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What's New With 529 Plans

During 2016, fees hit record lows, assets reached a new all-time high, and asset-allocation techniques improved.

Leo Acheson, 05/25/2017

Within the landscape of 529 college-savings plans, fees have reliably fallen and assets have consistently risen. However, one new trend has emerged within age-based portfolios' asset allocation: smoother glide paths.

529 Plans Taking Lessons From Target-Date Funds
Age-based options represent the most popular choice among 529 investors. These options' set-it-and-forget-it feature appeals to hands-off investors. Like target-date retirement funds, age-based portfolios aim to provide a well-diversified investment in one package. They do so by gradually reducing equities in favor of fixed income as the beneficiary ages. These age-based portfolios follow either static or progressive (commonly referred to as stepped or smoothed) approaches as they rebalance along the glide path. The former makes abrupt shifts from stocks to bonds at predetermined dates, often every few years close to a beneficiary's date of birth. Meanwhile, a progressive glide path uses smaller, more-frequent asset allocation adjustments, providing a smoother ride.

For example, the T. Rowe Price College Savings Plan uses a progressive process, readjusting its stock stake each quarter and targeting a less-than 6-percentage-point shift each year until college enrollment. At the opposite end of the spectrum, Tennessee's TNStars College Savings 529 Program employs a static approach. The plan's largest step occurs at age five, when it cuts equities by 35%, representing one of the largest single-day shifts in the 529 industry. Exhibit 1 illustrates the difference between these approaches.


Source: Morningstar.

We favor the smoother method employed by progressive age-based options or a static approach that uses moderate steps. The static approach can introduce meaningful market risk if it makes a large asset-allocation change in one day, but our research has indicated that steps of roughly 10% or less largely mitigate this risk. For a deeper comparison of the approaches, refer to last year's 529 College Savings Plan Landscape.

All target-date funds that we cover follow a progressive approach, but the vast majority of 529 plans still use the static approach. Currently, 17 plans, which offer an aggregate of 25 age-based tracks, use the progressive approach. The remaining 67 plans, which together have 149 tracks, feature static age-based portfolios. Fortunately for investors, many plans that use static processes have recently smoothed their glide paths. Since the start of 2016, 15 plans have implemented or approved smoother glide paths for 41 tracks. This list includes plans from multiple program managers, including American Century, Ascensus, The Hartford, Union Bank & Trust, and Vanguard. Whereas these plans previously had step sizes as big as 50 percentage points, the largest asset-allocation shift after the changes will be 15 percentage points. Exhibit 2 depicts this trend. In most cases, plans achieved smoother glide paths by adding more age-based static portfolios to make the reduction in equities a more gradual process. This trend represents a meaningful improvement by the industry.

Source: Morningstar.

Fees Continue to Fall
Fees on college-savings investments continue to trend downward. The simple average expense ratio for all 529 investment options decreased by 3 basis points during 2016 to 1.05% (this figure excludes money market funds, because most have significant fee waivers in place, as well as stable-value funds, which report inconsistent expense ratios to Morningstar's database.) This represents a slight improvement as compared with 2015, when the average fee fell by 2 basis points.

is a fund analyst on the fund-of-funds research team for Morningstar.

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