How to save for college and make a difference, too
Saving for college in a way that minimizes taxes and endeavors to make the world a better place is becoming easier to do.
To spark more saving for education, Congress in August made permanent the federal tax benefits of investing through 529 savings plans, which operate like an individual retirement account for education-related expenses. Knowing their 529 savings now won't face a federal tax hit upon withdrawal, Americans have increased their 529 plan investing by about 10 percent over the past five months for a total of more than $90 billion.
What's more, a few of the nation's state-based 529 plans are modifying their options to sweeten the deal for ethically motivated investors, whether they live in state or not. For example:
•In November, Pennsylvania introduced a relatively low-cost option, the Vanguard FTSE Social Index Fund, where the annual charge is 0.75 percent of assets under management. The state also dropped its minimum initial investment threshold from $1,000 to $25.
•Also in November, California signed up Fidelity Investments to manage its Social Choice Fund, which provides extra weighting for the most financially promising stocks within a socially screened index.
•Before July 1, Missouri plans to roll out a 529 option for the Roosevelt Anti- Terror Multi-Cap Fund, which shuns firms that do business in four nations that the State Department has linked to terrorism: Iran, Syria, Sudan, and North Korea.
Observers say states are improving their ethically screened options in part to attract more capital to their 529 programs.
"If a state program has a sufficient base of assets, it will be able to offer a more competitive fee" to encourage more saving for education, says Jacqueline Williams, chair of the College Savings Plans Network, which includes all state 529 programs. "As these 529 plans become more and more mature, you might see more of these kinds of developments [such as ethically screened products] as states try to differentiate their own product offerings to provide something unique."
But some financial advisers are skeptical of 529 options targeted at ethical investors. Allan Roth, a financial planner in Colorado Springs, Colo., warns that the Roosevelt Fund has a minuscule $14 million under management and drives up trading costs with an 86 percent annual turnover of its stocks. It also flunks a litmus test for many socially responsible investors by keeping tobacco giant Altria as its third-largest holding.
More broadly, he says that, as a rule, 529 investors pay premium fees to access ethical investments that tend to lag behind their competition in performance.
"They're going to pay more and take on additional risk" by limiting their universe of potential investments to ethically screened 529 funds, Mr. Roth says. "So the judgment they have to make ... is whether it's worth the cost to invest in such a style."
The popularity of 529s has grown since the first one made its debut in Michigan in 1988. The appeal stems in part from their flexibility. Savers can invest either in their state of residency, which triggers tax advantages in about half the states, or in another state, which may offer lower fees.
The cheapest is Utah, where investors annually pay as little as 0.35 percent of assets for investments that aren't socially screened. Once enrolled in any state's 529 program, investors can choose from among a list of investment options. In addition to mutual funds, Ohio, for instance, offers certificates of deposit.
Spending the cash can be a flexible experience as well. A single fund could pay for a son's college, a granddaughter's graduate school, or continuing education for oneself. The latter possibility might mean the financier funds his or her own degree program 10 years after dropping out of one, or bankrolls the cost of courses for personal enrichment in retirement. The benefactor simply needs to register all potential beneficiaries before withdrawing the funds.
For investors interested in social change, the broadest range of options comes from the District of Columbia, where Calvert manages the 529 program. Investors in the D.C. program may choose from among three funds whose holdings are 100 percent socially screened for such factors as good environmental citizenship and noninvolvement in tobacco manufacturing. Ten other funds in the D.C. program range from 0 to 75 percent socially screened.
To access these funds, investors must go through a broker, who receives a 4.75 percent load up front. They also pay a one-time $25 fee at the beginning and a $30 annual maintenance fee.
Calvert's fee structure leads to "high expense ratios," Roth says, but some investors are apparently undeterred. Fifty to 60 percent of investors in the 100 percent screened funds reside outside D.C., according to Laurent Ross, college savings program manager for Calvert.
"People from out of town are coming in to take part in these programs," Mr. Ross says. "The District of Columbia offers socially responsible options, so it may be worth paying more for that."
One reason: Ross says that, in the long run, socially screened stocks are likely to outpace others because they're less subject to the volatility that often results from scandals and lawsuits.
Missouri Treasurer Sarah Steelman also contends that her state's soon-to-arrive antiterror screens improve portfolio stability by keeping investors' dollars away from regions prone to flare-ups. They also meet a demand.
"We had a lot of people calling in and saying, 'I want to be sure my dollars aren't going to spread terrorism around the world,' " Ms. Steelman says. "We are empowering Americans to help fight the war on terror through choices they can make."
For Roth's part, the best socially responsible 529s are those with the lowest fees and broadest market exposure, since those factors reduce volatility and allow for capital appreciation over time. Of the bunch, he says he likes California's for its relatively low 0.8 percent annual fee and its linkage to the KLD Broad Market Social Index, which tracks more than 2,000 socially screened companies within the Russell 3000.
Yet because dollars and cents are of paramount concern to those with looming tuition bills, Roth suggests prioritizing financial considerations. He says to check first whether one's own state has tax benefits for residents who invest in its 529 plan. Then compare the net costs of doing so with investing through Utah's 529. In the end, Roth suggests going with the cheapest option – unless an investor believes an ethical component is worth paying an additional price.