The recent declines in the financial markets and ongoing volatility has brought into focus more than ever the benefits and value of an experienced and/or knowledgeable financial advisor helping clients stay on track with their financial goals. In difficult times such as these, many individuals and families often allow fear, ignorance and emotion to cloud their important financial decisions, instead of staying focused on their most important long-term planning goals, such as saving and investing for future education expenses, that may begin as early as with kindergarten, adding up all the way through graduate school.
The lack of sound financial advice in these types of markets, as well as during more “normal times”, is perhaps most pronounced in the field of education planning. Having spent the majority of the past twenty years traveling from Anchorage to Miami, and most places in between, I have met with thousands of financial advisors of most types, including those at most firms, ranging from those more successful to, those, well, not so successful.
To my ongoing amazement, despite the fact that most surveys show that investing for education is a leading priority for most families1, I have found that most financial advisors do not promote education planning to their clients or actively manage many education investment accounts, on their behalf. What perplexes me is that the advisor allows themselves, as well as clients and prospective clients, to lose out.
This missed opportunity for financial advisors is not only projected but has been real. One indication is that since 2012, when total 529 investment plan assets were estimated at $164B and flows were even between both types of 529 investment plans, the direct-sold plans have demonstrated impressive growth to $210B aum at year-end 2019, while the advisor-sold plans growth has lagged to total $145B aum2.
Thus, clients and prospective clients are in fact investing considerable sums in 529 plans, and/or presumably contributing to other vehicles as well, but without the benefit of a financial advisor. This fact alone means there is a huge opportunity for financial advisors to be talking and doing more with clients and prospective clients about investing now for future education expenses, especially given the opportunities available in the market today for long-term investors.
While there is never a bad time to begin funding an account for future education expenses, the current time to fund or review a 529 account represents a unique opportunity for several reasons. An advisor should nudge their clients to act now, reminding them that they have full control over their 529 accounts at all times and thus are not making any irrevocable commitment with these funds, which are always available to such account owner, if needed.
5 reasons why financial advisors should be doing more educational planning
1. Under federal tax law, 529 plans may only accept cash contributions. One may not transfer securities or rollover qualified plan accounts to a 529 plan. Advisors and/or clients have often expressed reluctance to liquidate other investments that may cause taxable gains as a result, in order to create a cash position.
Liquidating other investments under current market conditions with lesser valuations to raise cash is likely to yield less, if any, taxable gains thereby diminishing this funding concern. An additional consideration to invest now is that six states allow a taxpayer to earn an income tax deduction for the prior calendar tax year for contributions made up to April 15th of the succeeding year, which in most cases has been extended to July 15th during the current virus crisis.
2. Most investors realize that market valuations will eventually be considerably higher than today’s depressed levels, and therefore the eventual earnings and gains on those returns will result in substantial tax bills that could be avoided through a tax-deferred account such as a 529 account. Tax-deferred 529 accounts can avoid any taxation indefinitely and when the client decides to withdraw some or all of the account, they are able to do so without any federal or state income taxes for a very common future expense – education.
It should also be noted that a long-term account, such as a 529 account, may not be defined by 1 type of withdrawal, but may include Qualified (tax-free) and Non-Qualified. Non-Qualified withdrawals results in federal taxes due only on the earnings withdrawn- similar to a non-deductible Traditional IRA withdrawal. An additional tax of 10% on such Non-Qualified withdrawals earnings may or may not apply, depending on the beneficiary’s situation, making the total withdrawal experience more favorable than many assume.
3. Many existing education funding accounts are underfunded as they do not reflect the reality of projected, or even current educational expenses, with many private colleges’ annual cost of attendance exceeding $70,000 for the upcoming academic year. As high school seniors are notifying the colleges before May 1st of their decision to attend, families are reminded of the need to fund future expenses for such student, but also their younger siblings, for which 529 plans can do more for, than such senior.
A long-term perspective helps clients see investing in a 529 account now allows for more of the future expenses to be likely paid from tax-free gains, rather than other sources. Being able to fund just one 529 account using the unique 5-year application of the annual gift tax exclusion of $15,000 allows each person to fund each 529 account $75,000 today, taking advantage of depressed valuations and prices positions the 529 accounts for greater tax-free gains. If a couple wished to fund 1 account to its maximum limit of $500,000, their $150,000 5-year forward gifting could easily be supplemented with just $175,000 of their unified lifetime gift exclusion of $11.5M so as to therefore fund 1 account at once.
4. Advisor-sold 529 plans typically offer more investment options and choices than direct-sold plans and allows the advisor to better respond to how the client wishes to, or should be invested in the current markets. Whereas direct-sold plans are structured to meet the needs of the public at large with a consumer establishing an account without the counsel of an advisor, the advisor is able to use a more comprehensive menu of options to cater to the individual clients’ needs, risk tolerance and specific objectives. The advisor can tailor the account, whether it is means allocating more to different types of equities or fixed income.
ETFs and better mutual funds are more common in advisor-sold 529 plan investment options now, as plans have evolved considerably since many advisors since first took a look at these plans. Expenses in such plans have dropped considerably in recent years and thus even with the advisor compensation built into the offerings, the net performance is often quite competitive with the direct-sold plans. Amounts already invested in 529 accounts may be changed 2x a calendar year per account, or whenever there is a change in the beneficiary that the account owner may indicate from time to time. New money or rollovers contributed to each account is not included in such limitation.
5. Clients who set up plans years earlier should have their account reviewed and should be educated on new plan features and options. Many clients and prospects are unaware that 529 plans may now be used federally tax-free for apprenticeship programs as well as to pay student loans. Reviewing accounts set up in the past, many clients may unknowingly remain invested in 529 plan options that have underperformed in recent periods and are in need of review, not unlike many of their mutual fund or other investment holdings. Multi-manager plans, offering more investing flexibility, have grown more common and popular in the 529 advisor-sold plan space and should be considered. Fees on many, but not all, 529 advisor-sold plans have been reduced.
Further, some have indicated a frustration with certain 529 plans age-based portfolios, including their overweight allocations to foreign equities and fixed income funds. Clients may have additional time to consider such recommendation given that their tax filing deadline has been extended all the way out through July. Now may be an appropriate time to change investment options or roll over to a better plan, after considering state tax implications, if any, if a deduction was taken for contributing to such state’s plan now being considered for a rollover.
In summary, these 5 reasons above represent just some of the reasons why a financial advisor should be focusing on clients and prospective clients and their long- term financial goal of paying for future education expenses. The advisors who pursue such opportunities are more likely to join their more successful peers, providing better client service while managing more assets and accounts.
- Investment Company Institute Fact Book 2019.
- Strategic Insight, 529 College Savings Quarterly Data Update.