Guidance

RESOURCES TO HELP SHAPE YOUR FINANCIAL FUTURE

College savers need to be aware of many details when choosing a 529 plan, yet often the information either is not provided or takes too much digging to find. A recent Morningstar study of 529 plans’ disclosure found that the typical 529 plan website and plan document provide only high-level descriptions of the investment options. Basic information, including the name and tenure of the portfolio managers running the 529 investment options and details about the most recent portfolios, is not required disclosure for 529 plans.

What Investors Need to Know for Static Options
Static 529 plans are plans whose investment allocation does not change over time. Unlike the age-based options (discussed below), they do not move to a more conservative allocation mix as the beneficiary approaches college age.

For static options, crucial information includes how much the option costs, who manages the portfolio and how experienced they are, what the investment strategy is, what the portfolio owns, and what the performance record is.

For stock fund portfolios, it is good to know whether an investment is primarily exposed to big or small companies, or firms in a specific sector of the economy, like health care, technology, or energy. This information may help investors and advisors anticipate how an investment will perform and identify potential risks. With bond portfolios, it is important to look at credit quality and interest-rate exposure to broadly understand how the plan will perform in different market environments. For example, a portfolio with low credit quality may outperform in bull markets, when investors are less risk-averse, but it could post steep losses in a downturn.

What Investors Need to Know for Age-Based Options
Age-based options hold the majority of 529 assets and have a similar structure to the popular target-date mutual funds found in retirement savings plans. Age-based options’ asset allocation becomes more cautious over time, moving college savers’ assets from primarily stocks when the beneficiary is young to primarily bonds and cash as college enrollment nears. For an age-based option, necessary disclosure should include how much it costs and who is managing the portfolio, but also a description of the asset allocation strategy, the strategies of the underlying holdings, and the performance record.

Morningstar’s study showed that few 529 plans provide this valuable information. Professional investment researchers can dig it up by cross-referencing 529 investments with data on the plan’s ultimate mutual fund holdings, but college savers would be much better served if this portfolio and manager information were easily accessible.

Transparency Matters
Better informed investors can make better investment decisions, but most 529 plans are not providing the basics that college savers and their financial advisors need to make informed choices. Just as mutual fund investors can get access to the appropriate data to monitor and evaluate a fund, college savers deserve an equally high standard of transparency. Importantly, the data should be timely and easily accessible. Examples of good disclosure exist in both the 529 plan and mutual fund industry, so plans with poor transparency should emulate the disclosures of their peers.

 

529 plans are tax-deferred college savings vehicles. Any unqualified distribution of earnings will be subject to ordinary income tax and subject to a 10% federal penalty tax. Tax law is ever-changing and can be quite complex. It is highly recommended that you consult with a financial or tax professional with any tax-related questions or concerns. An investor should consider the investment objectives, risks, and charges and expenses associated with municipal fund securities before investing. More information about municipal fund securities is available in the issuer’s official statement, and the official statement should be read carefully before investing.

©Morningstar 2014. All Rights Reserved. Used with permission.