Updated: May 3, 2013 12:14PM
Originally published: April 18, 2005
Should you save for college in a 529 College Savings Plan? The answer is a definitive yes -- especially if you have at least 10 years to make your money grow. The advantages of 529 plans are dramatic: tax-free gains, easy access, high contribution limits and investing made easy through age-based funds.
These 529 investment plans are undeniably a great way to save for college.
Now there’s just one question: Which plan should you use?
Sorry folks, there’s no easy answer to that simple question. There are a lot of variables to consider. Some can be measured, and others are almost impossible to compare. There are three sources for basic information:
www.SavingforCollege.com This Web site, developed by Joe Hurley, has been the main source of information and comparisons of 529 plans. It provides costs, fees, tax breaks and investment choices in various plans and allows easy online comparisons. What it does not currently provide is a rating based on investment performance. Hurley says frequent fund changes within plans, and irregular performance reporting make comparisons a monumental task.
www.InvestforCollege.com This relatively new Web site was started by Burt Baker, a financial planning expert who has developed a double ratings system for 529 investment plans. His TCOP score measures the cost of the plan compared with available alternatives for college investments. The investment rankings score plan fund performance through recent bull and bear cycles, relative to benchmarks. But given short history and recent changes in many plans, other experts call his ratings controversial. Still, it’s the only place to start the performance comparison process.
www.Morningstar.com Morningstar, the mutual fund tracking and advisory company, also attempts to assign ratings to state 529 investment plans. But Morningstar analyst Kerry O’Boyle, who monitors the plans, admits that methodology is limited. You’ll find that information under the “personal finance” section of the Web site. You can search and compare fees and recent performance.
If you’re considering a 529 investment plan, you need to make three basic comparisons: costs, tax breaks and performance history.
Costs: There are actually three different costs to consider when investing in a 529 plan: commissions, annual fees and annual money management costs.
Many states have a two-tier commission level: no commission if you buy direct from the plan Web site, but commissions as high as 5.75 percent if you buy through a broker or financial planner. And, some plans have two different classes of shares: those with up-front commissions, and those that charge a lower fee on the larger pool of assets at withdrawal. Ask! You might be paying an unnecessarily high fee for your investment.
Then, there’s the annual management fee charged by the state. It can be as high as $30 to $50 per year, just to cover the costs of record-keeping.
Finally, there’s the cost of the investment management for the underlying funds. Some states have amassed substantial assets in their plans and have negotiated lower annual fees from fund management companies.
Tax breaks: The best part of 529 plans is that the money can be withdrawn free from federal income taxes to pay for college expenses. But some states do tax the withdrawals for state income tax purposes. And other states, such as Illinois, give a tax break on contributions, but only for residents contributing to their own state plan! (Since state treasuries get a small part of the management fee, it is their goal to maximize assets in their own state plan.)
Investment performance: Now here’s where it gets really tricky. States’ age-based plans have individual funds, changing components to become more conservative as your child moves closer to college. But many have switched funds in recent years, and few have a long enough track record to make historical patterns on which to premise future results.
All of this complication means that parents who are looking for an easy solution to saving for college have to do a bit of homework.
I’d suggest starting with your own state plan, if it offers you tax breaks. Then do comparisons with some of those listed above. It’s well worth the search. After all, the growth in your investment is free from federal taxes and supports an investment in education that will pay off many times over. And that’s the Savage Truth.
Terry Savage is a registered investment adviser. Distributed by Creators Syndicate.