Saving For College, ETF Style: An ETF-Friendly 529 Plan

by: Michael Johnston

The ETF industry has been routinely praised for its innovation over the last several years, which is no doubt a contributing factor to the surge in interest and assets. Generally, reference to such innovation relates to the growth in the product lineup, as issuers of all sizes have launched a number of creative, first-to-market products over the past few years that have dramatically opened up the asset classes and investment strategies available through the exchange-traded structures.

But there are other aspects of the industry that deserve credit for exciting new developments as well. While ETFs are still hard to find in most 401(k) account and other retirement plans, they are now readily accessible in a popular college savings account; a program from State Street allows new parents to use ETFs in a college savings plan for children, through an ETF-focused 529 plan.

The 529 plan is, of course, nothing new. As part of the Economic Growth and Tax Relief Act of 2001, 529 plans became more widely used thanks to some significant tax advantages. Specifically, distributions from 529 plans for qualified education-related expenses such as tuition and textbooks are exempt from federal income tax. So contributions are able to grow over time in a tax-deferred account, which can translate into significantly more appreciation over a period of several years. Moreover, many states allow for state income tax deductions of any contributions (see also Cheapskate ETFdb Portfolio ETFdb).

Move Over Mutual Funds

Historically, 529 plans have utilized mutual funds almost exclusively. But not surprisingly that is changing as ETFs claim a bigger market share. The SSgA Upromise 529 plan, for which State Street serves as the investment manager, allows for the creation of a static or dynamic 529 plan that uses primarily low cost SPDR ETFs as the underlying assets. Given the potentially significant cost advantages of ETFs compared to mutual funds, that can translate into reduced management fees and better long-term returns.

The SSgA 529 plans come in three different wrappers, including both packaged strategies and opportunities to build a portfolio piecemeal:

  • "College Date" Portfolios: These portfolios are similar to the concept of target retirement date ETFs; the underlying collection of stocks, bonds, and money markets adjusts over time from relatively high to relatively low risk tolerance.
  • Risk-Based Portfolios: Similar to some of the products in the Diversified Portfolio ETFdb Category, these strategies include an aggressive allocation (100% stocks), moderate portfolio (50% stocks) and conservative portfolio (100% bonds and money market accounts).
  • ETF-by-ETF Portfolios: There's also the opportunity to build a custom portfolio using SPDR ETFs; currently the lineup includes 15 funds: S&P 500 SPDR (NYSEARCA:SPY), S&P MidCap 400 SPDR (NYSEARCA:MDY), S&P SmallCap 600 SPDR (NYSEARCA:SLY), Dow Jones REIT ETF (NYSEARCA:RWR), Dow Jones International Real Estate ETF (NYSEARCA:RWX), S&P World Ex-U.S. ETF (NYSEARCA:GWL), International Small Cap ETF (NYSEARCA:GWX), S&P Emerging Markets ETF (NYSEARCA:GMM), S&P Emerging Markets Small Cap ETF (NYSEARCA:EWX), Barclays Capital Aggregate Bond ETF (LAG), Barclays Capital TIPS ETF (NYSEARCA:IPE), SPDR DB International Government Inflation Protected Bond ETF (NYSEARCA:WIP), Barclays Capital High Yield Bond ETF (NYSEARCA:JNK), Barclays Capital Short Term Corporate Bond ETF (NYSEARCA:SCPB), and Barclays Capital 1-3 Month T-Bill ETF (NYSEARCA:BIL).

Disclosure: No positions in any stocks mentioned at the time of writing.

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