After a 529 plan is opened, the next step is to select an investment portfolio that will help maximize college savings. Parents may want to consider a 529 plan portfolio that contains exchange-traded funds (ETFs). ETFs can be a low-cost way of investing in a total stock market or index portfolio.
What is an ETF?
Like mutual funds, ETFs hold a basket of securities in a single fund and provide diversification to investors. Yet while mutual fund investors are limited to once per day trading, investors can buy and sell ETFs throughout the day. Most ETFs track an index, such as the S&P 500 Index, but some track a specific industry or market sector, such as technology. Many invest in equities, but there are also currency ETFs, derivative ETFs and bond ETFs.
529 plan program managers offer ETFs in both age-based and static individual portfolios. An age-based investment portfolio automatically shifts investments over time based on the beneficiary’s age, and an individual portfolio mirrors an underlying ETF, mutual fund or other investment. Arkansas’ advisor-sold 529 plan, the iShares 529 Plan from BlackRock, offers only portfolios invested in ETFs, including seven “year-of-enrollment” (age-based) portfolios.
Advantages of ETFs
- Low costs. The majority of ETFs invest in passively-managed strategies that seek to track the performance of an index such as the S&P 500. This brings costs down, as investors pay higher fees for actively-managed portfolios that seek to outperform a benchmark.
- Low risk. ETFs can provide exposure to a wide variety of asset classes for investors who are seeking diversification in their portfolio. Ideally, when one security in the ETF is performing poorly, another security will be performing well, minimizing losses.
- Flexibility. Unlike mutual funds, which can be traded only once per day, ETFs can be traded all day long while the markets are open. ETFs can also be bought and sold on margin like a stock. This flexibility allows investment managers to make quicker changes to ETF portfolios than they are able to with mutual fund portfolios.
- Tax savings. Investors typically pay less in capital gains taxes with ETFs than when investing in mutual funds. Mutual fund capital gains are passed on to the investor throughout the life of the account, but with an ETF, investors only incur capital gains tax when the ETF is sold.
Disadvantages of using ETFs in 529 plans
Many of the benefits of investing in ETFs are lost when the ETF is held in a 529 plan. Investors who purchase an ETF through a brokerage can take advantage of the trading flexibility throughout the day, but a 529 plan account owner is permitted to make investment changes only two times a year. Also, the tax savings become irrelevant since 529 plans offer tax-free growth and tax-free withdrawals when the funds are used to pay for qualified higher education expenses.
However, ETFs can help diversify 529 plan investments while keeping costs low.
529 plans that offer ETFs*
Almost two dozen 529 plans offer ETFs as investment options within their portfolios. Click on the plan name for more details.
How to Enroll
District of Columbia
*Based on most recent Savinforcollege.com data.