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Age-Based Options Take Over 529 Industry

Even advisors are pouring money into plans that adjust asset allocations.

Kailin Liu, 12/03/2012

This article originally appeared in the December/January 2013 issue of MorningstarAdvisor magazine.  To subscribe, please call 1-800-384-4000. 

In September, the behemoth CollegeAmerica 529 plan surprised the 529 industry by launching its very first age-based track. Age-based options are popular in the industry because they automatically adjust the asset allocation of savings to become more conservative as the beneficiary ages. Nonetheless, CollegeAmerica had rode along comfortably for more than 10 years and gathered billions of dollars in assets without these options. Program manager American Funds maintained for several years that the advisors added value by creating a custom asset allocation for their clients. When asked to explain their change of heart, American Funds said it was simple: Rebalancing, especially for multiple children, was operationally difficult for advisors. Age-based options allow advisors to outsource that process.

The Growing Popularity of Age-Based Options
American Funds is late to the party with regards to age-based options, which have been embraced by the 529 industry for many years. The $160 billion 529 industry is split roughly in half between direct-sold plans and advisor-sold plans. According to Morningstar data from Sept. 30, roughly 32% of advisor-sold assets are in age-based options, compared with 40% of direct-sold assets. The share of advisor-sold assets in age-based options has stayed relatively stable since 2008, while the share of direct-sold assets in age-based options has risen dramatically since 2008 (Exhibit 1).

Age-based options are popular among advisors and likely to become even more widely adopted in the near future. Of the six largest advisor-sold options, CollegeAmerica is the only plan with less than 50% of assets in age-based options (Exhibit 2). The next five largest advisor-sold plans have at least half and up to 75% of assets in age-based tracks. CollegeAmerica’s introduction of age-based options alone could fuel a big increase in age-based assets. The $34 billion plan is the largest in the industry and holds a whopping 42.5% of the industry’s advisor-sold assets. Its impact on the asset distribution is so large that when we calculate the percentage of advisor-sold assets in age-based funds with CollegeAmerica excluded, the figure jumps from 32% to 55%.

Doing More With Age-Based Options
At first blush, the money pouring into agebased options from advisor-sold accounts may indicate that advisors are less interested in managing college savings. The relatively modest 529 account sizes, especially compared with retirement savings, can certainly lower incentives for advisors to make custom asset allocations and rebalance 529 accounts. Additionally, many 529 plans benefit from a rigorous asset-allocation process—monitored by investment committees at such industry heavyweights as Vanguard, T. Rowe Price, and BlackRock—that the typical advisor may not have. For some advisors, age-based options are a perfect “set-it and forget-it” solution. However, the data also suggests that the conveniences of age-based options can help advisors become more, not less, involved in customizing clients’ college savings.

For example, the behavior of registered investment advisors validates the idea that advisors are open to creating custom asset allocations as long as they can outsource rebalancing. The customized age-based option in the Utah Educational Savings Plan allows investors to combine any mix of the underlying Vanguard index funds available through the program and preset the asset allocation, leaving the plan to rebalance for them. Anecdotally, this option attracts many RIAs, and the data suggests that the option is meeting their needs well. Since the inception of the track in August 2011, it’s grown to almost $400 million in assets.

Age-based options can also make it easier for advisors to pursue a “core and explore” strategy with clients’ 529 savings. While the premade asset allocations in age-based options are frequently set by dedicated teams at well-respected fund companies, it’s impossible for these teams to consider the entire financial picture for every college saver. Advisors can start with the age-based option and adjust the portfolio according to their client’s individual needs, using individual funds or static allocation options in their 529 plan of choice.

The menu of investment options and distribution of assets at many plans certainly indicates that advisors are taking advantage of the single-fund options to make a custom asset allocation or tweak an existing age-based option. Excluding CollegeAmerica, single-fund options hold 21% of all advisorsold 529 assets. Static large-blend funds, money market funds, and intermediate-term bond funds soak up the most single-fund assets, suggesting that advisors use these funds to adjust asset allocations that are too aggressive or conservative for their client’s needs (Exhibit 3).

The Big Financial Picture
Whether or not to use an age-based option is only one choice in the college-savings process. Advisors also help college savers meet their goals by offering input on where, how much, and when to invest, not to mention how to maximize potential tax benefits in light of a client’s complete financial picture. Advisors can benefit from taking a close look at the quality of a 529 plan’s underlying investments, the stewardship practices of its program manager and asset managers, and its fees. The Morningstar Analyst Rating for 529 Plans accounts for all of these factors. It sums up multiple evaluations into one rating and can become a helpful part of advisors’ evaluation process.

Kailin Liu is a Mutual Fund Analyst with Morningstar.

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