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The Ins and Outs of 529 Plans

By Harold Simansky
Educational Investment Advisor

529 Savings Plans are among the most popular options for families wishing to build a college fund for their children. What’s really nice about these state-created investment accounts is that they can be used at virtually any college or university in the country. But nobody will tell you it’s easy to get started. The main reason? There are so many 529 plans out there! Almost every state offers at least one, and each has its own slightly different rules and requirements. Choosing among them has unfortunately become a confusing and cumbersome affair. Be forewarned that you’ll have to do some homework, but here are some tips to make the process a lot more comprehensible.

Tip #1: Start by looking close to home.

Your own state's plan may offer some advantages that out-of-state plans do not. The answers to these three questions will tell you if this is the case.

  1. Does my state offer any state tax deduction for choosing its 529 Plan?
  2. Does my state offer any matching grant programs for contributions and do I qualify?
  3. Does my state penalize residents for investing in another state's 529 Plan?

You can get the answers to these questions by calling the office of your state treasurer or the financial service company that handles your state's 529 Plan. If the answer to any of the three questions is “yes,” it is highly recommended you choose your own state's plan because it offers you advantages no other plan can. If all three answers are “no,” you are free to consider the plans available in other states.

On the other hand, if all three answers are “no,” you’ll want to check out plans sponsored by other states. This is the case for residents of Massachusetts. There is absolutely no financial advantage or tax savings to be gained through the high-fee, state-sponsored plan called the U.Fund, which is offered by Fidelity Investments. If your own state plan offers no advantages, the next important factor in choosing a plan is fees.

Tip #2: Focus on fees.

Many people choose a fund based mainly on its performance, but this is not the best strategy. It is far more worthwhile to look at the fees each charges, with a bias toward low-fee funds.

Here’s why. Although performance over time is an extremely important consideration, it is impossible to predict. More often than not, high-performing funds one year will disappoint the next, and vice versa. Over time, nearly all funds will under-perform a comparable index fund. You’ll be far better off choosing an index fund and finding one with low fees.

Here are four of the most common fees you will see:

Load/Sales Fee

This is a charge paid on every dollar invested and is generally computed as a percentage (usually two to five percent). You regularly see such fees with broker- or insurance agent-sold plans.

Enrollment/One-Time Fee

This is a fee charged when an initial investment is made and is generally a standard dollar amount.

Annual Fee

This is a fee you pay once a year and is generally a standard dollar amount.

Annual Expense Ratio

This is a fee you pay to own a mutual fund and is generally computed as a percentage of assets under management.

To see how the fees of the plan you are considering compare to two of the lowest cost plans – Iowa and Minnesota – complete the matrix below. (You should be able to easily get the information about the plan you are considering by calling the plan's toll-free number.)

 

State Plan You Are Considering

Iowa State Plan

Minnesota State Plan

Fund Manager

  Vanguard / Upromise TIAA-CREF

Load/Sales Fee

  $0 $0

Enrollment/One-Time Fee

  $0 $0

Annual Fee

  $0 $0

Annual Expense Ratio

  0.62% 0.65%

As this illustrates, by choosing the correct plan you can avoid the first three fees altogether and keep the fourth one very small. And this should be your goal when choosing a 529 Plan - low fees!

Tip #3: Be absolutely sure!

For most people, a 529 Savings Plan is going to make the most sense. But there are certain conditions under which it doesn't make good sense. It won't be the right choice if:

  • You are not adequately invested for retirement. You can borrow for college, but not retirement.
  • You are considering a private primary or secondary school. Only a Coverdell Education Savings Account will provide tax benefits for private primary and secondary schools. A 529 Plan does not.
  • Other people will fund a 529 Plan for your student. A plan owned by a grandparent is more beneficial from a financial aid perspective than a parent-owned plan. This is a particularly good choice if the grandparent lives in a state that offers a tax break for choosing the state plan.
  • You think you might need the money for other things. If you use the money for anything but education, there’s a 10 percent penalty.

While saving for education can be confusing, choosing from among the various 529 Savings Plans out there can be downright mind-numbing. Rather than feeling paralyzed, methodically answer some of the questions that have been outlined above and choose a plan that is right for you. For most people, a 529 Savings Plan (offered by a low-fee provider) is going to make the most sense. But remember it only helps once you’ve actually put some money into it. So get going and start saving!

Article #5 -
Which Plan is Best for You?


About the Author

Harold Simansky is the founder of Educational Investments, LLC, (www.educationalinvestments.com) a Registered Investment Advisory firm focused on helping families save for education. His book, College Costs How Much?! The Workbook to Help You Save for School, which explains the financial aid process, is available at www.CollegeCostsHowMuch.com. You can send him an e-mail at Harold@edinv.com.




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