When my son was born I learned the absolute love and infinite hope a parent has for their child. There’s something deeply wrong when that collides with someone else’s self-enrichment.
Unfortunately, that happens to many parents saving for their child(ren)’s college, and that “someone else” is their financial advisor.
529 plans are often marketed to busy parents of young kids, and a full understanding of many plans can require reading (and understanding) a 100+ page disclosure booklet.
I spent over 10 years as an investment banker and hedge fund investor at Goldman Sachs. Spreadsheets and financial disclosures are practically my natural habitat. And I happen to be passionate about transparency and fairness in financial services. So I decided to dive into the 529 plans offered in my home state, New York, and share that analysis with you.
Quick Background: Why 529 plans are popular
529 plans can be a great way to save when you’re financially ready to commit savings to college, grad school or trade school for your kids (post-secondary education, not just college) because the money grows free from Federal taxes (and almost always free from state taxes) when used for educational expenses the IRS permits (the IRS lays these out in detail, but it includes the vast majority of expenses most students typically have).
We go into more detail about 529 plans - and guide you through other ways to save for college - in our interactive AboveBoard Parents' Financial Guide.
How to Choose a 529 Plan
Each state offers a selection of plans, and while you’re permitted to open a 529 plan in any state, some states offer tax incentives to open in your home state. You need to know the tax laws that apply to you, and consider the fees and potential performance of different plans.
The New York 529 Plans (there are two of them, I like one of them)
This post is about New York, but it illustrates problems common to many advisor-sold plans. (There are some not-so-great direct plans, but that’s for another post.)
There are two New York state 529 plans:
1) New York Advisor-Guided 529 Plan by JPMorgan
2) New York Direct 529 Plan by Vanguard
For many New York residents opening a 529 plan, a New York plan is attractive because New York gives a generous state tax deduction for contributions to New York 529 plans.
What’s Wrong with the JPMorgan New York 529 Advisor-Guided College Savings Plan?
In a word: fees.
In one more word: disclosure.
This is a big problem: the New York 529 Advisor-Guided 529 Plan has over $4 billion in assets, so a lot of children (and their loved ones saving for college) are affected.
JPMorgan’s Fees are Much Higher than Vanguard’s Fees
Example: You contribute $10,000. JPMorgan keeps $525 for itself and passes $9,475 along to your child's 529 plan.
You'll also pay:
Note: JPMorgan fees of 1.04% are a weighted average, assuming you selected the age-based portfolios (starting at 1.09% for ages 0-5 years, ending at 0.84% for 18+). Vanguard has a flat fee of 0.16%, regardless of what you choose.
That's a big difference in fees, with big impact on your kids' college savings.
Example: assume you contribute $10,000 to the plan each year for 10 years, so a total contribution of $100,000. Let’s assume the investment performance is the same for both plans before fees, say 6% / year.
After 18 years:
In this theoretical example with the same investment performance between the two 529 plans, you end up with an extra $36,000 in the Direct 529 Plan by Vanguard. There’s a lot you and your child could do with $36,000. JPMorgan siphons off an extra 30% of your gains in this illustrative example.
Q: What would you have to believe about the JPMorgan Advisor-Directed 529 Plan to reasonably expect that this higher-cost plan would give your child more college savings than the Vanguard Direct 529 Plan?
A: You’d have to believe the JPMorgan funds would perform much better than the Vanguard funds, enough to make up for the higher expenses. Specifically, the JPMorgan Plan would have to return an extra 0.91% (the difference in Annual Asset-Based Fees: 1.04% - 0.16% = 0.88%) each year AND make up for the 5.25% front-end load.
Over 18 years, you'd need the JPMorgan plan to return about 1.20% more each year to break even w/ Vanguard.
That might not sound like a lot, but it is a high bar – and rarely achieved - in investment performance. Vanguard is largely a manager of index funds (no picking stocks, just tracking an established index, like the S&P 500), so JPMorgan needs to outperform to make up for the higher expenses.
I took a look at all 17 actively managed funds in JPMorgan’s 529 plan investment choices. Only one fund appeared to have outperformed its index before fees (the index being what JPMorgan lists on its website) by that much in each of the last 3 years, 5 years & 10 years (as of Dec-2016). That fund was the Small Cap Equity Fund (= “small companies”), and a mere 3.5% is the maximum amount of JPMorgan 529 Plan assets held in that particular fund. (I don’t disagree with that decision, I’m just noting this track record applies to a tiny portion of what you’re getting with the 529 plan.)
Sustained 1.20% outperformance is a big bet, an unlikely bet for any active manager, and one that – if achieved – would still put you even with the Direct Plan.
This does not sound like a good bet to me.
Comparison of 529 Plan Investment Performance
So how has the performance of JPMorgan stacked up to the Direct Plan so far?
Let’s take a look – here we’ll assume you chose the “Aggressive” age-based option for children ages 0-5 years.
This table shows JPMorgan has performed worse than Vanguard during the past 3 years and 5 years. We look further back than that because JPMorgan hasn’t been offering the plan for that long.
I discovered that JPMorgan reserves the right to take additional money out of your account, there’s no stated cap on this amount, and they don’t even publish data about what these secret expenses have been historically. These expenses are tough to audit because they simply affect underlying return…so you could find yourself wondering why, if you’re in an offering with 2.00% disclosed expenses each year and the investments went up 10%, your actual performance is meaningfully less than the 8% you might think you should have earned.
You can scope out the detail of this disclosure here if you’d like, but I’ll share this for the folks who don’t want to read all that (spoiler alert!): two different JPMorgan employees confirmed that this is indeed how it works (one of them in writing).
What You Can Do To Protect Your Kids’ College Savings
AboveBoard has an interactive Parents’ Financial Guide, a free guide with succinct, clear info about college savings (not just 529 plans, also includes other possibilities), life insurance and estate planning. It’s state-specific and responsive to what you tell us about your situation. Our goal is to connect you with the right info at the right time, so you can quickly and confidently make decisions that are right for you.
For parents in states not covered by the guide (we’ll be adding more states soon!), you can “DIY research” with our tips for choosing 529 plan for your kids.