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This hidden factor could raise the cost of saving for college

Key Points
  • Share classes in your college savings plan influence the fees you pay: A-shares assess an average upfront cost of 4.4 percent, according to Morningstar.
  • C-share classes have no upfront costs, but charge annual fees.
  • Whether a particular share class is right for you will depend on when your child will need the money.
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If a financial advisor is working with you to help you save for Junior's education, be sure to ask if your college savings plan is appropriate for your child's time horizon.

That's because the fees that you'll ultimately pay on your advisor-sold 529 college savings plan will depend on the types of underlying funds you choose — as well as how long you intend to hold it.

Families can use 529 plans as a way to save for higher education on a tax-preferred basis. Investment of your after-tax dollars will accumulate tax free.

Distributions from the account are tax-free as well as long as you're using the money to pay for qualified higher education expenses, including tuition, fees and books.

If you're going to be invested for at least 10 years, the Class A is fine. Less than that? Class C is better.
Mark Kantrowitz
vice president of research at Savingforcollege.com

Starting in 2018, the Tax Cuts and Jobs Act began allowing savers to take tax-free distributions of up to $10,000 a year from their 529 accounts for private elementary and secondary school tuition.

As a result, families with shorter time horizons could end up facing higher expenses if they select the wrong share class.

"In terms of suitability, what's the time period of the investment?" asked Paul Curley, director of college savings research at Strategic Insight. "You have to know the goal that the money is going toward: Is it for private K-12 or is it for college?"

Here's what you need to know.

Back to class

There are two ways for families to invest in a 529 plan.

With a direct-sold 529 plan, you buy your plan on your own through the state you choose.

Though more than 30 states offer tax benefits for investing in a 529 plan, you have no obligation to pick the plan that corresponds with the state that you live in.

529 tax break map

Families can also buy their plans through a financial advisor. These advisor-sold plans tend to come with higher costs.

On average, advisor-sold plans had a fee of 96 basis points, while direct-sold plans charged 44 basis points, according to fourth quarter 2018 data from Strategic Insight. A basis point is one-hundredth of one percent. That means 100 basis points equals 1 percent.

Among advisor-sold plans, investors can choose the share classes for the funds within the 529. Class A fund shares tend to come with high upfront commissions, which now average 4.4 percent, but lower annual fees, according to Morningstar.

Meanwhile, Class C shares have no upfront charges but impose higher annual fees compared to A shares.

In that sense, A-shares have an average annual asset based fee of 96 basis points, but C shares have an annual asset based fee of 163 basis points, as of the fourth quarter, according to Strategic Insight.

Timing matters

Compassionate Eye Foundation/Robert Daly/OJO Images | Iconica | Getty Images

If you choose to work with your financial advisor on a 529 plan, be sure to ask whether his or her recommendation reflects your timing as to when you will use the money.

Consider it this way: You're comparing an A-share fund with an upfront cost of 5 percent to a C-share fund that has an asset-based fee of 1 percent that is assessed every year.

In this case, the A-share is costly in the near term, but overall it's less expensive the longer you hold the fund. Meanwhile, the C-share might be the cheaper of the two if your intention is to use the money fairly soon — you're paying the annual fee for less time.

Time horizon is especially important because families that may have initially opened a 529 to save for college may consider tapping them for near-term K-12 costs.

VIDEO0:4300:43
A change to 529s that few people know about

"In general, 10 years is often the key differentiator between Class A and Class C," said Mark Kantrowitz, publisher and vice president of research at Savingforcollege.com.

"If you're going to be invested for at least 10 years, the Class A is fine," he said. "Less than that? Class C is better."

In recent years, plans have also made convertible C-share classes available, wherein the fund changes to the A-share after a certain period of time.

The conversion generally takes place once the cost of the C-share over time reaches parity with the upfront cost of the A-share version of the fund, according to Leo Acheson, associate director, multiasset and alternative strategies at Morningstar.

Some fee-only advisors — financial professionals who don't collect commissions — also encourage clients to use direct-sold funds and provide general recommendations on them, Kantrowitz said.

Cost-savvy savers aren't the only ones keeping an eye on advisors' 529 share-class recommendations.

FINRA, the self-regulatory organization that oversees broker-dealers and their advisors, recently kicked off an initiative, encouraging firms to come clean about advisors inappropriate 529 share class recommendations.

"It's important to understand what plans the advisor or broker is able to recommend to you," said Gerri Walsh, senior vice president of investor education at FINRA.

"You will want to ask what the costs are so that you can make informed choices about which plans fit your budget and work best for your circumstances," she said.

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