ETFs losing their luster in 529 college savings plans

New report says benefits of exchange-traded funds don't make sense when nestled within the tax-advantaged 529 plans

Dec 10, 2014 @ 2:07 pm

By Liz Skinner

Interest in offering exchange-traded funds within 529 college savings plans seems to be petering out because the benefits of them fall short when they are held within these tax-advantaged accounts, according to a consultant.

Over the past year, very few college savings plans created investments that offer access to exchange-traded funds, said Andrea Feirstein, managing director of AKF Consulting Group, which released a report on 529 plan trends.

ETFs were popular in 2012, and today, six 529 plans that sell direct to the investor contain ETFs and 10 college savings plans sold through advisers contain them, the report found.

“They were introduced to lower costs of the savings plans and as a direct appeal to advisers who are very comfortable with them,” Ms. Feirstein said. “But in most cases, an ETF is sort of a high-priced index fund and you're paying for things you don't need.”

Intra-day trading is a major benefit of ETFs but in 529 plans, there is no advantage because 529 investment options are traded like a traditional mutual fund with a net asset value established once at the end of the day.

( More: Morningstar analysis of best 529 plans)

With ETFs, investors also are paying for transparency of holdings, or knowing exactly what the fund is invested in, Ms. Feirstein said. But with 529 plans, investors can only make one change to their holdings a year, according to Internal Revenue Service rules that established the plans.

“The truth is, even if I see the holdings are moving into things I don't want, there's nothing I can do about it,” she said, adding that some college-savings-plan sponsors have decided investors are equally or better served by cheaper index funds.

“I think we're seeing fewer ETF investment options in the last year or two because administrators are just asking for the lowest cost option,” she said.

The report examined investment changes at the nation's 60 direct-sold college savings plans and 31 adviser-sold plans. One plan, offered by Washington, offers the same investment choices in its direct and adviser plans.


Advisers should be examining 529 college savings plans to see how fixed-income investments offered in the plan are positioned for future increases in interest rates, Ms. Feirstein explained.

Age-based investment choices offered within college savings plans have increasing exposure to fixed-income investments as the plan beneficiary grows closer to his or her college years, when the funds will be tapped tax-free to pay for those expenses.

( More: How advisers are helping clients with college decisions)

With nearly every forecaster predicting a hike in interest rates next year, advisers should investigate the components of that fixed-income investment to make sure there are short-term-duration options, and possibly hedging devices like bank loans and floating-rate bonds, she said.

“This is the perfect opportunity for advisers to show their value and reassess what the underlying investments are in the fixed-income allocation,” Ms. Feirstein said. “If the annual investment change hasn't been used up yet, this is the time to use it, before Dec. 31.”

Investors in 529 plans are poised to win the right to make changes twice a year to their investments if the tax-extenders bill that was passed in the House of Representatives last week is approved by the Senate Wednesday and then signed by President Obama.

Part of an Achieving a Better Life Experience measure, which would create tax-free investment accounts like 529s for use by disabled individuals, also edits rules for 529 college savings plans to allow for investment changes twice a year beginning in 2015.


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