Should Local Residents Use HI 529 - Hawaii's College Savings Plan?

By J.R. Robinson, Founder/Financial Planner

Hawaii residents who want to save for their children's or grandchildren's education have their own state-sponsored 529 college savings plan. It is appropriately called HI529.

At first glance, there is much to like. Hawaii has selected two highly respected companies to run important parts of the program. Ascensus College Savings Recordkeeping Services handles the program's day-to-day operations, including recordkeeping and administrative services, while Vanguard serves as investment manager.

I regard both of those as positives.

Ascensus is one of the country's major 529 plan administrators, and Vanguard hardly needs an introduction. Vanguard has been one of the driving forces behind low-cost index investing and manages investments for a number of state 529 programs.

So, what's not to like?

There are two shortcomings that have historically caused me to direct Hawaii residents to other states' 529 plans. There is also a separate issue involving Hawaii's tax treatment of K-12 withdrawals that local residents should understand regardless of which state's plan they choose.

Hawaii Gives Residents Little Reason to Stay Home

The first problem is that Hawaii does not offer a state income-tax deduction or any other incentive for Aloha state residents to contribute to HI529.

This matters because state tax incentives are often the strongest argument for choosing your home state's 529 plan.

A Hawaii resident does not have to use Hawaii's plan. Residents can generally invest in another state's 529 plan while retaining the principal federal tax advantages of a 529 account.

That means Hawaii's plan has to compete with 529 programs around the country on investment quality, flexibility, service and cost.

Some states tilt that decision heavily in favor of their own plans by offering residents a state income-tax deduction or credit for contributions. Hawaii provides no comparable incentive.

HI529 does waive its $20 annual account maintenance fee for Hawaii residents, which is certainly preferable to paying it. But that is a relatively minor benefit compared with a potentially recurring state income-tax deduction.  The leading competing 529 plans do not charge a maintenance fee anyway.

Without a meaningful Hawaii-specific tax incentive, local residents are free to ask a very simple question:

Which state's 529 plan gives me the best combination of investments, expenses and features?

That leads to my second concern.

HI529 Is Comparatively Expensive

HI529 currently charges total annual asset-based fees ranging from approximately 0.55% to 0.66%. That means an investor pays roughly $5.50 to $6.60 annually for every $1,000 invested.

Those percentages may not sound particularly alarming until you compare them with other low-cost 529 plans.

A number of large state plans using Vanguard investments have total expenses that are considerably lower. This illustrates an important point: Using Vanguard funds does not necessarily mean that a state 529 plan will have Vanguard-like pricing.

The underlying investments are only part of the expense structure. Investors also bear program management and administrative expenses.

Hawaii Has a Scale Problem

Higher expenses do not necessarily mean there is anything wrong with the administration of HI529.  Hawaii simply has a disadvantage that is difficult to overcome: scale.

We are a small state with a population of roughly 1.4 million people. Larger state plans have much greater opportunities to spread the fixed costs of administering a 529 program across more accounts and a much larger asset base.

Recordkeeping systems, websites, regulatory compliance, customer service, investment oversight and other administrative functions all cost money. The larger the asset base, the more accounts those expenses can be spread across.

Unfortunately, the reason for the higher expenses doesn't change their impact on investors. Higher expenses reduce investment returns dollar for dollar.

Because 529 plans are often established when a child is very young and remain invested for 15 or 20 years, seemingly small differences in annual expenses can compound into meaningful amounts of money.

A Hawaii Tax Trap for K-12 Expenses

There is another Hawaii-specific issue that has nothing to do with which state's 529 plan you select, but local residents should know about it.

Federal law permits 529 distributions for certain K-12 education expenses. Beginning in 2026, the federal annual limit increased from $10,000 to $20,000 per beneficiary and the list of eligible K-12 expenses was expanded.

Hawaii, however, does not conform to the federal treatment.

For a Hawaii taxpayer, a 529 distribution used for K-12 expenses may qualify for favorable treatment under federal law while still being considered a nonqualified withdrawal for Hawaii income-tax purposes.

This is an important distinction because using another state's 529 plan does not solve the problem. The issue is Hawaii's tax law, not the HI529 program itself. A Hawaii resident who owns a New York, Nevada or other state's 529 account still needs to consider Hawaii's treatment of a K-12 withdrawal.

That is particularly important for Hawaii families considering using 529 assets for private-school expenses. Don't assume that because Congress considers the withdrawal qualified, Hawaii does too.

I Would Avoid HI529's Age-Based Option

I also have a philosophical disagreement with HI529's age-based investment approach.

Age-based portfolios sound sensible. When the beneficiary is young, the portfolio holds mostly stocks. As college approaches, the allocation automatically becomes more conservative.

The problem is how "conservative" is defined.

HI529 progressively shifts assets from stock funds into Vanguard bond funds and short-term reserves. By ages 15 and 16, the age-based portfolio is 87.5% bonds. At age 17 and older, the portfolio is 75% bonds and 25% short-term reserves.

I don't believe bond funds necessarily provide the degree of principal stability that families need as college approaches.

Bond funds fluctuate in value as interest rates change. When rates rise, existing bonds become less attractive relative to newly issued bonds paying higher yields, and bond-fund prices can decline. The longer the duration, the greater that interest-rate sensitivity tends to be.

To illustrate this problem by example, Vanguard Total Bond Market Index Portfolio, which provides the backbone of the HI529 Plan age-based portfolio at matriculation, declined 13.1% in response to interest rates rising in 2022.  For a parent who has a tuition bill coming due next semester, that level of volatility is probably not acceptable.

As the beneficiary approaches college, I belive the emphasis should shift from maximizing returns to making sure the money is there when the tuition bill arrives.

Stocks for Growth, Cash for College

For that reason, if I were using HI529, I would eschew the age-based portfolios in favor of the indivudal investment options.

During the early accumulation years, I would favor the low-cost Vanguard stock index options for long-term growth. The appropriate allocation will obviously depend upon the family's circumstances, the child's age and the amount already accumulated.

As matriculation approaches, however, I would begin thinking very differently about the money that will soon be needed.

Rather than automatically moving from stock index funds into bond funds, I would prefer gradually moving the portion of the account expected to be spent over the next several years into HI529's Vanguard Money Market Portfolio, which invests in the Vanguard Federal Money Market Fund.

HI529 specifically describes the objective of this portfolio as providing income consistent with preservation of capital.

My preference would generally be to begin making this transition within approximately five years of matriculation. The closer the money gets to being spent, the less willing I would be to expose it to either stock-market risk or the interest-rate risk associated with bond funds.

In simple terms, my philosophy is stocks for long-term growth and cash-like investments for near-term college expenses.

Is HI529 a Bad Plan?

Absolutely not.

I actually like much of what Hawaii has done with the program. Ascensus is an experienced 529 administrator. Vanguard is an excellent investment manager. The investment choices are straightforward, and Hawaii residents don't pay an annual account maintenance fee.

If Hawaii offered residents a meaningful state income-tax deduction for contributions, my assessment might be different.

Similarly, if the state's program were eventually able to reduce its asset-based expenses significantly, HI529 would become much more competitive.

But investors have to evaluate the plan that exists today.

For Hawaii residents, there is no state income-tax deduction to offset the plan's relatively high expenses. And because residents are generally free to shop nationally for a 529 plan, there are alternatives offering excellent investment choices at substantially lower costs.

My Bottom Line

There is something intuitively appealing about keeping your college savings dollars here at home. If two 529 plans were otherwise roughly equal, I would certainly have no objection to choosing Hawaii's.

But they aren't equal.

HI529 has two excellent service providers in Ascensus and Vanguard. Unfortunately, Hawaii's small size appears to leave the program at a significant cost disadvantage compared with larger state plans.

More importantly, Hawaii doesn't give its residents a compelling financial incentive to accept that higher cost. There is currently no Hawaii income-tax deduction for making contributions to HI529.

For those reasons, I have historically recommended that Hawaii residents shop nationally rather than automatically choosing our home-state plan.

For residents who do choose HI529, I would also think carefully before simply selecting the age-based option and forgetting about it. I prefer using stock index funds during the long accumulation period and then deliberately moving money needed for college into the Vanguard Federal Money Market Fund as matriculation approaches rather than automatically migrating into bond funds.

Finally, Hawaii residents should remember that plan selection and state taxation are separate issues. Hawaii does not currently follow the federal treatment of 529 withdrawals for K-12 expenses. That Hawaii tax treatment follows the taxpayer, not the name on the 529 account.

HI529 isn't a bad 529 plan. It simply has to compete against some excellent plans offered by much larger states. Without an in-state tax deduction to tip the scales in its favor, Hawaii residents have little reason not to shop around.