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Personal Finance

The Best 529 Plans for 2023

These plans earn Morningstar’s highest rating. 

Key Takeaways

  • One of the key benefits of a 529 savings plan is that when you invest in this vehicle, your money grows tax-free, and then when you spend it on qualified education savings for college and room and board and books, you’re not liable for capital gains.
  • The first step to take is to figure out if your state offers a tax benefit before investing in a 529 plan.
  • Direct-sold 529 plans will tend to have more of an index fund lineup. The ones that are advisor-sold tend to have a much bigger menu because you have an advisor helping you.

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. 529 education savings plans have become popular vehicles for saving for college. Here today to discuss the two 529 plans that earn Morningstar’s top rating and to talk about some best practices when it comes to evaluating 529 plans is Patty Oey. Patty is a senior analyst with Morningstar Research Services and leads Morningstar’s 529 plan research.

Nice to see you, Patty.

Patricia Oey: Hi, Susan.

Dziubinski: Let’s start out with a brief definition of what a 529 education savings plan is and how it works.

Oey: Sure. A 529 savings plan is an investment vehicle, and one of the key benefits of it is that when you invest in this vehicle, your money grows tax-free, and then when you spend it on qualified education savings for college and room and board and books you’re not liable for capital gains. Typically, a plan, they’ll offer a menu. So, there will be a menu of different equity funds. There will be some bond funds. And then, the most common investment is typically like a target-date fund, and we call them either target-enrollment or age-based portfolios. And basically, what it is, is that depending on your child’s age, if your child is 5, they still have 13 more years of school. You pick that five-year-old portfolio. It will have a relatively high allocation to equities, and over time it will gradually derisk. The idea is that you let the money grow, it’s derisking, and then, just before you go to college, it shouldn’t have that much equity left because as we saw in this year’s market, you would take a big hit if you had too much equities.

Dziubinski: Given that the tax benefits that you mentioned about these plans, it seems like the first step to take to figure out if your state offers a tax benefit before investing in a 529, right?

Oey: Yes. Like with all tax issues, it’s very, very complicated and depends does your state even have state income taxes. So, if it doesn’t have income taxes, it’s not a question. But if it does have an income tax, you also have to check does it offer an income tax benefit. And those come in all different amounts. The easiest thing to do is that we have an article on it, which we will put a link to in the bottom of this video, but basically it can provide a benefit of $100 or so, but also it depends on how much you’re contributing, what your tax rate is, and what the state benefit is.

Dziubinski: Patty, one of the other things that investors should be considering when they’re examining 529 plans besides taxes is the idea of expenses of these plans. Talk a little bit about that.

Oey: Right. The sponsors have done a great job over the last few years. Fees have come down a lot. So, for a lot of direct sold plans, which are plans that you can just access on your own, usually through the internet, a lot of these plans, they offer mostly really cheap index funds. Their target-enrollment and their age-based portfolios hold low-cost index funds. So, those plans can actually be very, very cheap. There are some plans that offer an all-active lineup and those tend to be a little bit more expensive, but some of them are worth it, like the ones offered by T. Rowe, or Fidelity, or American Funds. They are more expensive, but the underlying holdings are these top-rated funds from those houses. So, we like those plans, too.

Dziubinski: What about investment options and processes? Do these tend to be similar across different plans? Or are there some significant differences? I mean, you mentioned some of them have actively managed funds versus index funds. What are some of the other differences you see?

Oey: Generally speaking, the ones that are direct-sold, they will tend to have a more index fund lineup. The ones that are advisor-sold, they tend to have a much bigger menu because you have an advisor helping you. They’ll have maybe more asset classes, and they’ll have a mix of active and index funds that you can choose from.

Dziubinski: Morningstar, of course, rates 529 plans, and there are two plans that currently hold our highest rating of Gold. The first Gold-rated plan is the Michigan Education Savings Program, which is managed by TIAA-CREF. Why do we think so highly of this plan?

Oey: Yes. Very importantly, it’s a well-designed plan. It has low fees. We like that very much. And also, the state that sponsors it, their governance and their oversight over the plan is very, very strong. So, they recently moved to a target-enrollment structure. They used to have an age-based structure. Target enrollment is a smoother glide down. The equity trims are smaller. So, that is better. So, there’s less market-timing risk with a smoother glide path. And when they worked with TIAA-CREF to create this new glide path, they incorporated how their state investors, when do they usually open accounts, how much are they putting in? And so, they optimized the glide path using participant data, which we thought was very good. And another thing they also did was they also made an open architecture. So, they used a mix of funds. Sometimes from a certain provider, the provider will want to use their own funds. In this plan, they use a mix of Vanguard and other funds as well. So, an open architecture also is very good.

Dziubinski: Interesting. And then, the second Gold-rated plan is Utah’s my529 plan, and this is the only plan that has consistently earned a Gold rating every year for the past decade since Morningstar started rating 529 plans, which seems quite noteworthy. What is this plan doing right?

Oey: Right. So, similar to the Michigan plan, very, very strong state oversight. They use a progressive glide path. They use low-cost index funds as underlying holdings. One thing that’s different about the Utah plan is that they actually also have a feature where you can customize your own glide path. So, you can decide if you want to be more aggressive; you can create your own more aggressive glide path; and then, you can also pick the underlying funds to build it. They offer you a mix of Vanguard and DFA funds. So, that’s an interesting option. Actually, it’s the only plan that offers this kind of customizable feature.

Dziubinski: Well, Patty, thanks for your time today. We always enjoy talking with you about 529 plans.

Oey: Thanks, Susan.

Dziubinski: And for those viewers who are interested in seeing Morningstar’s 529 plan ratings, we will provide a link to those ratings at the end of this transcript. I’m Susan Dziubinski. Thanks for tuning in.

Watch Should You Be Worried About Your 529 Plan in 2022? for more from Patricia Oey.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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