The Uncomfortable Thing You Need to Talk About Before You Get Married

Written by: Kathryn Flynn | 529 plans are investment products designed to help families save for future education costs. A direct-sold 529 plan is a lower-cost, DIY option that can be opened online. Advisor-sold 529 plans must be purchased through a licensed financial advisor.

There are many advantages to using an advisor-sold 529 plan. According to a study by Fidelity, 67 percent of families who work with a financial advisor feel they have a good understanding of the best way to save for college, compared to only 40 percent of families who do not work with an advisor.

But financial advice rarely comes free, and college planning is no exception. Families who purchase a 529 plan through a financial advisor often pay a sales charge in addition to the plan’s underlying mutual fund fees. The amount of commission an advisor earns depends on the mutual fund share class selected within the 529 plan.

Under the suitability standard, broker-dealers must have a reasonable basis to believe their share class recommendations are suitable based on the client’s needs and investment profile. The Financial Industry Regulatory Authority (FINRA) recently launched a 529 Plan Share Class Initiative to improve the supervisory practices and procedure of broker-dealers who sell 529 plans.

Two areas of concern were brokers who were recommending share classes to beef up their commissions, and the change in tax code that made K-12 tuition a qualified 529 plan expense.

A Sneaky Sales Practice

Advisor-sold 529 plans offered through brokerage firms (Merrill Lynch, Morgan Stanley, UBS, etc.) are typically sold as Class A shares or Class C shares. Class A shares have an upfront sales charge (as high as 5.75%) and low annual fees, and Class C shares have no upfront sales charge with higher annual fees.

Generally, Class A shares are recommended for 529 plan beneficiaries who have a longer investment time horizon, since there is more time to absorb the cost of the upfront sales charge and the investor will benefit from the lower annual fee.

But, some advisors intentionally placed clients with young children in Class C shares to collect the higher ongoing sales charges.

Shorter Investing Time Horizons for K-12

As a general rule of thumb, some broker-dealer firms recommended Class A shares for all beneficiaries younger than 12 years old. This was considered a suitable investment since the child had at least six years until college.

However, the Tax Cuts and Jobs Act of 2017 allows families to use up to $10,000 per year of 529 plan savings to pay for K-12 tuition expenses. Families paying for K-12 tuition typically have a much shorter time horizon than those saving for college, and therefore have less time to absorb the cost of an upfront sales commission.

How Broker-Dealer Firms are Responding to the Initiative

Many broker-dealer firms now use a suitability questionnaire and breakpoint calculator to see which share class is the best fit. FINRA supplied firms with a framework for the calculator, which provides a recommendation for Class C shares or Class A shares based on the investor’s time horizon.

Jeff Motske, President at Trilogy Financial Services in Orange County, CA, says that some broker-dealers are very strict about share class recommendations. Advisors are expected to understand the client’s investment goal and time horizon and keep documentation.

“With these new rules and regs, you’ve got to be examining pricing as part of your planning practice with your clients or you’re just not meeting the standard,” says Motske.

Russ Ryan, formerly FINRA’s Deputy Chief of Enforcement and a partner in King & Spalding’s Special Matters and Government Investigations team, says that although the deadline to self-report violations to FINRA has passed, taking a look at a firm’s supervision is a good business practice.

“The initiative may be prompting brokers to ask more questions of their customers before they make a recommendation to make sure they really do understand all the facts and circumstances of the customer’s situation and making sure that they are recommending the right type of 529 share class,” says Ryan.

How 529 Plan Fees Affect Your College Savings

With almost any 529 plan, the investor pays annual mutual fund fees. Direct-sold 529 plans typically invest in passively managed funds (such as index funds) with very low expenses. However, many advisor-sold 529 plans invest in actively managed funds with expenses as high as 1% and come with an additional sales charge to compensate the advisor. A 529 plan's expense ratio also varies by share class.

Even a small difference in 529 plan fees can add up over time. For example, if you invest $100,000 in a 529 plan with a 1% expense ratio you would pay $1000 in fees. If you instead invest in a 529 plan with a 0.10% expense ratio you would only pay $100 fees that year.

And remember, a 529 plan’s annual expense ratio is based on a percentage of assets in the account. So, as your account balance grows you end up paying more in fees. The more you pay in fees, the less money you are investing for your child’s college education.

Alternatives to Broker-Sold 529 Plans

Advisor-sold 529 plans are also sold by registered investment advisors (RIAs). RIAs have a fiduciary duty to put their clients’ best interests first. Instead of Class A shares or Class C shares, some RIAs place 529 plan clients in no-load share classes, such as Class I shares. The sales charge is waived, and the advisor typically charges an hourly rate, or an AUM advisory fee based on the assets in the 529 plan.

But, not all RIAs charge for 529 plan advice. Matthew Murawski, a financial planner with Goodstein Wealth Management, LLC in Encino, California offers pro-bono college planning advice to clients. His firm recommends 529 plans with low-cost index funds, no sales charge and no asset-based fee.

In Murawski’s experience, consumers are generally unaware of 529 plan share classes and that they can usually get the same investment at a lower cost. He recently helped two clients roll existing 529 plan assets from Class A and Class C shares to lower-cost Class I shares.

“Even if we were charging for it, let’s say we had an asset fee on there, we would still be saving you an incredible amount of money over the lifetime of the 529,” he says. “Fees really add up over the lifetime of a 529.”

Another RIA option is U-Nest, a college savings app that determines an optimal 529 plan investment portfolio based on your child’s age and time horizon. The funds are invested in Class I shares of the CollegeBound advisor-sold 529 plan managed by Invesco. Instead of charging an hourly rate, there is a $3 per month fee to use U-Nest.

According to Ksenia Yudia, Founder and CEO of U-Nest, the app is ideal for low- to middle-income families who may not be comfortable investing in a direct-sold 529 plan.

“Direct-sold plans come with certain complications, meaning the clients need to be comfortable opening their own investment account without the help of a financial advisor,” she says. “They need to have at least some basic knowledge of finance and investing.”

Final Thoughts

Families should regularly review their 529 plan to make sure the investments are still appropriate for their situation. It's perfectly reasonable to ask your advisor about which 529 plan share class you are invested in, especially if you have concerns.

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James Rooney hadn’t planned on carving out a niche working with deaf clients. But nearly 30 years after his first encounter with a deaf client, he has become Morgan Stanley’s go-to adviser for this unique community of clients.

“If a deaf client were to walk into any Morgan Stanley office anywhere in the country, they will find me,” he said.

Mr. Rooney, who is based in West Hartford, Conn., and has been an adviser at Morgan Stanley for 20 years, was with Merrill Lynch in Long Island, N. Y., in the early 1990s when he noticed the receptionist struggling to communicate with a deaf client.

“I walked over and started talking to the person in sign language,” Mr. Rooney recalls. “Within six months, I probably got a dozen or more unsolicited walk-in deaf clients.”

Mr. Rooney, who now has 225 deaf clients, learned sign language as a child growing up in a household with two deaf parents.

Even though he and his team also work with about 1,000 other clients without hearing impairments, he considers his work with deaf clients as a “way to honor my parents.”

“I have grown my client base of deaf people every year and it’s mostly word-of-mouth referrals,” he said.

There are an estimated 2.2 million deaf people living in the United States, a number that is shrinking as a result of medical and technological advancements. But financial advisers who work with one or several deaf clients uniformly agree that it is an underserved market.

It was less than two years ago that wealth adviser Matthew Phillips had his first encounter with a deaf prospective client who emailed him at Trilogy Financial and closed with the explanation, “we are deaf.”

Mr. Phillips, who had studied sign language in college but didn’t consider himself fluent, wasn’t sure how to proceed.

“I reached out to our team to ask how we should handle this, and nobody had any idea,” he said. “I started to realize no one at Trilogy [which has 150 advisors in 10 offices] has dealt with this before.”

Mr. Phillips, who now works with 20 deaf clients, contacted his former sign language instructor at California Baptist University for some advice.

The instructor, W. Daniel Blair, organized a tutorial for a half dozen Trilogy advisors.

One of the challenges when it comes to providing financial advice to a deaf person is clear communication. With technology and creative determination, the communication can be managed even if the adviser isn’t fluent in sign language. But even being fluent in sign language doesn’t guarantee perfect communication.

“There’s so much in the financial world that doesn’t exist in sign language,” Mr. Blair said.

Not only does sign language differ by region, similar to regional accents, but he said some words just don’t exist in sign language.

“Take compound interest, for example, which I don’t think most hearing people even understand, but there’s just no way to interpret that in sign language,” Mr. Blair said.

In another example, he recalls watching a certified American Sign Language interpreter signing for the word investment in a way Mr. Blair said he would have signed for the word contribute.

“And what I was signing for investment, the interpreter was using for saving,” Mr. Blair said.

Mr. Rooney of Morgan Stanley has had similar experiences trying to employ words and phrases that did not yet exist in sign language.

“There’s a sign for interest and most everyone understands that, but I found there was not a sign for dividend, which is similar to interest,” he said. “So I decided to make a sign for dividend, and now I see other signers using it. That’s exactly the way it works. Sign language, like all language, evolves.”

Of course, many financial advisors don’t even have a foundation in sign language to start with. But that hasn’t prevented John Cooper, private client advisor at Greenwood Capital, from working with a deaf client for the past 10 years.

“We meet in person once a year, and I give him a notepad and I have a notepad, and that’s how we communicate,” Mr. Cooper said. “Let’s just say there’s not a lot of small talk.”

Technology, including the internet and smartphones, has made communication a lot easier than with the early teletype phone communication of decades ago when deaf people would have to type messages to a hearing operator, who would act as translator.

Mr. Rooney said he now has a video phone in his office that enables him to sign with his deaf clients in real-time.

For advisors who are interested in working with deaf clients, or who might be having trouble communicating with current clients who are deaf, Mr. Rooney said it’s important to make eye contact and remember always to face the deaf person.

“They may be able to read lips, so be sure to enunciate properly, maybe even over-enunciate,” he said. “And be patient. I find it much more frustrating for me not being able to get my ideas across than they were with me because they couldn’t understand what I was trying to say.”

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