct-sold plans, as opposed to advisor-sold plans, the growth is welcome.
"Personally, I'd like to think that the direct-sold plans are getting the word out more effectively than ever before, particularly through the personal-financial press, and so more American families are aware of the impact a 529 plan can have on paying for college," she says. "Regardless, in a way, a rising tide of awareness lifts all boats. So as we see, asset and account growth in the direct-sold plans is the key driver to national market growth overall, and that's just fine."
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