Investing

529 Plan Investing For High Net Worth Investors

Section 529 plans have grown to become one of the most common ways to save for college. While the decision to establish a 529 plan account is often straightforward, the management of assets in the course of time can be much more complicated.

The rising costs of higher education, which have outpaced inflation consistently in recent years, have raised the stakes. With more than $ 200 billion invested in 529 plans, savers are clearly looking for 529 accounts as a way to keep up with rising costs. Section 529 accounts can be used as a tax-free vehicle for college saving, and contributions may be deductible, depending on your state of residence. Expenses that are eligible for the 529 account distributions, which include the costs of tuition, books, supplies and equipment necessary for a beneficiary’s enrollment or attendance at an eligible educational institution.

Withdrawals from 529 plan accounts are not authorized for expenditure are allowed, but at a price. They are subject not only to federal and state income tax, but also an additional 10 percent federal penalty tax on the investment income. This penalty does not apply to non-withdrawals resulting from a beneficiary’s death, disability, scholarship (up to the amount of the scholarship) or attendance at a military academy.

There are two types of 529 plans: prepaid tuition plans and college savings plans. This article focuses on the latter. Prepaid tuition plans are guaranteed by the governments of the states that offer them, and allow investors to lock in future tuition in the state public colleges at current prices. These plans do not involve the same kind of investment decisions for the account of the owner and, in our opinion, are generally more risky because of their dependence on state capacity and inclination to meet their financial commitments. In contrast, the college savings plans offer menus of investment options and allow the account assets to be exchanged once per calendar year.

The main objective of some 529 investors is simply to try to save enough to contribute to the beneficiary the costs of tuition, assuming that the rest will come from other sources such as financial aid, scholarships, grants and loans. But the high net worth individuals with the means to pay full tuition regardless of the market environment will have different decisions to consider about the account’s asset allocation and the optimal changes to that allocation over time, or the “glide path.”

A glide path is a plan for gradual changes in an account’s asset allocation as the target date approaches. For 529 plan accounts, this is very often the time at which the beneficiary reaches the age to go to college. The age of the beneficiary should be the basis for the 529 plan’s investment strategy. Investors may obtain a better performance when the beneficiary is young and college costs are still relatively far in the future, so that the risks are more easily borne. As the beneficiary of the age and of the liability becomes more immediate, the investors should focus on the preservation of the principal, which will necessarily limit growth.

There are no solid rules on how to choose the best 529 plan asset allocation, not to mention the best glide path. While many plans have standardized glide paths, these paths offer no guarantee, and the results can diverge significantly, depending on the plan you select. In September 2012, The Wall Street Journal published an article describing the large variance in the investment strategies and returns between the different plans, as well as some 529 plans, the most and the least aggressive glide paths. Customization will always offer the solution best suited to your personal situation and your goals.

Although no strategy will be right for everyone, the first step for the creation of a custom 529 glide path is to consider an appropriate starting point. For our clients, we recommend a baseline approach of maintaining 100% equity allocation in the account at first, usually until the beneficiary is 12 years of age. Thereafter, 10 percent of the allocation may be moved to a more conservative option each year. The result will be 100 percent conservative allocation by the beneficiary of the final year of a four-year program, assuming he or she goes directly from high school to the university.

For some investors, this basic approach may need to be further customized. For example, it may be appropriate for some investors to maintain 100% distribution of shares more or to begin moving funds to more conservative investments, earlier. Some of the factors to be taken into consideration in the development of your personal 529 plan investment strategy are:

The Risk Tolerance. Some investors are willing to take more risks than others, even among those with equal ability to do so. It is important to realistically assess your risk tolerance, both for your whole portfolio and your 529 plan account.

Other Sources Of College Funding. If you are in a position to meet college costs from other sources, such as your taxable accounts, riskier 529 strategy may be more enjoyable for you. In addition, you can expect the payee to receive outside college funding, such as scholarships, financial aid or gifts from other family members. In this case, you might be willing to take more risk in the account.

The School Of Graduate Studies. If the beneficiary intends to attend graduate school, you do not want to move to a fully conservative asset allocation as soon as you otherwise would. It may be appropriate to maintain a more aggressive allocation until a few years before the beneficiary intends to enroll in graduate school.

The Anticipated Cost Of The University. If the beneficiary appears likely to attend a lower cost public or state school, you may want to take less risk in the account. Conversely, if the beneficiary has his heart set on an expensive private institution, taking on more risk might make sense.

Number Of College-Bound Children Or Grandchildren In The Family. A 529 plan account with a surplus of funds after a beneficiary graduates can be transferred to another beneficiary in the family. As a result, you can take more risks in an ancient account of the child. If the markets underperform, you can supplement the older child’s account using a young child’s account, with the intention of recovering losses with the help of the younger child’s account with a longer time horizon.

Note that this list is not exhaustive, but rather highlight some of the most common factors that can cause investors to deviate from our baseline recommendations. At Palisades Hudson, we customize this decision on the basis of the situation of each client and its needs, and we revisit the strategy over time. Section 529 plans have become a staple of the savings for education costs. For high net worth investors, they may prove to be an extremely valuable piece of an overall financial plan. Paying for college can be stressful, but by customizing your 529 account asset allocation and glide path, you can be assured that you will avoid taking unnecessary investment risk while paying for college on a tax-advantaged basis.

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