By Randy Myers
NOTE: Correction at end of article
They have different funding goals, of course, but in many other respects 529 college savings plans are a lot like 401(k) retirement savings plans—with at least one notable difference. While stable value funds can be found in a high percentage of 401(k) plans, they are only in four of the nation’s 51 state-sponsored 529 plans. And that, a panel of industry insiders explained at the 2013 SVIA Spring Seminar, is a growth opportunity that stable value providers should be keen to embrace.
Steve LeLaurin, senior client portfolio manager at Invesco Advisors, conceded that there are challenges to breaking into the 529 market. As a group, stable value wrap providers are just now emerging from a period in which wrap capacity was constrained, and they have not spent much time looking at the market. Also, because 529 plans are not qualified plans under the Employee Retirement Income Security Act, they cannot participate in bank collective trust funds, which means they cannot use standard pooled stable value funds. Finally, there’s just not as much awareness of 529 plans, as they have only been available since 1996, as there is of 401(k) plans. In fact, although they’ve been around since 1996, 529 plans did not really begin to gain traction until qualified withdrawals were temporarily exempted from federal income taxes beginning in 2001. That exemption was not made permanent until 2006.
Still, 529 plans are a big and growing market, with $190.7 billion in assets at the end of 2012 . And their similarities with 401(k) plans make them attractive to stable value providers who have already broken into the market. To illustrate the point, LeLaurin showed a graph of crediting rates over the past 10 years for two 529-plan stable value funds under his firm’s management, and compared them to crediting rates for a 401(k) plan stable value fund the firm runs. The general trends and absolute numbers were highly correlated.
The one area where the performance of the 529 funds did diverge from that of the 401(k) fund was in their monthly cash flow histories. Unlike 401(k) plans, 529 plans experience withdrawal patterns that tend to be seasonal, with the heaviest outflows coinciding with the beginning of the spring and fall college semesters, when tuition, room and board payments are due. Still, LeLaurin noted, those withdrawal patterns are highly predictable, and ultimately tend to be less volatile than those for 401(k) plans.
The Invesco stable value fund in the 401(k) plan example, LeLaurin noted, was completely and successfully underwritten for the last 10 years, and considered by wrap providers to be a good risk. Yet in terms of cash flow volatility, he said, the funds in the 529 plan look to be an even better risk.
Gary Ometer, chief financial officer for the Virginia College Savings Plan, noted that there have been no large, net, cash outflows from stable value investments in that $2.2 billion plan, where about 21 percent of the total assets are allocated to stable value investments. Most of that stable value money is in age-based target-date funds that progressively shift more of their money into stable value funds as the target date approaches, eventually reaching a 100 percent allocation. A contributing factor to the cash-flow stability in the fund, he said, is that the Internal Revenue Code allows investors in 529 plans to make only one change in investment direction per year.
Ometer noted that the Virginia College Savings Plan weathered the 2008-2009 market downturn well, continuing to post positive cash flows throughout. “These are definitely sticky deposits,” he said. “People don’t change investments often.”
In addition to a 529 college savings plan, Virginia also operates a so-called “prepaid” 529 plan in which investors buy tuition credits rather than simply amass savings. Ometer said the cash flow and investment patterns of stable value investors in that fund have been similar to those of stable value investors in Virginia’s 529 savings plan.
The Virginia plans eliminated money market funds from their roster of investment options in 2012, Ometer noted, in a bid to attract additional wrap capacity for their stable value funds.
In neighboring West Virginia, Hartford Life Insurance Co. administers the West Virginia Direct 529 plan. It also administers the Hartford SMART529 in that state and the SMART529 Select plan in Connecticut, both of which are sold nationally by registered investment advisors. Stable value funds are offered in the West Virginia plans. Jeff Coghan, assistant vice president with Hartford, said his company would like to offer stable value in the Connecticut fund, too, “if there was availability out there.” Combined, he said, the three programs have about $1.8 billion in assets, including about $271 million in stable value funds.
Coghan said his company participates in the 529 market in part because the assets are so sticky. “Participants don’t chase from fund to fund like they do in the more traditional mutual fund business,” he said. “Inter-plan transfer activity is basically non-existent. It’s that stability and predictability, that ability to serve as anchor to our fund business, which caused us to enter the business, and it’s why we continue to be excited about it. We see a tremendous opportunity, not only in the growth of the market but in the stability of the assets. We need some more wrap providers, and I think those that get into the business will have a lot of opportunity to find their way into target-date portfolios and other structures that would be very appealing.”
Two wrap providers already active in the business are ING Life Insurance and Annuity Co. and Aviva Investors.
Eric Hasenauer, managing director at Aviva Investors, said his firm decided to enter the 529 market as a wrap issuer about a year and a half ago. While acknowledging the similarities between 529 and 401(k) plans, he noted that some of the differences may actually be beneficial to stable value providers. In addition to limitations on changes in investment allocations, for example, 529 plans offer greater participant diversity, with individual plans often having tens of thousands of participants with relatively low account balances (about $17,000, on average, at the end of 2012, according to The College Savings Plans Network). There also are no corporate events to worry about and no pooled-fund considerations.
Among the potential risks of participating in 529 plans, Hasenauer said, are the potential for headline risk should a plan’s operator run into hot water, the potential for a state to run into solvency issues, the ability of account owners to transfer funds to other qualified tuition plans, and the potential for new tax legislation that could establish a more popular college savings vehicle in the future. “Ultimately, he said, “we thought these were risks we could overcome.”
ING Life and Annuity provides wrap contracts for four 529-plan stable value funds in Virginia, West Virginia, Rhode Island and Illinois, covering about $1 billion in assets. In addition, its sister company, ING Investment Management, serves as program director for the 529 plans in Wisconsin, Ohio and Iowa.
Tony Camp, vice president, ING Stable Value Products, explained how his firm created its 529-plan wrap contracts. It started with the base contract it uses for a synthetic GIC funding agreement in the defined contribution retirement-plan market, then eliminated provisions specific to that market and added in others specific to 529 plans. The vast majority of the contract’s original provisions, however, remained intact. Areas that required customization pertained primarily to IRC code references and annuity provisions, benefit withdrawals, participant-directed transfers and contract termination. “It wasn’t that big of a job,” he said. “In fact, it was fairly straightforward”
For wrap providers considering entering the business, Camp advised paying attention to the quality and popularity of the 529 plan under consideration. He also suggested looking closely at states where the conservative investment option today is a money market fund. In his own informal survey of the marketplace, he said, he counted 27 states where the 529 plan was using money market funds. Those funds are currently yielding near zero percent, while the average stable value fund is offering a crediting rate of about two percent. After accounting for inflation, Camp said, investors are losing money in money market funds. That should make stable value funds attractive to 529 plans currently offering money market funds as their conservative investment option.
Stable Times’ “529 Plans -Ready Market For Stable Value” did not highlight Colorado’s 529 college savings plan. The article, which was based on presentations made at SVIA’s Spring Seminar, did not include a panelist from/for Colorado. Colorado uses a MetLife stable value fund in its plan. To learn more about Colorado’s use of stable value in its 529 plan, please go to http://www.collegeinvest.org/collegeinvest-savings-plans/stable-value-plus-plan/