- A 529 education savings plan is a type of investment vehicle that is tax-advantaged. Your money goes tax-free, and if you use that money to fund certain qualified education expenses like tuition and books, then you don’t get tax on the capital gains.
- The main appeal of opening a 529 account is the tax benefit. So, if you have a state income tax benefit by staying in-state for your 529 portfolio, then it makes the most sense to do that.
- Like any investment product, 529 plans have fees that help support the administrators and investment managers who maintain the plan for the end investors.
Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. 529 education savings plans are popular vehicles for saving for college. Here today to discuss the 529 plans that earn Morningstar’s top medalist rating and to talk about some best practices when it comes to evaluating 529 plans is Hyunmin Kim. She is an analyst with Morningstar Research Services. And before we begin, a note to viewers, we’re including a link to Morningstar’s 529 plan ratings in the transcript of this video.
Thank you for being here today.
Hyunmin Kim: Thank you.
What Is a 529 Education Savings Plan?
Dziubinski: Good to see you. Before we start discussing some specific plans, let’s start out by defining what a 529 education savings plan is and how it works.
Kim: Yeah, so a 529 education savings plan is a type of investment vehicle that is tax-advantaged. So, your money goes tax-free, and if you use that money to fund certain qualified education expenses like tuition and books, then you don’t get tax on the capital gains. That’s the idea. And within each plan, they usually have a menu of investment options, which looks something like some equity funds, some bond funds, some allocation funds. And most have, what we call a target-enrollment or age-based option, which kind of looks like a target-date fund in that it starts with higher equity allocation and over several years it derisks and arrives at a more bond or cashlike investment portfolio. The idea is that you take more risk when you’re younger so that you can grow your money, and then by the time you draw out your money to fund your education, your portfolio is less vulnerable to market drawdowns.
How to Choose a 529 Plan
Dziubinski: You mentioned a little bit about tax benefits, so let’s delve a little bit into that. It seems like the first step to take when it comes to choosing a 529 plan is to figure out if your state offers a tax benefit before investing. Is that right?
Kim: Absolutely. The main appeal of opening a 529 account is the tax benefit. So, if you have a state income tax benefit by staying in-state for your 529 portfolio, then it makes the most sense to do that. The amount of tax benefits or the form of tax benefit might vary from state to state, but it’s really fairly easy to check what that would look like either through the plan website or we also publish an annual article kind of rounding up all the tax benefits across states, so that could be one reference. And after you’ve done all that exercise and find out that you don’t get any tax benefit from your home state or the benefit isn’t enough for you to justify in-state, then that’s when you go out of state and shop for nationally available plans.
Costs of a 529 Plan
Dziubinski: Got it. In addition to understanding the tax break that you may or may not get from the 529 plan, you also say that it’s important for investors to understand the costs associated with a 529 plan. Talk a little bit about those.
Kim: Like any investment product, 529 plans have fees associated with them, and they help support the administrators and investment managers who maintain the plan for the end investors. The good thing is that fees have come down a lot over the past several years because the administrative fees have gone down and a lot of plans have incorporated cheaper funds by negotiating the fees with the investment managers or incorporating cheaper index funds. So, that’s an improvement. There are still plans that have more actively managed funds in their menu and those tend to be a little more expensive, but quite a few of them are actually worth the higher price tag, especially when they’re managed by really high-caliber investment managers from firms like T. Rowe Price or Capital Group.
Do Investment Options Tend to Be Similar Among Plans?
Dziubinski: Do investment options—you mentioned some have active managers, some have passive managers—do the investment options and processes tend to be pretty similar among plans? Sounds like they could be quite different from plan to plan, is that right?
Kim: At a higher level, we see that the menus have kind of started to look similar in structure in that they have a core target-enrollment or age-based option and then that those are supplemented by other equity funds and bond-fund options. So, structurally, they start to resemble one another, and they also have gone up in quality. We see a lot more funds that are rated more favorably by Morningstar analysts, for example. But there are still differences, notably between direct-sold and advisor-sold plans. So direct-sold plans are the ones that you can sign up for without financial advisors, and those tend to have a smaller menu and a lot more index funds so that do-it-yourself investors can easily navigate that menu. On the other hand, advisor-sold plans are chosen by advisors, so they tend to have more options within each asset class. They tend to have a lot more active funds in the menu. On some occasions, they would have access to asset classes like emerging-markets debt or commodities that might not be available in other plans.
How Morningstar Rates 529 Plans
Dziubinski: Interesting. Morningstar rates 529 plans on an annual basis. Now, what are some of the qualities that we think make a really top-rated 529 plan? What are some qualities of the exceptional plans?
Kim: We aren’t exaggerating when we say we look at all aspects that might influence investor outcomes. So, a good 529 plan would have a combination of a well-researched asset-allocation process, a robust fund selection and monitoring process, a solid risk management process, a team that has a relevant track record and the expertise to run a 529 plan in the portfolios associated with them, and the engagement of the state sponsors on behalf of the participants.
Gold-Rated 529 Plans
Dziubinski: There are two plans that currently have our highest medalist rating of Gold. The first Gold-rated plan is Utah’s my529 plan, and this plan has pretty much earned a Gold rating since we started rating 529 plans a decade ago. So, obviously, this plan is doing something or more than one thing right. Well, tell us about it.
Kim: Utah’s my529 has set the standard for a very long time for the industry. It’s run by knowledgeable and experienced investment professionals. And also, they have multiple layers of independent investment oversight, so making sure that the portfolios are set up the right way and managed in a risk-aware manner. And it also evolves with the industry, which we really like. So, one of the things that my529 rolled out recently is a customizable age-based option where you can choose how aggressive or defensive you want to be in your portfolio and choose the building blocks to populate the portfolios from a really well-curated high-quality menu. So, they’re not kind of sitting on their laurels. They’re trying to evolve with the industry. Those are some of the things that we like on top of an overall well-managed plan.
Dziubinski: And the second Gold-rated plan was actually upgraded from last year. It earned a Silver rating last year, upgraded to Gold. And it’s the Pennsylvania 529 Investment Plan. Why the upgrade?
Kim: Similar to Utah, the Pennsylvania Treasury team has shown really impressive oversight and advocacy for the end investors. So, recently, they have aggressively negotiated the fees down with the investment managers. And they’ve also cut their own administrative fees for the benefit of the participants, which is a big plus. The team also has really good investment professionals who augment the already solid team at Vanguard that manages the portfolios for the participants. That’s a big plus. And the risk management process is very robust. So, we get a sense that the portfolios are well set up for the future.
Dziubinski: Lastly, what if an investor who is already contributing to a 529 plan learns that the particular plan that he or she is contributing to gets a Negative rating or a Neutral rating from Morningstar, which isn’t too hot. Is there any way to switch to another 529 plan? Should an investor in that situation consider switching? How should they be thinking about that?
Kim: It is possible to roll over assets from one plan to another. And we’ve seen people do that. The catch is that you can only do that once every 12-month period. If you switch plans more often than that, there will be tax implications. I would also note that if you have a Neutral-rated plan, it might be worth a second look because benefits like state income tax benefits, those don’t factor into the Morningstar Medalist Rating. So, if you take a look at those and see that you get a tax break from staying in-state, even if it’s Neutral-rated, you might consider staying in-state.
Dziubinski: Well, this is very insightful. Thank you so much for your time.
Kim: Of course. Thank you.
Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.