Choosing A 529 Plan

Family Finances, Planning & Saving
on July 8, 2013

College education price increases have outpaced the rate of inflation ever since the 1970s. The current cost of a typical four year degree program at a state university is now approaching a total tab of $70,000. If the historical trends continue, college education costs will increase by about 5-6% per year. If you’re starting to save for your children’s education, and they’re four years old now, by the time they enter college, that $70,000 education is going to run right around $140,000 by the time they’re enrolling.

With bond interest rates running around 2%, and current inflation adjusted savings interest rates at around 0% or less, the tried and true methods of saving for your children’s education (buying bonds and socking some money away in savings accounts) aren’t going to cut it for the graduating class of 2030.

Enter the 529 plan, named for the section of the 1996 IRS Code revision that enabled it. A 529 plan is a tax-deferred plan, similar to a 401(k) retirement plan. While 529 plans contributions aren’t tax deductible on the Federal level, most states offer a tax break for investing in the 529 plan run by the state for their state university systems.

529 plans are professionally managed investment vehicles, and there are several vendors competing for your business. There are points of differentiation that needs to be considered.

Tax Benefits

The single largest benefit to 529 plans is that the money they accrue from their interest is tax deferred; rather than paying the taxes at the point where the interest accrues, the taxes are paid only when money is withdrawn, and the taxes may be waived if you’re spending the funds on federally approved expenses, like tuition and books. While most states have a tax deduction for 529-plan contributions, there are exceptions, predominantly states without a state income tax.

Prepaid Tuition Plans

Somewhat more controversial are pre-paid tuition plans. Pre-paid tuition plans, like Washington State’s, let you pay current tuition prices now to lock in the price. These work well if you can afford the current tuition payments, and theoretically are less risky – there’s no chance of a stock market bubble destroying your accumulated savings. The drawback to them is that unlike other 529 plans, you’re effectively committing to a state college degree program and the funds aren’t easily rolled over into other programs. In short, if you pay for Washington State’s prepaid tuition plan, you’re going to have a hard time using those funds to enroll your child in the University of Texas.

Risk Management

529 programs are investment pools. You put your money into an accredited fund, and the funds managers take the pool of all investments and invest them in portfolios of stocks and bonds. While 2008 saw many 401(k) programs lose more than half of their value, most of those losses have been made back as of 2013. Stocks involve some element of risk, and most state-run fund programs are invested conservatively. Morningstar has ratings for 529 funds, with some of the highest rated being the T. Rowe Price College Savings Plan for Alaska, the Nevada 529 College Savings Plan, managed by Vanguard Investments. New York’s 529 College Savings program is highly rated, and New York has one of the most generous tax deductions for annual contributions.

Fees And Other Consideration

First, while your home state would like you to invest in their plan, there is no requirement that you do so. You can live in Vermont, invest in Alaska’s 529 plan, and send your children to the University of North Carolina without serious penalties. You will want to investigate roll-over limits (how often you can change the named beneficiary) and you’ll want to read the prospectus of the plan carefully to figure out their fee structure.

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