529 Savings Plans
Information is partially excerpted from Alt Energy Stocks, 12/17/20, by Tom Konrad Ph.D., CFA
529 plans are named after section 529 of the Internal Revenue Code 26 U.S.C. § 529. A 529 savings plan is a tax-advantaged savings plan designed to help pay for education. There are also prepaid tuition plans offered in other states than California, so we will focus on 529 savings plans.
While most savings plans allow investors from out of state, there can be significant state tax advantages and other benefits, such as matching grant and scholarship opportunities, protection from creditors and exemption from state financial aid calculations for investors who invest in 529 plans in their state of residence. Contributions to 529 college savings plans are made with after-tax dollars. Once money is invested in the account, it grows tax-free, and withdrawals from the plans are not taxed when the money is used for qualified educational expenses.
The money in 529 plans can be used for college as well as K-12 education, apprenticeship programs, and paying off some student debt. Savings plans are different in that all growth is based upon market performance of the underlying investments, which typically consist of mutual funds. Investors can select stocks and bonds via preset investment menus. Most 529 savings plans offer a variety of age-based asset allocation options where the underlying investments become more conservative as the beneficiary gets closer to college age.
The problem with most 529 plans is, like 401(k)’s, the plan sponsor chooses the investment provider and the investments available within the plan. This is a good thing in that a limited number of well curated investment choices can help unsophisticated investors make investment choices that are appropriate for college savings goals.
For example, New York’s plan offers both age based options and individual portfolios color coded by risk and potential reward. These portfolios are built from Vanguard’s low cost index mutual funds, which are also a good choice for unsophisticated investors interested solely in maximizing their investment returns. But the Plan also helps destroy the future planet that child has to live on by investing in fossil fuel companies.
Fortunately, the ability to choose between 51 different plans means that no matter where you live in the US, you do have a few environmentally responsible options.
Coverdell Education Savings Accounts
Coverdell Education Savings Accounts (ESA) are similar to 529 plans in that they grow tax-free and the money can be withdrawn tax-free for qualified education expenses, but these can be set up as brokerage accounts, and so can be invested in any fossil free mutual fund or stocks that you choose. Unfortunately, you can only contribute $2,000 a year to these accounts, which may not be nearly enough to pay for four years of college (and possibly high school or K-12 education) at today’s prices, even if you start saving the year the child is born.
For investors well-versed at choosing their own investments, however, it’s probably worth putting that $2,000 a year in an ESA, with any additional money you can save for the child’s education going into a 529 Plan.
529 Plans With Sustainable Investing Options
Brian Boswell, CFP® (Forbes, March 2017) lists the following state plans with more sustainable options:
Note that all of these funds are equity funds, and so may be too risky for some college savers if used alone.
Choosing a Sustainable 529 Plan
If you live in Connecticut, Oregon, Pennsylvania, Virginia, or Wisconsin, then your choice is easy. Your state offers a relatively sustainable choice in its 529 plan, and offers state tax benefits for using the plan. California also has a more sustainable option, but does not offer state tax benefits to residents.
For residents of the other 44 states and California who can get only federal tax benefits it makes sense to choose a fund based on the quality of its offering. The table below compares the available funds based on four measures. Fossil Fuel exposure data is from FossilFreeFunds.org, and Deforestation risk is from DeforestationFreeFunds.org. Both sites are maintained by the nonprofit As You Sow.
(Editor -- NC-CAN has added Military Weapons from As You Sow MilitaryFreeFunds.org and updated table data to December 2021. Funds contain a small number of holdings and one fund (PRBLX) shifted from B to D in military this quarter. Holdings are always shifting and As You Sow updates them monthly.)
As you can see from the chart, there is no good reason to select the TIAA Social Choice Equity Fund (TNWCX) unless you live in Connecticut, Oregon, and Wisconsin and want to take advantage of the state tax benefits.
Considering all the above factors, the best fund is Illinois’ Calvert Equity Fund (CEYIX). While it has a higher annual fee than Pennsylvania’s Vanguard’s FTSE Social Index Fund, it has still produced a comparable five year annual return after fees, owns no fossil fuel companies, and engages with companies on deforestation issues. Unfortunately, this fund can only be accessed through an advisor who offers the Illinois 529 plan.
This leaves Pennsylvania’s Vanguard’s FTSE Social Index Fund and Virginia’s Parnassus Core Equity Fund. Between these two, we are confronted with a trade-off between our environmental values and cost/historical performance.
While Vanguard’s FTSE Social Index Fund is not completely fossil fuel free, it’s much better than the typical equity portfolio in a 529 plan. For example, the Vanguard Total Stock Market Index Fund (VTSAX) has a 6% exposure to fossil fuel companies, including both fossil fuel producers and utilities. It also scores an F on deforestation. The Social Index Portfolio only has an eighth as much ownership of fossil fuel utilities, and no exposure to fossil fuel producers at all. While the Vanguard Social Index Fund is not perfect, it is low cost and nearly fossil fuel free.
On the other hand, the Parnassus Core Equity Fund (PRBLX) is truly fossil fuel free, and Parnassus is a dedicated socially and environmentally conscious investment shop. Investing responsibly is core to what they do. Further, past performance is no guarantee of future results, so historical performance should always be considered skeptically. You do pay a little more for Parnassus’ environmental expertise, but you are also getting something for that.
Author of the artcle Tom Conrad says: I'm setting up 529 plans for my two grandsons. I had trouble choosing between the Virginia and Pennsylvania plans for the reasons outlined above. Fortunately, money can be transferred between siblings's 529 plans without any tax consequences, so one grandson got the Virginia Plan, and the other got the Pennsylvania plan. I plan to balance out any future differences in performance by transferring money from one plan to the other.
Below NC-CAN has summarized 529 ESG (Environmental, Social, Governance) funds available as of 12/2021