Are you paying too much for your “529” tuition-savings plan?
Regulators are trying to get to the bottom of that at a time when the plans continue to grow in popularity and are open to wider uses following the Trump tax overhaul.
So-called 529 accounts allow families to sock away funds for a child’s education and then withdraw them tax-free to pay for expenses such as tuition, books, and often room and board. The tax overhaul that kicked in last year expanded the plans so that they now can also be used to pay for private education starting with kindergarten.
In January, the Financial Industry Regulatory Authority, or Finra, said it had begun to look at whether brokers have made suitable share-class recommendations for the plans in recent years. Finra is only looking at plans sold by brokers, which make up about half of the 529 plans held by American families. The rest were bought directly from states. In particular, Finra is looking at how firms oversee brokers’ recommendations and if they have proper systems in place to flag potential problems.
And the expansion of the plans to a wider range of students makes the issue of fees even more pressing. For example, a higher ongoing-fee account may be unsuitable for families opening an account for a small child’s college tuition, as they would rack up more costs than one-time commissions. With varying fees on different classes of shares, parents potentially can end up paying thousands of extra dollars over the life of the account.
Attorneys representing brokerage firms say some may be in violation of a “suitable recommendations” standard, in part because the recent broadening of the plans’ use makes recommending one type of share class over another more complicated.
Brokerage firms that offer 529 plans have until April 30 to self-report sales violations to Finra.
Finra’s probe comes as regulators are looking more broadly at the kinds of investments brokers are pushing to clients. This week, the Securities and Exchange Commission announced settlements with 79 firms in connection with steering clients to higher-cost mutual funds without being clear that cheaper versions were available.
Sales of 529 plans have climbed in recent years as families put away more money to fund the rising cost of higher education and look to reap the tax benefits of doing so. The number of 529 accounts in 2018, the first year in which the plans were expanded, rose 5% from a year earlier to a record 12.9 million, according to research firm Strategic Insight. Assets in those accounts were $288.9 billion last year, near record levels and helped by the decadelong stock-market bull run.
The plans are often sold by financial advisers who can earn big commissions in the form of one-time and annual fees. Plans are also offered directly by states and about three dozen states allow an income-tax deduction or credit for savers who contribute to them. Most of those states’ tax incentives are for in-state residents only, though brokers could recommend out-of-state plans.
Dominique Ricks, a mother in Goose Creek, S.C., recently opened a 529 account to help save for her young children’s education. Ms. Ricks, a 29-year old fitness-company owner, purchased the account from her Edward Jones broker. She said she thought of putting aside money in certificates of deposit, but her broker recommended she opt for a 529 instead.
“I don’t want my children to be like me, with about $80,000 in loans,” Ms. Ricks said.
When sold that way, 529s, like mutual funds, come in different flavors with varying fees. Ms. Ricks was sold a Class A plan, which usually means the broker gets an upfront commission, in addition to annual management fees charged on the balance. With Class C shares, the other common plan type, a broker typically gets higher annual fees instead of a big upfront commission.
The average upfront fee for class A 529 plans sold by brokers is as much as 5.75%, according to Paul Curley, director of college savings research at consulting firm Strategic Insight. For those accounts, the average annual fee is about 1% of the account balance. For Class C plans sold by brokers, which tend to have no or a lower upfront fee, the average annual management fee is 1.63%, he said.
There is a big difference in what the classes mean for fees. Consider a parent opening an account with $20,000. The broker selling A shares stands to make around $1,150 off the top. If $100 goes into the account each month for 18 years, the account earns 7% annually and the annual broker fee is 1%, the parent pays about $15,000 in fees before tapping the plan for college. With class C shares, that parent pays about $24,000 in annual fees over 18 years.
Paying an upfront fee may make sense for parents who want to use a broker and who are saving for a newborn’s college education. But if the money might be used much earlier, or the beneficiary is older when the account is opened, an annual fee could save the client money.
Brokers are paid by distributors. For example, American Funds Distributors Inc., one of the biggest makers of 529 plans, pays Edward Jones $3.50 for every $10,000 of assets.
Consumers can bypass big fees if they buy a 529 directly from a state. That way they don’t pay a sales commission and the average annual fee is 0.44%, Mr. Curley said. Buying directly from a state would on average cost the $20,000 client about $7,000 over 18 years.
Some brokers are opting to forgo high fees. Fred Iacovoni of Synergy Wealth Management in Grand Rapids, Mich., said he has seen increased interest in 529s since the recent tax changes, and instead of selling plans with commissions, he charges a flat fee of about $100 to facilitate a client’s direct purchase from the state.
“It’s on autopilot,” he said, of how the accounts work, “so the notion that I’m managing the money doesn’t hold water.”
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