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Trending in 529 plans: Compliance-friendly share classes (2/2)
http://www.savingforcollege.com/articles/trending-in-529-plans-compliance-friendly-share-classes-1057

Posted: 2017-05-18

by Brian Boswell

Financial Professional Content

The first half of this review of C to A Convertibles.

In this second part of our look at C to A Convertibles, SFC reviews the math behind the share structure. How do these new share classes compare against an A share held long-term? Or a straight C share that is accidentally overheld? And what are the drawbacks to these new classes? Are we just making it that much more difficult to weed through the alphabet soup of share class options?

Are C to A Convertibles really better?

Among those plans that offer the convertible share classes, they appear to be unilaterally better than a Class C, with certain conversion schedules slightly underperforming Class A shares – depending on the front-load – over the longest time horizons. From a practical standpoint, the return difference is negligible, and the flexibility and simplicity of using a C to A Convertible would outweigh the minor potential return handicap.

CHART - IA: Account value on a $10,000 investment over 18 years

No, you’re not reading the chart wrong: Class A and Convertible C to A shares in Iowa have nearly identical return schedules for periods beyond seven years. Consider this example using a sample initial account value of $10,000 in Iowa’s iAdvisor 529 Plan. For purposes of this exercise, the investment fee – the underlying fund expense – has been excluded. But taking into account share class, plan, and other account fees, the difference in the account value at the end of 18 years assuming an 8% annual return is $147, or 42 bps less than an A share held for the full duration. For the sake of comparison, we also ran the C share as if it did not convert, which would have resulted in a difference of $2,796, or 841 bps. Mathematically, the A share still wins out, but only just. In fact, running the same simulations for Rhode Island shows that the C to A Convertible actually wins out slightly in year 18 over the Class A using the aforementioned assumptions, earning $35,670 versus $35,563.

CHART - RI: Account value on a $10,000 investment over 18 years

What happens when you take into account shorter time horizons and accidental share class purchases of A shares when the client is closer to college age? At the end of the day, the C to A Convertible is more practical, straightforward, and dummy-proof than either the Class A or straight Class C alternatives.

What’s the catch?

Right now, automatic share conversions are fantastic. They simplify the share class selection process for everyone involved when opening a 529 account- sort of. There are some unfortunate drawbacks:

  • Simpler, but not simple. By virtue of being yet another share class, and because the structure adds additional complexity, it makes it more difficult for advisors and investors to understand how the share class works, and when they should pick one over another.
  • Does not play well with low sales charges on Class A or breakpoints. Tomorrow’s Scholar does not offer breakpoints for less than $1,000,000 in its Class A shares. This is because when the ratio between the Class A and Class C shares is less than 4.75% to 1.00%, it makes the math more difficult to reconcile. Automatic share class conversions would be less favorable in plans that offered breakpoints or a lower up-front sales charge for their Class A shares, such as the advisor-sold plans in Alabama and Illinois, whose sales charge is only 3.50%.
  • Ahead of its time. Voya was early to market, but definitely garnered fans among several influential broker-dealers with its innovative share class structure. But the cost of trailblazing is the burden of educating advisors and customers, which takes time and resources.
  • When their time arrives, they may be outdated. The DOL rule is not yet set in stone, having gone under review almost immediately following the inauguration of President Donald Trump. Plus: It doesn’t apply to the college savings market, at least not yet. As a result, this share class could end up being insufficient to meet future requirements, or the opposite, and unnecessary.

There is a significant movement towards fee-based and fee-only investment advice. Will there be an inflection point where traditional broker-dealers turn and say, “The commission model just doesn’t make sense anymore?” Only time will tell, and the fee-only nugget hasn’t been cracked quite yet, since current rules and, to a lesser degree, administrative impediments prevent RIAs from using their own fee structure and drawing down on their clients’ 529 accounts for compensation.

In the meantime, we will be seeing more plans offering C to A Conversion share classes. They make life a lot easier for everyone involved, are compliance-friendly over the long-term, will help avoid the accidental purchase of unsuitable share classes, and get the 529 market one step closer to a fiduciary standard of service for college savers using an advisor. More importantly, it gets the industry closer to eliminating the current alphabet soup of share class offerings that are currently available to consumers, which can result in confusion and inappropriate recommendations by advisors who are earnestly seeking the best outcome for their clients.


Appendix – Charts and Tables

Following are additional charts from the C to A Share simulations mentioned in this article. Simulations were run for Iowa’s iAdvisor 529 Plan and the Rhode Island CollegeBound 529. Results may have slight variations with other 529 plans and with those plans that have not introduced C to A Convertibles as of the time of this publication.

CHART - IA: Timeline of fees charged over 18 years for various share classes

CHART - IA: Cumulative fees charged in Class A vs. Class C shares on $10,000

CHART - RI: Timeline of fees charged over 18 years for various share classes

CHART - RI: Cumulative fees charged in Class A vs. Class C shares on $10,000

Financial Professional Content

The first half of this review of C to A Convertibles.

In this second part of our look at C to A Convertibles, SFC reviews the math behind the share structure. How do these new share classes compare against an A share held long-term? Or a straight C share that is accidentally overheld? And what are the drawbacks to these new classes? Are we just making it that much more difficult to weed through the alphabet soup of share class options?

Are C to A Convertibles really better?

Among those plans that offer the convertible share classes, they appear to be unilaterally better than a Class C, with certain conversion schedules slightly underperforming Class A shares – depending on the front-load – over the longest time horizons. From a practical standpoint, the return difference is negligible, and the flexibility and simplicity of using a C to A Convertible would outweigh the minor potential return handicap.

CHART - IA: Account value on a $10,000 investment over 18 years

No, you’re not reading the chart wrong: Class A and Convertible C to A shares in Iowa have nearly identical return schedules for periods beyond seven years. Consider this example using a sample initial account value of $10,000 in Iowa’s iAdvisor 529 Plan. For purposes of this exercise, the investment fee – the underlying fund expense – has been excluded. But taking into account share class, plan, and other account fees, the difference in the account value at the end of 18 years assuming an 8% annual return is $147, or 42 bps less than an A share held for the full duration. For the sake of comparison, we also ran the C share as if it did not convert, which would have resulted in a difference of $2,796, or 841 bps. Mathematically, the A share still wins out, but only just. In fact, running the same simulations for Rhode Island shows that the C to A Convertible actually wins out slightly in year 18 over the Class A using the aforementioned assumptions, earning $35,670 versus $35,563.

CHART - RI: Account value on a $10,000 investment over 18 years

What happens when you take into account shorter time horizons and accidental share class purchases of A shares when the client is closer to college age? At the end of the day, the C to A Convertible is more practical, straightforward, and dummy-proof than either the Class A or straight Class C alternatives.

What’s the catch?

Right now, automatic share conversions are fantastic. They simplify the share class selection process for everyone involved when opening a 529 account- sort of. There are some unfortunate drawbacks:

  • Simpler, but not simple. By virtue of being yet another share class, and because the structure adds additional complexity, it makes it more difficult for advisors and investors to understand how the share class works, and when they should pick one over another.
  • Does not play well with low sales charges on Class A or breakpoints. Tomorrow’s Scholar does not offer breakpoints for less than $1,000,000 in its Class A shares. This is because when the ratio between the Class A and Class C shares is less than 4.75% to 1.00%, it makes the math more difficult to reconcile. Automatic share class conversions would be less favorable in plans that offered breakpoints or a lower up-front sales charge for their Class A shares, such as the advisor-sold plans in Alabama and Illinois, whose sales charge is only 3.50%.
  • Ahead of its time. Voya was early to market, but definitely garnered fans among several influential broker-dealers with its innovative share class structure. But the cost of trailblazing is the burden of educating advisors and customers, which takes time and resources.
  • When their time arrives, they may be outdated. The DOL rule is not yet set in stone, having gone under review almost immediately following the inauguration of President Donald Trump. Plus: It doesn’t apply to the college savings market, at least not yet. As a result, this share class could end up being insufficient to meet future requirements, or the opposite, and unnecessary.

There is a significant movement towards fee-based and fee-only investment advice. Will there be an inflection point where traditional broker-dealers turn and say, “The commission model just doesn’t make sense anymore?” Only time will tell, and the fee-only nugget hasn’t been cracked quite yet, since current rules and, to a lesser degree, administrative impediments prevent RIAs from using their own fee structure and drawing down on their clients’ 529 accounts for compensation.

In the meantime, we will be seeing more plans offering C to A Conversion share classes. They make life a lot easier for everyone involved, are compliance-friendly over the long-term, will help avoid the accidental purchase of unsuitable share classes, and get the 529 market one step closer to a fiduciary standard of service for college savers using an advisor. More importantly, it gets the industry closer to eliminating the current alphabet soup of share class offerings that are currently available to consumers, which can result in confusion and inappropriate recommendations by advisors who are earnestly seeking the best outcome for their clients.


Appendix – Charts and Tables

Following are additional charts from the C to A Share simulations mentioned in this article. Simulations were run for Iowa’s iAdvisor 529 Plan and the Rhode Island CollegeBound 529. Results may have slight variations with other 529 plans and with those plans that have not introduced C to A Convertibles as of the time of this publication.

CHART - IA: Timeline of fees charged over 18 years for various share classes

CHART - IA: Cumulative fees charged in Class A vs. Class C shares on $10,000

CHART - RI: Timeline of fees charged over 18 years for various share classes

CHART - RI: Cumulative fees charged in Class A vs. Class C shares on $10,000

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