The Gap In Advisor-Supported 529 College Savings Plans For RIAs

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#OfficeHours with @MichaelKitces Video Transcript

Welcome, everyone! Welcome to Office Hours with Michael Kitces.

This week, I want to talk about one of the challenging issues of the industry shift towards RIAs, which is the fact that most products made for advisors to implement with clients are actually made for brokers who sell those products and not necessarily the advisors at RIAs who simply advise on insurance and investment products. Now, this has long been recognized as a challenge for RIAs that want to implement with clients. So we have a relatively limited number of fee-based annuity solutions. There are a few, but not a lot, even fewer fee-based no-load life insurance policies. And it's not even just limited to traditional insurance-related products, it crops up in other parts of the investment domain as well, like today's topic, 529 college savings plans.

This week's question comes from Randy who asks:

"I'm starting an RIA and I'm wondering how other RIAs handle 529 plan recommendations. Do you just send clients to direct-sold plans? Do you always use the in-state plan? Do you bill on those assets, and if so, how much, since the plans can't really be actively managed? Do you try to pick allocations and adjust them periodically or just put clients into age-based options?"

This is a great question, Randy because you're right, these issues of which plan you choose and how you actually manage it and how you bill for your services are real issues for independent RIAs trying to help clients with their 529 college savings plans. And it's a problem because of the way that 529 plans are simply distributed and made available to the public.

Advisor Sold vs Direct Sold 529 College Savings Plans [Time - 1:47]

From their start, there basically have been two types of 529 college savings plans, advisor-sold plans, and direct-sold plans. Now, direct-sold plans were simply marketed and made available directly to consumers who could open the accounts themselves. It's the solution for those who are self-directed enough to find, open and invest their own 529 plans. Now, obviously not everybody either wants to or is comfortable trying to pick 529 plans and doing it for themselves, and so many state 529 plans also created an advisor-sold option.

And some mutual fund companies that have long-standing relationships with advisors like American Funds established advisor-sold plans specifically because they hoped it would become appealing to advisors even regardless of their state location. And the strategy worked. The CollegeAmerica plan for American Funds has been the most popular amongst financial advisors, and it actually is more than double the assets of even the largest direct-sold plan, which is the New York College Savings plan with Vanguard funds.

And the reason why this advisor-sold structure matters is because these 529 plans are truly sold by financial advisors who get paid a commission to implement them, which means they're really technically broker-sold because it's the broker's commission that compensates the advisor, not an advisory fee. And I think that's ultimately a problem because what it means is RIAs that cannot receive a commission and don't have a license with a broker-dealer can't access advisor-sold 529 college savings plans, instead as advisors and RIAs, our only choice is to work with clients through direct-sold plans, except direct-sold plans are made for do-it-yourself investors. They're not built for advisors to be involved. They were made to be direct-sold.

Which means if the advisors want to actually help clients implement 529 plans with direct-sold options, that means not necessarily any way to track the performance and the results of the 529 plan, can't pull it into existing performance reporting tools, which means the advisor is trying to provide advice on the outside account, no way to pull in the value of the account to bill on it as a part of the advisor's Assets Under Advisement. And the plans are so not prepared in many cases to deal with advisors being involved that we don't even have a way to access the actual account to help clients do things like implement investment trades or just do the account paperwork because it was a system that was built for broker-based advisors to be involved, not registered investment advisors.

Finding Solutions For “Advisor-Supported” 529 College Savings Plans For RIAs [Time - 4:13]

Now, that being said, it's worth noting that there have been some solutions emerging from what I'll call the more creative direct-sold 529 college savings plans. The rise of account aggregation means that often as advisors, we can at least pull 529 client account balances into existing portals and dashboards. Now, that might be a client link through their retail account in an eMoney Advisor dashboard or using ByAllAccounts to automate the flow of the account balance data into a financial plan, updating your client's net worth. We get some tools now. Or you can actually get set up directly with Ascensus, which is the back-end record keeper for a huge number of 529 plans already. And they have a 529 QuickView, a solution which is meant to give advisors the ability to see what's happening in client's 529 plans.

And a few of the 529 plans have established now direct feeds into the popular portfolio performance reporting solutions that we as RIAs already use. So groups like the Utah Educational Savings Plan can pipe its account data directly into Orion or Tamarac, or Black Diamond, or Morningstar Office. TD Ameritrade's 529 plan has some RIA integrations as well, which makes it at least a little more feasible to track the value and even get the transaction-level data to do real performance reporting.

But unfortunately, groups like the Utah Educational Savings Plan seems to be the exception to the general rule for direct-sold 529 plans right now as advisors try to plug in. And of course, even if you can get the client's 529 data plan, that doesn't necessarily mean you can do anything with it because it's a direct-sold plan that's meant to be self-directed on implementation by the client. And since we the advisor are not literally the client, often 529 plans won't even take our calls or any of our involvement. We may get the account feed data, but unless the client is on the phone line too, they can't do anything with us. And of course, if the client has to be on the line kind of eliminates the point of the client delegating this to us as registered investment advisors. And if the client gives us their login information for the 529 plan, we can then do trades, but that potentially triggers custody issues if you have client passwords.

Fortunately, some states are starting to come up with workarounds on this as well. Doing things like allowing advisors to become an authorized user of a direct-sold plan or RIA-friendly solutions like the Utah plan actually include a form right alongside the rest of the account opening paperwork that allows a financial advisor to be designated with a limited power of attorney to act on the client's behalf for that 529 plan, essentially turning the direct-sold 529 plan into what I call an advisor-supported 529 plan.

The good news of these advisor authorizations is at least it lets us contact 529 plans to request information and make investment changes, but even that at the end of the day is still limited because it's not practical or really it's not scalable if you have a substantial number of clients because when you contact the 529 plan, you still have to do it one client at a time. Most advisors just don't have the time to systematically track and report on performance just one 529 plan, one account at a time, calling for each client's account to make those investment changes, rebalancing trades one client at a time. Not if you have a full practice with a lot of clients.

And it's really a notable difference when you contrast this with the power of what rebalancing software lets us do for traditional portfolios. Where with rebalancing software, I can queue up a rebalancing trade for 1,000 clients in a few minutes, upload 1 trade file per custodian to execute and allocate all the trades. But with a direct-sold 529 plan, even as an authorized user with an LPOA and be allowed to make trades, we can't do it efficiently when we're going one client at a time. Not if you've got 100 or especially 1,000 clients.

Now granted under current 529 plan rules you're only permitted to investment changes a year so it's not like most of us would be actively trading anyways, but still, advisors may want to make tactical tilts based on their investment views. They may have certain views about factor-based investing. If the market crashed 35% of bear market, it would be nice to be able to systematically rebalance the clients and reload their equities at that point, or maybe even overweight them slightly in anticipation of recovery. All of which can't be systematically done without true advisor tools that don't exist in direct-sold plans.

Creating A True Advisor-Supported 529 College Savings Plan [Time - 8:24]

And the key point of all of this is that means if we're really going to get better at facilitating RIAs to help clients with 529 plans, and if direct-sold plans really want more adoption from the rapidly growing RIA community, I think we basically need a third type of 529 plan. So we already have direct-sold plans for do-it-yourselfers and advisor-sold, or what's really broker-sold for the broker-dealer community, and so between direct-sold and broker-sold, we need a third category that I would call advisor-supported. And a successful advisor-supported 529 college savings plan has to get good in four core areas.

1. Reporting

A good advisor-supported 529 plan should be able to facilitate performance reporting. That means the ability to send transaction-level data so that we can do real dollar-weighted performance reporting, not just the account balance. And the data needs to flow directly into our core portfolio of performance reporting tools, Orion, Tamarac, Black Diamond, etc. Or at least it needs to route through account aggregation players like ByAllAccounts and Quovo that can manage transaction-level data so that they can pipe it into the performance reporting tools. Because as advisors, it's hard to help clients manage a 529 plan as part of a holistic management process if you can't actually track and report on the results of your investment advice. So we need to have the data feeds, and it needs to connect to what we already use if we're going to do this efficiently, because for most of us as RIAs, we're not going to solely be in the business of 529 plans, we're going to do it as part of the client's household, so it needs to be managed within the systems we already use to manage the household.

2. Trading

A good advisor-supported 529 plan needs to be able to integrate to our existing trading system so that we can manage client 529 plans in a scalable way. That means not only being able to pipe the data feeds directly into our model management software tools, so iRebal, Tamarac TRX, TradeWarrior, but also being able to accept a trade file from the rebalancing software that queues up each trade with the right dollar amount types, the right accounts that can be uploaded to the 529 plan at the click of a button. That not only allows advisors to execute their own rebalancing process and their own investment management process, but making those adjustments to risk exposure, making investment tilts, or whatever else the advisor wants to do within the twice-per-year trading constraint of 529 plans. And with trading within our existing centralized trade management tools, it also becomes possible to execute things like asset location strategies, where we specifically allocate high-return less tax-efficient investments into the tax-free 529 plan as part of the household's overall asset allocation. That's a huge value-add opportunity, but you can't do it until it's within the entire household's trading tools.

Now, I realize that some direct-sold 529 plans are really made for one advisor at a time. They don't even have their own back-end systems to be able to handle trade files to be uploaded from an advisor and then put all of their own back-end error tracking in place, right? Because we do need to make sure at some point the trade orders are correct, the advisor had access to those accounts, the trades are the right dollar amounts, they don't violate the twice-per-year trading rule, but at a minimum, advisor-supported 529 plans need to at least allow advisors to set their own models, including the ability to change that model periodically twice a year, and then the 529 plan can take the responsibility for rebalancing client portfolios automatically to the advisor-created models. So at least a 529 plan that can use its internal trading and rebalancing systems, but the advisors can be model strategists that set allocations and manage them over time for clients. It doesn't allow the asset location strategies around the rest of the household investments, but at least it allows us as advisors to manage our client's 529 plans consistent with the rest of how we manage the client's household.

3. The ability to facilitate billing

At a minimum, this ties back to the reporting and account aggregation requirement. If a direct feed for the data can be piped into portfolio reporting tools, which for most RIAs is also our billing software tool, then the advisor overseeing outside 529 plan assets can bill on the outside assets under advisement as part of a streamlined and consolidated billing process when the 529 values are piped in directly.

Now, better yet would be a 529 plan that can actually allow the advisor to directly bill their AUM advisory fee from the account, because while there are some advisors out there that would bill their client's other managed accounts, that's not always feasible, right? If the only managed account for the client is an IRA, IRAs can't pay outside investment management fees for non-IRA accounts, nor is it feasible if the 529 plan is just a very large portion of the total investment assets because the fee from just the managed accounts may look disproportionately large if it bears the burden for everything, right? This is the scenario like the client's $100,000 investment account and $200,000 in 529 plans, so at a 1% AUM fee on $300,000, it's a $3,000 fee, but you don't want to bill a $3,000 fee from 1 investment account because it looks like it accrued just 3% AUM fee.

Now, ideally, for a lot of us, we would actually want to bill outside non-529 assets because the 529 plan is a tax-free account. So ideally I want to pay the fee from not tax-free dollars, other accounts instead, but that's, again, not always feasible or practical. Sometimes the 529 plan needs to pay its own way just as it does now with broker-sold plans. The rumor is American Funds is actually working on a direct billing solution like this for RIAs, and other 529 plans that are serious about the RIA channel need to figure out how to do this as well. We need to be able to get paid for what we do when we're managing accounts and providing holistic advice on everything, even if that means figuring out how to make 1,000 RIAs into 1,000 different sub-advisors for that 529 plan so we can each get paid as an internal manager for the account without triggering adverse tax events when the advisory fee comes out.

4. Education and planning tools to help us

Now, I view this as a little bit more optional than the other three requirements of reporting, trading, and billing, but this is important for at least a subset of RIAs because the reality for most of us is that we don't focus on college planning as specialized in 529 plans. Maybe a few advisors do under a retainer model that's targeted there, but most advisors in the RIA channel if they help with 529 plans at all, it tends to be because it's one of many accounts in the client household, which means even if the advisor does holistic financial planning and knows all the rules and benefits of 529 plans, we don't necessarily live and breathe the details of all 50 states.

Which starts raising questions like should this client use their in-state plan even if it's direct-sold with no advisor-supported option or an out-of-state plan that is advisor-supported instead, right? Some states offer tax deductions only for in-state plans and not out-of-state plans, others only offer asset protection for in-state plans, not out-of-state plans. So education tools that help us as advisors figure out when is it appropriate to use an outside advisor-supported 529 plan and not maybe a direct-sold in-state plan, wherever that client is located, would be really helpful especially given the fiduciary duty attached to our advice. Now granted we can research this, and we'll probably learn the rules for our home state pretty quickly because that's where most of our clients are, but tools to help support this evaluation and help us effectively fulfill our fiduciary duty would be helpful.

Of course, the reality is that even with core trading and reporting and billing tools to support advisor support of 529 college savings plans and the educational planning tools, not all RIAs are realistically going to partake in helping clients with 529 plans. As I've discussed in Office Hours in the past, really even our whole RIA channel can be segmented into what I call investment-centric firms versus planning-centric firms. And in general, investment-centric firms I think aren't as likely to be interested in doing 529 plans because they're still too limited for an investment-centric firm to execute an ongoing investment management process when you can only do two trades a year. And the market opportunity may not be big enough for them anyways given the typical size of a 529 plan relative to an affluent household's total investable assets. But I suspect there is a subset of larger investment-centric firms where their clients or more affluent, which means the 529 plans can get pretty big, or there may still be some interest in helping clients implement 529 plans if the firm can at least do some of its investment process scalably with the requisite tools and get paid for it as a way for them to grow their business, expand their wallet share of household managed assets.

For the planning-centric firms, though, where almost any reasonably affluent household has some kind of education planning as part of the financial planning process either for their kids or because they're past that age and it's for their grandchildren instead, where there would be a lot of appeal for having an advisor-supported 529 plan option. Some firms might view it as a way to expand their assets under advisement and actually bill for managing and providing advice on outside accounts, others might just charge the retainer fee but want to be able to help with implementing the 529 plans for their clients as part of that holistic planning and good service, but only if they had the advisor-supported tools to actually facilitate the process. Otherwise, it's not scalable for advisors to execute.

But the bottom line is just to recognize that historically 529 plan adoption frankly has not been very significant in the RIA channel, and the few of us that do use them tend to just choose simple age-based glide path portfolios and direct-sold plans, but it's not necessarily because the only thing that RIAs want from a 529 plan is because of the lack of any kind of advisor-supported 529 plan. That's been the only thing that was feasible when we can't use broker-sold plans. And I think this becomes only more pertinent if the recent House GOP tax plan goes through, which would consolidate Coverdell Education Savings Accounts in the 529 plans, growing the 529 plan space, and the fact that it would allow 529 plans to be tax-free savings vehicles for private elementary and high school as well, which gives the affluent a whole other reason to start saving more dollars in 529 plans.

I hope that's helpful food for thought on the current 529 plan's landscape and the need, I think, for a third option for advisor-supported 529 college savings plans beyond just what direct-sold plans do, but not as a broker-sold option.

This is Office Hours with Michael Kitces, normally 1 p.m. East Coast time on Tuesdays. Obviously, we're off a little bit today, but thanks for joining us, and have a great day!

So what do you think? Do we need an advisor-supported 529 plan option? What features would you like to see? How can advisors in an RIA efficiently help clients in the meantime? Please share your thoughts in the comments below!