College Saving

Should 529 contributions be treated as part of portfolio?

With the removal of the sunset provisions of the tax-free withdrawal status from 529 college savings accounts, the 529 account is now more attractive than before. In particular, for qualified withdrawals, it functions effectively the same as a Roth account, where contributions are made with after-tax money and all withdrawals are tax-free.

For high income earners who are priced out of the Roth IRA, the 529 college savings account can become somewhat like a “giant” Roth IRA for you to sock away your savings, up to the limit of the estimated college costs. A Roth IRA is a great location for asset classes that have high expected returns but would otherwise be severely eroded by taxes due to high capital gains or dividend (especially the unqualified kind) distributions. This would include assets like the REITs, small-cap value and international small-cap asset classes.

Taking this view, one would then wonder why the 529 account should not be treated as part of the entire portfolio, instead of just treating it separately. When the 529 account is considered as part of the entire portfolio, an investor would have more freedom and less limitations as to where he/she can place the asset classes in the most efficient manner.

Conversation 54876 from the Diehards forum has a lively discussion on this issue. Personally I have not given serious thought into considering the 529 contributions as part of my portfolio but I believe it is an interesting idea that is worth exploring.

Changes to Fidelity’s 529 College Plans

There have been several changes to Fidelity’s 529 College Plans. The most notable are the withdrawal of the 2% rewards card and the introduction of indexed investment options.

Rewards card reduced to 1.5%

The new rewards card is issued by American Express. According to the web page, the features of this card are

  • 1.5% of your net retail Card purchases are automatically contributed to your Fidelity-managed 529 Plan account4
  • Up to $1,500 in annual contributions per Card to your 529 account managed by Fidelity
  • Family and friends can also carry College Rewards Cards linked to your Fidelity-managed 529 Plan account
  • Identity theft recovery and fraud protection
  • No annual fee

The rewards are good by itself but pales in comparison to the old 2% rewards card. 🙂

Note that according to this thread on the Fatwallet finance forum, at least one user has reported success with application on the old card. This might be the last chance to get in on the old 2% card. But YMMV.

Indexed investment options added

With the transition of California’s 529 plan from TIAA-CREF to Fidelity, new indexed investment options were added to all of the 529 plans managed by Fidelity. The new options are

2006-11-22-fido-indexed.png

The expense ratios of the new options are all at 0.5%. These are all lower expenses compared to the old actively-managed options

2006-11-22-fido-active.png

I am submitting a request to switch my investments to the lower-cost indexed options. Note that now is a particularly good time for the switch since you are limited to one switch per calendar year and it is already almost December.

From an earlier post, I mentioned that my main college savings actually goes into the Ohio plan. Currently, the college investment allocation is

  • 30% US Large cap equity
  • 30% US Med/Small cap equity
  • 30% International equity
  • 10% Fixed income

Compared to Fidelity’s 0.5% expense ratio for all indexed options, the expense ratios of the Ohio plan are

2006-11-22-ohio-er.png

The international equity option from the Ohio plan has the highest expense ratio and the corresponding Fidelity option costs only 7 basis points more. It therefore makes sense for me to use Fidelity’s international equity option for my funds at Fidelity. The following table shows my new overall 529 college allocation.

2006-11-22-529-er.png

My 529 college saving plans

I am currently contributing to two 529 college saving plans. Even though for simplicity reasons, it is usually better to consolidate investments into one account, I find that having two accounts actually works better for me. Why did I end up with two plans? Read on…

The first step in selecting a college saving plan is to check if your home state provides any financial incentive (e.g. state income tax deduction) to invest in the state-sponsored college plan. For me, the state of California provides no such incentive. The California plan, managed by TIAA-CREF, is fairly respectable. It’s costs (ER 0.8%) is reasonable, but not the lowest; so I looked elsewhere.

My main criteria for selecting a college includes the following:

  • Cost of the plan (expense ratios and account fees),
  • Range of investment options, and
  • Other special incentives.

The two accounts I ended up with are the following.

Account 1: Fidelity’s Unique College Investing Plan (sponsored by the state of New Hampshire).

I selected this plan based on the special incentives available with this plan. With this plan, I was able to apply for the Fidelity-MBNA co-brand 529 College Rewards credit card. This card gives you 2% back on practically anything you charge to the card. In addition, it also offers you online Bill Payment service which lets you pay many merchants including even your mortgage or electric bill (but no rewards for these). The rewards are accumulated and posted to the 529 plan once every calendar quarter.

The overall expense ratios of this plan are on average about 1%. These are reasonable numbers but not particularly attractive. The following table shows the expense ratios of the funds and the account fees:

2006-09-19-fido-529-plan-480�388.png

Note from point (6) that there is an account maintenance fee of $20 a year but this can be easily avoided by setting up a systematic contribution of at least $50 a month. This is the amount I am contributing to this plan.

To summarize, the main benefit for me to contribute to this plan is to get the credit card rewards. By my calculations, I would get about $500 to $600 in rewards a year from this card, almost the same as the amount I would contribute from systematic contributions (12 x $50 = $600).

Account 2: Ohio state’s College Advantage Plan

The second account is where I do my serious college savings. This plan was selected based on its very low costs and a respectable range of investment options.

I was interested to have the following asset allocation for the investment plan: 30% US Large-Cap equity, 30% US Small-/Med-Cap equity, 30% International equity and 10% fixed income. With that in mind, I started looking at the various plans available. Some of the plans I considered are tabulated below.

2006-09-19-529-compare-480�400.png

The Utah plan has always been touted as the cheapest 529 plan but what I found was that based on my options, it is not the cheapest (especially if you are not a resident in Utah). Besides, I dislike its confusing account fees, and I think this could actually be the reason why some think it is the cheapest: simply because the various UESP add-on fees were not accounted for.

The Vanguard 529 (Nevada) plan is interesting for those who like to see their 529 account with one Vanguard login. The funds in this plan can also be counted towards the qualification for Voyager / Flagship status. This is quite an attractive benefit.

Those interested in DFA’s funds can also look into West Virginia’s SMART529 plan. The fees range from 0.75% to 1.05%.

In the end, I found that the plan that makes the most sense for me is Ohio’s College Advantage Plan. The total expense ratio for this plan is only a mere 0.352%. Besides, I see no reason paying almost double the expense ratio for the Vanguard 529 plan just to get the ability to qualify for Voyager / Flagship.