by Richard F. Stolz
Helping clients prepare for putting their children through college
hasn't been easy lately—but the task remains as critical
as ever to the achievement of most clients' fundamental financial
goals.
Volatile investment markets and legal constraints on the ability to
actively manage Section 529 college saving plan portfolios have
challenged some planners' efforts to guide clients down a smooth
higher education funding path. At the same time, planners are being
encouraged to play a greater role in helping clients gain a more
precise assessment of actual college funding
needs, and to help them pursue practical strategies to minimize the
required cash outlay. Doing so may be both a financial opportunity
for the planner, and perhaps a responsibility to clients.
Although financial markets have rebounded nicely since their nadir
nearly a year ago, some planners and clients are still smarting
from having their hands tied with regard to managing 529 plan
investments.
Prior to last year, 529 plan investment election switches could
only be made once a year—assuming one didn't go through
the cumbersome exercise of rolling 529 funds into different new
accounts with different investment choices. For 2009, that annual
switching limit was doubled—a change that may be made
permanent. But even two annual investment switches may not provide
the flexibility that many planners are seeking. Some planners have
felt particularly hamstrung with the popular age-based 529
portfolios.
"If you want to manage college savings assets, you need to have
control. With age-based plans, we lose control of the assets,"
complains Shikha Mittra of ASNA Retiresmart Consulting in
Princeton, New Jersey. "When the market crashed, we were at the
mercy of the portfolio managers. We didn't get to see how the funds
were allocated; we are just told which portfolio to invest in based
on the student's age," she says. "Some of my clients [with students
in or at the threshold of college] don't have time to recoup their
investments."
The same concern may exist for an environment of rising markets if
529 assets are pinned down in an overly conservative investment
posture.
Despite these concerns, age-based 529 portfolios represent
approximately two-thirds of the approximately $110 billion in 529
plan assets, and the same proportion of sales, according to
Boston-based Financial Research Corp. (FRC) data. Static
portfolios—including target risk or asset allocation
portfolios with no glide path, hold 27 percent of 529 assets, and
the balance are represented by individual mutual funds, according
to FRC. For more information about 529 sales, see Figure 1.
It appears that the popularity of age-based 529s continues to grow:
"They were the only category of funds that had net growth in the
third quarter of 2009," reports FRC research analyst Bridget
Bearden.
This may suggest these investments may be less troubling to many
parents who invest their funds directly, rather than through
advisers. Another interpretation of that result, Bearden suggests,
is that age-based plans are relatively more popular with younger
parents and their advisers, because tuition payments will come due
farther into the future, with more time to recover from a sharp
market downturn.
Mitigating the Risk
In either case, planners are not without some tactics for
mitigating—if not eliminating—the investment
management constraints of 529 plans. For example, Jill Boynton,
CFP®, of Cornerstone Financial Planning in Newington,
New Hampshire, uses both age-based portfolios and static portfolios
for her clients. She often recommends a combination of the two "to
create my own allocation," she says, rather than strictly relying
on the pre-packaged age-based portfolios.
Her approach uses the asset allocation glide paths of Fidelity's
age-based 529 funds as a starting point for her analysis, "but then
I also make adjustments for my own thinking about what's coming for
the economy over the next few years," she says.
Boynton says that during the downturn in 2008, she did take
advantage of the limited 529 fund-switching opportunity to protect
assets of plans for students ages 14 and older. And today, she says
she's more diligent than ever "about making sure I have the
allocation that is appropriate for that child. You don't just want
to let the plan ride and all of a sudden he's 14 and you've got him
in an aggressive equity portfolio."
Also critical to the 529 plan investment planning process, Boynton
says, is how much is actually in the plan—and whether
those funds represent the primary source of college
financing—other than planned future borrowing. When 529
funds will be insufficient to cover the ultimate need, Boynton says
she would recommend that they be more conservatively
invested.
"But if there's a lot in the plan and it's going to be used over
four years, that can make the allocation different," Boynton
says.
In the case of a more fully funded 529, assuming distributions can
be made by asset class, a greater equity allocation can be
maintained for withdrawal later in the student's college career if
time is needed for asset values to recover from a decline.
Some of Boynton's clients aggressively fund a single 529 account
with the expectation that it will ultimately fund more than one
child's education, avoiding the administrative nuisance of
maintaining multiple accounts. In such situations, recognizing that
the investment time horizon extends beyond the period when the
first child will attend college, Boynton is comfortable maintaining
a more aggressively invested 529 portfolio than would otherwise be
the case, even with limited investment switching opportunities.
The Big Picture
Finally, Boynton is always mindful of the client family's
complete financial picture and how other assets that might also be
used for college funding are deployed, and she adjusts the 529
assets accordingly to create the aggregate asset allocation that
she considers appropriate.
When it comes to having the ability to construct a 529 portfolio
with a degree of precision, some state-administered plans are
better than others. If age-based plans represent the extreme of
inflexibility, James Holtzman, CFP®, CPA, of Legend
Financial Advisors in Pittsburgh, believes he has found the other
extreme.
"We've gone through every one of them and found an adviser plan
(administered by Nebraska) that lets you use about 25 different
funds from several different fund families," Holtzman says. See
Figure 2 for more information about popular state plans and
managers.
Pennsylvania is one of five states—the others are Arizona,
Kansas, Maine, and Missouri—that give residents the same
tax benefits whether they invest in its own 529 plan or that of
another state. In other states, particularly those with high
marginal tax rates, planners may be hard-pressed to justify
recommending 529 investments other than those administered by their
state.
Having all those investment choices still doesn't eliminate the
problem of limited annual fund switching flexibility, however. For
that reason, Holtzman says he often encourages clients to use a
"multi-account" approach and not put all college savings in the 529
basket. For example, he encourages clients also to use Coverdell
Education Savings Accounts that, although they have low ($2,000)
annual contribution limits, add a measure of investment flexibility
(switching investments within Coverdell accounts is not
restricted), and provide the same basic tax benefits as 529
plans.
In addition, assets from Coverdell accounts can also be applied to
education expenses for primary and secondary schooling, as well as
college, should the client's education funding priorities
change.
And, Holtzman believes, it may even be worth sacrificing some of
the tax benefits associated with 529s and Coverdells for the added
investment flexibility available by parking some college savings in
custodial accounts. "Kiddy tax" rules apply the parents' tax rate
to the bulk of investment earnings on these accounts, however, so
the tax considerations cannot be taken lightly. In addition, assets
in these accounts are fully factored into the determination of a
child's eligibility for financial aid.
Diversifying Risk
Finally, Holtzman encourages some of his Pennsylvania resident
clients to diversify their market risk by taking partial advantage
of the state's pre-paid tuition plan. In theory, pre-paid plans
provide an investment return equal to the rate of college tuition
inflation. Pennsylvania's pre-paid tuition plan sells future
college credits at today's prices based on a five-tier schedule
according to category of institution, from community college to
elite private college. Students are able to apply the proceeds to
colleges outside of Pennsylvania, Holtzman says.
The promise of pre-paid tuition plans is not always iron-clad,
however. If states sustain heavy losses on those funds, as many
have, they may have legal escape hatches to modify the originally
projected financial benefits, or impose additional fees when
students enroll. In addition, some states facing the prospect of
having to appropriate additional funds to the plans to offset
investment losses may choose to close down prepaid plans to future
investors. Alabama, for example, has already done so.
Meanwhile, some of the traditional 529 savings plans have been
getting the message from the marketplace about discontentment with
the inflexibility of the standard age-based investment options.
According to 529 plan expert Joseph F. Hurley, CPA, author of
The Family Guide to College Savings and founder
of the content-rich savingforcollege.com Web site, a trend is
developing for plans to offer a spectrum of risk-level options for
age-based plans. For example, today, Nebraska's plan provides four
risk-based alternatives in its age-based fund menu.
And some states have simply fine-tuned their glide paths to make
them minimize equity exposure earlier than before, he adds. (See
sidebar "What's Ahead for 529 Investments?" on page 22.)
Still, those changes don't address the fundamental issue of being
able to make regular portfolio adjustments, whatever the market
condition, Hurley acknowledges. But, he says, "Anyone who really
wants an investment change can get around the restrictions simply
by coupling the investment change with a beneficiary change."
That's easier to accomplish in a family with more than one
college-bound child, he concedes. "The beneficiary change can be
done as frequently as you want, program permitting," he says.
In the case in which there is only one child, it is possible to
change the beneficiary designation to a parent. "But, when you
switch back to the child in the future, there can be gift tax
consequences," Hurley adds.
In general, says Hurley, "if you're a very self-directed investor
or day trader," you just might never be fully satisfied with the
inherent limitations of 529 plans.
But of course, not all planners fit that description. One who
doesn't is Nancy Flint Budde, CFP®, of Salem, New York.
If a planner sets up a good allocation and isn't trying to time the
market, she reasons, two annual switching opportunities should be
plenty. "In fact," she adds, "it might actually provide some
protection from yourself if you try to over-manage it."
Budde did have clients with children in college at the early
distribution phase of the 529 plan when the equity markets tumbled
in 2008. Her response was to take advantage of low interest rates
and borrow some funds to pay tuition bills, while not trying to
switch funds around, allowing the stock-based component of the 529
portfolio some time to rebound. This clearly worked best with
clients who still had plenty of good collateral to facilitate
borrowing, even in recent tight lending environments. So far,
the strategy has paid off.
Although 529 funds cannot be used (without adverse tax
consequences) to pay off college debt, if the fund winds up with
more assets than required due to the use of borrowing, any residual
assets can be transferred to a plan for the benefit of a younger
sibling.
Service Beyond Investments
In her own planning practice, Budde has found that clients are
not just interested in the investment of college savings assets,
but in getting support with minimizing the actual cost of
college—which may provide greater financial value than an
incremental improvement in college savings investment performance
through hands-on management.
Assisting clients in this way may involve helping them (directly or
indirectly, through referrals to specialists) with the college
selection process. "If you can make a choice that takes into
account what the actual costs are going to be given your own
individual situation, that's the best thing you can do from a
financial planning standpoint," she believes.
Adds Lynn O'Shaughnessy, author of The College Solution
and the College Solution blog: "A lot of people are missing the
boat on the fact that the price tag is meaningless. They need to
find good fits and not be put off by the price tag."
Indeed, many parents say they're looking to their financial
advisers for help precisely on these issues. About one-fifth of
parents responding to Fidelity Investments' Third Annual
College Savings Indicator survey late last year reported they
would like help from their advisers on the process of identifying
grants and financial aid opportunities. Roughly equal proportions
reported their financial advisers are already providing help in
those areas.
The survey "highlights an even larger opportunity for advisers to
offer holistic college planning advice, not just in savings,"
according to Jeff Troutman, who heads up Fidelity's college savings
division.
Doing so does not necessarily involve scaling a steep
learning curve. It begins by grasping the fact that "colleges and
universities are, foremost, businesses, no matter how benign," says
Phillip C. Johnson, CFP®, of Clifton Park, New York, a
business partner of Budde. "There are people who claim to be
college planning specialists who don't seem to understand how
higher education really works," he adds.
College Business Dynamics
One of the current business dynamics at work in the higher
education industry that may create savings opportunities in some
situations, according to Johnson, is that average private colleges
are becoming more competitive with public universities, which have
been forced to raise their tuition rates aggressively because of
state funding cuts, and are attracting applications from
higher-achieving students. To maintain their market share, certain
private colleges with the means to do so have to be very aggressive
in their financial aid, Johnson says.
The biggest challenge to providing meaningful support to clients
who want to make funding college affordable may be the future
college student. "Too often, parents are letting kids control the
decision," Budde laments. That might not be a problem if the
decision were based on comprehensive research and due consideration
to the financial implications of the choice. Instead, she said,
children often make decisions based "just on what they heard from
someone else."
That might be different if the student had a significant financial
stake in the decision. (See sidebar "Should Students Share the
Burden of Funding Their Higher Education?") One college adviser who
believes it is beneficial for students to have skin in the game is
Todd Fothergill, managing director of Strategies for College Inc.,
in West Lebanon, New Hampshire. His firm's function is to
"integrate and synchronize the financial side of college with the
academic side, the search, and the admission side," he says.
Fothergill helps clients and their children determine the net
financial requirements they'll face for attending the most
appropriate institution, factoring in a host of variables, but
leaves the savings and investment management function up to the
general financial planning practitioners who refer clients to
him.
Fothergill teaches a class on college financing strategies to
financial planners to help broaden their perspectives on the
subject. "Planners are amazed at all of the little intricacies that
are going on that they don't know about," he says.
For example, Fothergill says that many planners are unaware that
there are two formulas that measure a family's eligibility for
financial aid—the federal method, linked to the FAFSA
(Free Application for Federal Student Aid) and all federal aid
programs, as well as the "institutional method," or CSS Profile,
used by many private colleges.
He also notes that the use of variable annuities to shelter assets
from college aid formulas works for the FAFSA, but not the
institutional method. Similarly, the value of the client's home is
not factored into the FAFSA, but it is under the institutional
method.
Another comprehensive college adviser is Deborah Fox of Fox College
Funding in San Diego, California. She says that by creating a
customized, comprehensive plan including financial aid planning,
cash flow planning, tax-reduction techniques, admissions and
academic strategies, her clients are able to shave off one-fourth
of the cost of a standard four-year college education.
She encourages planners to help their clients understand some of
the fundamentals of college planning—particularly that
even if a student can't qualify for need-based financial aid,
there's a lot that can be done to lower the college price tag. A
fundamental step in that process is what Fox calls "college
matching"—getting clients and their children to zero in on
institutions that are seeking students like them based on criteria
beyond basic academic achievement, including specific
extra-curricular activities, geographic diversity, and family
history.
And the particular student profiles colleges are seeking may change
from year to year, along with their financial capacity to offer
non-need-based financial aid—suggesting the critical
importance of timely research, whether conducted by a planner,
college planning specialist, or the clients themselves.
If a college has been experiencing a drop-off in its applicant
pool, it is likely to be more aggressive in offering merit-based
scholarship funds to high-achieving applicants to maintain its
standards for competitive college profiling purposes. Conversely,
if a college has seen its applicant pool swell, it may have less of
an incentive to offer such aid, notes Johnson.
At the ultimate point when colleges accept students and make
whatever merit or need-based financial assistance package they are
willing to offer, clients should not assume the first offer is the
best offer. "Once the school has put that offer out there, they
have a lot invested in your accepting that offer," Johnson
says.
Assuming the student has a less expensive alternative available
with another school lower on his or her order of preference,
thoughtful negotiation is always an option. "If you come back to
the school and, in a very non-confrontational way, say, 'We're not
sure we can afford it. Would you please review the file and let us
know what you think?'" there is at least the possibility of getting
a better deal, according to Johnson.
Another often neglected but important factor that can affect the
net cost of college education is the opportunity for specialized
scholarship grants funded by private endowments. These endowments
are typically established by individuals seeking to support or
attract a particular kind of student to that school.
"It's unbelievable how many times scholarship money is available
but doesn't go out, even when the criteria aren't that tight,"
according to Craig Rivas, CFP®, the director of planned
giving for the Southwestern Assemblies of God University in
Waxahachie, Texas.
Universities don't always do all that they might to encourage
students to apply for such scholarships, Rivas says. Therefore,
basic as it sounds, financial planners should not overlook
encouraging their clients to contact universities' financial aid
offices and scour their Web sites to learn about any such
unpublicized opportunities, he suggests.
A general-practice financial planner's decision to venture, at
least to some degree, into problem-solving and advising clients on
college planning issues beyond the essentials of 529 plan
investments, tax, and other college-related financial issues is, of
course, an individual business strategy decision. But doing so may
at least keep them from flinching when they hear people like
college financing specialist Lynn O'Shaughnessy accuse most
financial planners of "totally dropping the ball" by limiting their
services to setting up 529 plans and offering no help "when their
clients' kids are teenagers and they haven't saved enough and they
want to go to an expensive school."
Richard F. Stolz is a financial writer and publishing consultant based in Rockville, Maryland.
Endnote
1. Gordon Van de Water, "The Effect of Part-Time Work on Academic Performance and Progress: An Examination of the Washington State Work-Study Program," in Rick Kincaid ed., Student Employment: Linking College and the Workplace, Monograph Series No. 23, South Carolina University: National Resource Center for the Freshman Year Experience and Students in Transition (1996): 57–67.
Sidebar
What's Ahead for 529 Investments?
Although many planners have been frustrated with the limits on
switching 529 investments around, they do not appear to be
abandoning the basic 529 vehicle itself. FPA's 2009 Trends in
Investing survey on the topic showed a 50 percent increase, to
70 percent, in the proportion of planners recommending 529s to
their clients.
However, the adviser-sold funds, which as recently as 2005
represented 65 percent of 529 plan sales, have dropped to about 50
percent, according to the Financial Research Corp. (FRC), based on
data it gathers from the College Savings Foundation. But that can
be explained, FRC research analyst Bridget Bearden says, by another
trend she has detected: the growth in the population of fee-based
RIAs who are directing their clients to purchase direct-sold,
no-load 529 plan funds.
The expense ratio of adviser-sold funds, which averages 119 basis
points, according to FRC, is considerably higher than the 71 basis
point average for direct-sold funds—"a pretty significant
premium," Bearden comments.
She predicts that if Congress ultimately holds financial advisers
to a fiduciary standard instead of merely a suitability standard,
that move will accelerate the use of direct-sold 529 plans, or the
use of more economical fee-based 529 plan share classes.
Meanwhile, the U.S. Treasury Department last year issued a report
encouraging states to increase their use of low-cost, index-based
529 fund options as a means of giving investors more bang for their
buck. But according to 529 plan expert Joseph Hurley, CPA, many
states have already been moving in that direction anyway.
Along similar lines, at least one
state—Arkansas—has begun offering an
exchange-traded fund-based 529 using BGI's iShares. Fidelity and
Vanguard have also made their ETF products available for use by 529
plans.
Yet another 529 investment trend, Hurley says, is the offering of
bank-based 529 products "for people who want to be ultra-safe and
have FDIC coverage."
But Newington, New Hampshire-based planner Jill Boynton,
CFP®, says she's not planning to steer any of her
clients to those products. "There's just not enough of a return,
and when the CDs come due and you take those proceeds and put them
into something else, that's your switch for the year," Boynton
says.
Sidebar
Should Students Share the Burden of Funding Their Higher Education?
Perhaps for most middle or upper-middle class planning clients,
it is simply assumed that their children will contribute to the
cost of their higher education, particularly if they are to attend
a private college or university. Such an assumption may be based on
the practical consideration of the limits of the parents' means to
finance that education entirely on their own. In addition, students
typically can easily borrow at least $25,000 through attractive,
fixed-rate Stafford loans whose payments don't begin until after
graduation. Such students are also typically expected to contribute
earnings from summer or part-time jobs.
But when high-net-worth clients can easily afford to pick up the
entire tab, to what extent should they? It's an issue planners are
sometimes drawn into that can be challenging.
Fidelity's Third Annual College Savings Indicator survey
suggests that 19 percent of parents consult their financial
advisers on this very issue, and another 17 percent don't receive
guidance on the topic—but would like to.
The challenge comes when members of a couple have opposing views on
the subject, and the planner is caught in the middle. "One parent
will say, 'I had to pay my way through college, and I'm not going
to make my kid do that,' and the other one will say, 'I paid for my
education and it was the best thing that happened to me. I want my
kid to experience it,'" says Nancy Flint Budde,
CFP®.
One compromise she has proposed to such clients is to have the
parents agree to pay the full freight for a public institution, and
if the child opts instead for a more expensive private school, let
the child finance all or some of the difference. And the amount of
any reduction in the "sticker price" tuition secured through
scholarships earned by the child could be paid to the student upon
graduation to be used, for example, for graduate school—or
perhaps any other purpose.
When wealthy clients don't disagree on the topic, but simply
solicit planners' view on the matter, there appears to be a
consensus that students should, in fact, share some of that
burden.
Why?
For one thing, it may actually improve their academic performance.
"Based on evidence I have from what parents have told me, it does"
have that effect, according to Todd Fothergill, managing director
of Strategies for College Inc.
Adds Deborah Fox, of Fox College Funding: When students contribute,
"we see that the kids are much more likely to show up to class and
try to get out in four years."
An academic study published in 1996 generally supports that
perception—to a point. The study suggests that students
who work part-time—specifically, between 10 and 20
hours—to assist with funding college tend to perform
better than students who don't have any part-time jobs, yet
students who work more than 20 hours a week, or less than 10, tend
to perform worse.
If academic performance is the principal consideration, wealthy
parents also can have their children shoulder some of the burden,
but hold out the "carrot" of retiring students' debts if they
achieve a particular performance standard, suggests Phillip C.
Johnson, CFP®, of Clifton Park, New York.
Other planners focus more on the benefit of the financial education
students will gain simply from getting a taste of financial
responsibility early in life, sometimes drawing from personal
experience.
