Best 529 Plans for College Savings
Is College in the Future?
I know that Suze Orman would advise my husband and me to save first for retirement and then invest in college savings for our four children. But now that my oldest has just turned 14 and is going into high school next year, we have turned our attention back to the 529 plans we opened nearly 10 years ago.
There are many ways to save for college, but one of the most popular investment vehicles is the "529 Plan," offered by each of the fifty states in the U.S.A. The money you put in grows tax-free over the years, and when it is withdrawn for college expenses, the interest is never taxed.
A 529 Plan can be started for any person, by anyone, even for yourself! A parent, grandparent or other friend or relative maintains the account in their name (unless the 529 plan is created for you), which means that the impact on the student's financial aid eligibility is reduced. Further, compared to other college savings vehicles that are held in the student's name, including a Uniform Gift to Minors Account (UGMA aka Uniform Transfer to Minors), the assets in a 529 plan are assessed at a lower rate on federal financial aid forms.
What is a 529 Plan?
A so-called "529 Plan" receives its name from the section of the Internal Revenue Code (IRS) Code that allows college savings funds invested in a specialized investment account to grow, without being subject to federal taxes. Investments in a 529 Plan can help cover college tuition, required textbooks and many room and board costs.
In addition to growing tax-free, when a beneficiary withdraws money for so-called "qualified education expenses," the withdrawals are not subject to federal taxes, either. Some states also allow tax credits or deductions for 529 plans held by residents.
Although many people have been wary of making investments in the stock market recently, a dollar-cost-averaging approach of putting a consistent amount into a fund like a 529 Plan will allow you to take advantage of dips in the market because you'll be buying low (i.e. getting a bargain). The accounts are managed by investment funds such as Schwab, TIAA-CREF, Vanguard and Fidelity.
While you are not guaranteed a rate of return, you can manage the amount of risk to take, depending on the child's age and how many years until he or she attends college. As with retirement accounts, 529 Plan accounts for younger children can be more heavily weighted in stocks, but as they near college age, funds may be shifted to more conservative investments.
Most states allow you to either go with an account in which you can invest directly, and a portfolio that can only be purchased through advisers or brokers. All states, except for Washington State,
Basics of a 529 Plan
Top 10 State 529 Plans
According to SavingsforCollege.com, these states currently offer the best 529 plans for college savings*:
- Alaska (via University of Alaska)
- Alaska (via T. Rowe Price)
*Rankings based on 5-year investment performance (2005-2010).
Common Questions and Answers About 529 Plans
Q: How many 529 Plans are currently in existence? A: There are a total of 117 plans, as of the date of this publication. Some states offer more than one 529 Plan.
Q: Who can enroll/invest in a 529 Plan? A: Anyone interested in setting money aside to pay for college expenses, regardless of state residency or relationship to the future student.
Q: Where are 529 Plans offered? A: All 50 states in the U.S. offer the plans. They are not offered in any other country - at least not as a "529 plan" - however.
Q: What is the minimum amount required to open a 529 Plan? A: This varies, depending on the plan, but may be as low as $25.
Q: Do I have to make regular contributions to a 529 Plan? A: No, you are not required to do so. You can make one-time contributions as you wish. However, like many types of savings accounts, it helps to have regular investments automatically made each month so you do not miss the money!
Q: Do you have to be a resident of the state in order to invest in its 529 Plan? A: No. In fact, we live in Oregon and have 529 plans for our children in Michigan. However, many states offer their residents state income tax deductions for 529 plan investments in their state's program.
Q: If I have a 529 Plan in California, does the student have to attend college there? A: No. It does not matter where you live, or where your child wants to go to college. My kids, for example, can choose any higher education facility to attend.
Q: Do I have to be related to the student for whom I am investing in a 529 Plan? A: No. Anyone can open a 529 plan for any beneficiary, regardless of relation. You can even save for your own future higher education costs.
Q: What is the average return on investment for a 529 Plan? The 5-year returns for 529 Plans (2005-2010) averaged 3.3% according to Morningstar.com.
Can you Decide Not to Go to College?
No matter what type of 529 Plan you have, whether a pre-paid tuition program (like that offered in Washington State), or a traditional savings plan, you are not required to go to college. However, if funds are not put toward for tuition or other qualified education expenses, you will be charged penalties and taxes, but only on the earnings, not on the entire amount withdrawn.
What Makes a Good 529 Plan for College Savings?
Back in 2002, I researched and compared 529 plans for several months before settling on the Michigan Education Savings Program (MESP). Among the factors we considered included low fees, a variety of diversified investment choices and the option of direct investment, rather than purchasing through brokers. Plus, we tend to be conservative investors.
According to Kiplinger.com:
The Michigan Educational Savings Program, run by TIAA-CREF, is ideal for investors who shy away from putting their college savings into the stock market. The plan has a savings option that guarantees principal and a minimum annual interest rate based on a Treasury note index. That option doesn't charge an annual fee. The plan also offers portfolios of TIAA-CREF mutual funds that are tilted more toward bond funds than most other 529 plans. Those options cost a very low flat fee of 0.45% annually.
You should make your own investment decisions in choosing a 529 Plan, considering: (1) tax breaks offered by your state; (2) fees/costs of a plan; (3) mixes of investment choices; (4) underlying fund portfolios; and (5) quality of advisors or brokers, if you would rather work with - and pay - a professional than make direct investments yourself.
If you have questions concerning how a 529 Plan fits into your overall investment strategy, consult your account or CPA.
Recent Improvements in 529 Plans
College Calculators and Financial Aid Estimators
Private College 529 Plans
As of 2003, there is another 529 Plan option for people saving for college. The Private College 529 Plan allows parents to lock in current private college tuition rates via a pre-paid plan. That means you can purchase 4 years at MIT - up to 30 years from now - at today's tuition prices. Pretty amazing, don't you think?
There are currently 270 colleges and universities that are participating across the United States. As with state-sponsored 529 plans, there are penalties and taxes that apply if your student does not withdraw the funds for private college expenses and you request a refund. However, you can change the beneficiary of the plan to another child, or roll it over to a state 529 plan.