Should I use the Michigan Education Savings Plan (MESP) 529 plan for my college savings?
When ranked against other 529 plans, the MESP receives high grades for its low costs and tax deduction to Michigan residents. However, as an independent financial advisor, Clear Financial Advisors prefers to weigh all of the financial considerations prior to deciding if the plan is right for you.
First, consider your college funding goals. Do you want to pay for 100% of your child’s education? 50%? Four years? Six? Public school, or private? What expenses do you plan on covering - tuition, room & board, and materials?
It is also important to realize that many pay for part of college through loans, scholarships, tax credits, and work. This is where having your own personal financial plan is critical. Without considering your own financial security, as well as your options for saving that may have multiple uses (for retirement if your child does not need it), you may fund junior’s college degree at the expense of being a burden on them in your later years.
Our preferences for investing include that we have increased control and the ability to use an account for multiple goals. 529 plans rate low on both of these goals. There is another college plan we discuss below that provides more control with similar tax benefits.
Consider as well that the concept of college will likely change over the next 18 years. What we experienced in the recent past will be impacted by technology, pricing pressures, cost / benefit questions, and new alternatives. Likewise, many will continue to benefit from government subsidized education in the form of tax credits, grants, and subsidized loans, which are not always available for money used from a 529 plan.
Are the MESP investments good?
As noted above, the MESP receives high marks for low-costs. However, there are many limitations within the plan, and like all 529 plans, they are not necessarily ideal for investing without understanding the risks.
The investment options are not diverse enough for a complete investment plan. The limitations on investment asset classes is the most unappealing characteristic of the plan. There is very little ability to diversify or implement a sound investment plan.
The age-based investment options are not diverse, and are prone to taking more risk than most individuals should consider.
The investment options can only be changed once per calendar year.
You must pay the state in order to invest. In addition to the costs, the benefits continue to change, and not often in the favor of the 529 saver
One concept I discuss with clients is that the entire idea of investing is long-term in nature in two distinct periods. 529 Plans by design require taking higher than necessary risks in both periods.
The accumulation period that most financial advisors seek for taking on stock market risk is at a minimum 5-10 years. Historically, a period of 10 years in most markets has not lost money. There have been markets where this has not been the case. With accumulation for college, we are looking at a relatively short period of time very we have a 10 year window, and even within that window we do not have a full range of investment options or strategies for adequate diversification.
The drawdown period in college plans is where investors are subject to extreme risk. Not only is the drawdown period extremely short, providing minimal opportunity to recover from losses, but due to the costs associated with investing in any 529 plan, the lifecycle investment options still continue to take inappropriate risks.
Consider the Plan
For the above reasons, I often discourage only using the MESP without first considering all of the other possibilities for saving for college under accounts that serve multiple purposes. This is best done under a financial planning review with an independent financial advisor who is not selling 529 plans.
The decision to utilize the 529 plan should also be carefully considered, as well as who will own the plan, and who will be the contingent owners.
If you do determine it is in your interest to use a 529 plan, below are our current client model portfolios for Michigan’s MESP 529.
Consider the Alternatives
A Coverdell Education Savings Account (ESA) may be an appropriate investment option for most college savers.
An ESA allows for tax-deferred growth and tax-free use of funds for qualifying educational expenses, which unlike 529 Plans also includes pre-college expenses. There is no state tax-deduction (in those states that allow such deductions), however since ESA’s can be established at many low-cost brokerages and mutual fund providers, allowing you to manage your investments in a much more meaningful way than 529 Plans allow.
The ESA allows for $2,000 to be contributed each year per beneficiary (note: this is not a “per account” limit, but it in fact limits everyone who has an account for a given beneficiary; so, mother can not contribute $2,000 to an account with daughter as the beneficiary if father already has an account that has hit that limit for daughter). There are contribution income limits for the owner of the account (not the beneficiary) as well to be aware of.
At a 7% annual rate of return, the amount in the ESA after 18 years would be approximately $70,000. At 8%, the total is $80,000. This may be more than enough for many college plans when combined with tax and other funding strategies.
ESA’s can be rolled into 529 Plans should there be a desire to move those funds.
For all of the above, an ESA may be appropriate for the first $166.67 / month of future educational savings for a beneficiary where long-term investment is appropriate.
While not all investment providers have ESA account options, Scottrade Institutional, a low-cost broker that Clear Financial Advisors utilizes for client accounts does have ESA accounts. Clear Financial can provide investment oversight or flat-fee guidance wherever you may choose to establish an ESA.
Using an effective combination of the above investment categories in combination with your Michigan plan can improve your investment experience. The benefits of increased diversification can result in a less volatile portfolio.
For more information on the above strategies and other investment ideas linked here is a complementary PDF version (Password = clearandfree) of our book Clear Investing, Intentional Investing.
Also often ignored is the use of retirement accounts, such as Roth IRAs, if not presently being utilized. A Roth IRA can even be established for a child if they have earned income. There are penalties for using the ‘growth’ of a Roth IRA, however, since assets can be withdrawn at any time, and contributions are deemed to have been withdrawn first, the growth may not be necessary to be used for college purposes, and can be left in the Roth IRA for retirement purposes. Again, the investment options in a Roth IRA can be structured in a more meaningful way than any 529 Plan.
Also, review if there are better 529 Plan’s available. Clear Financial’s current preference for a 529 Plan is the Utah Educational Savings Program, utilizing their individual investment options to create a personalized portfolio.
MESP 529 Model Portfolios
Our model portfolios utilize the Aggressive Age-Based Portfolio.
As noted above, the Age-Based plans likely take an inappropriate amount of risk for the average investor. That being said, they offer investment asset classes that are not available to select as individual investments.
Aggressive Age-Based Portfolio 100%
80% Aggressive Age-Based Portfolio
20% Principal Plus Interest Fund
65% Aggressive Age-Based Portfolio
35% Principal Plus Interest Fund
50% Aggressive Age-Based Portfolio
50% Principal Plus Interest Fund
20% Aggressive Age-Based Portfolio
80% Principal Plus Interest Fund
100% Principal Plus Interest Fund