Sensible-Investor:

How to choose a 529 Plan for college savings -- not quite everything you need to know

For middle-class and a


book

This book (from a Sensible-Investor affiliate) examines 529 Plans in detail.

ffluent parents saving for their children’s college education, 529 college-savings plans were a valuable tax-reduction option even before they got a big boost from the 2001 tax-cut law. The overall advantages of these plans are clear, and  how to choose among the different states’ options is slowly becoming clearer too. The 2003 tax-cut law made the situation a bit more complex, but 529 plans retained their edge over other savings options.

The plans, which are authorized under Section 529 of the federal Internal Revenue Code, are established by individual states. All 50 states have set up one -- or several -- hiring money managers including Fidelity, Vanguard, TIAA and Merrill Lynch to run them. Many 529 plans welcome non-residents and allow contributions to be used toward out-of-state college tuition and expenses.

Advantages of 529 plans

1. Although contributions aren’t tax-deductible (at least not on federal tax returns), earnings grow tax-free. Starting with passage of the 2001 federal tax law, withdrawals to pay for tuition or college expenses are free of federal income taxes, too.

2. Unlike Education IRAs, contributions to 529 Plans are not sharply limited. The maximum contribution, which differ from state to state, can be as much as $235,000.

3. Assets in 529 Plans don’t have a major impact on financial aid, in contrast to prepaid tuition plans (and Education IRAs). As Kiplinger’s Personal Finance notes, “Though Congress may eventually  change the rules, prepaid plans are treated more severely than savings plans under federal financial-aid formulas. Prepaid plans are considered a ‘resource’ that reduces a family's aid eligibility, dollar for dollar. Savings plans are treated as a parental asset, of which only 5.6% is considered available to cover college costs each year.”

Difficult choices

The financial planning community can’t come up with a simple set of recommendations about 529 Plans, because new ones keep popping up and because the advantages and disadvantages of a specific 529 Plan depends on which state you’re from, and what the state tax laws are. As a result, parents won’t yet find a comprehensive Web site that provides all the information an investor would want to know before choosing a 529 plan. Here are some Web sites that come closest to that goal.

Saving for College with 529 Plans*. This site provides the most bookcomprehensive ratings of 529 Plans, based on the book “The Best Way to Save for College” by Joseph F. Hurley, CPA. Each state plan gets a "one-cap" to "five-cap" rating based on an evaluation of its overall usefulness and flexibility, but (wisely) not on past investment performance. The site does list the plans’ quarterly investment results, however, plus an extensive list of articles on various topics related to saving for college. (* Sensible-Investor is a partner of the SavingForCollege site and receives a percentage of any purchase by visitors who arrive via the link above. That link goes to  SavingForCollege’s online store -- from there, follow the links at the bottom of the page to get to the SavingForCollege home page and the site’s abundance of useful information.)

Morningstar Inc. Now that the Morningstar investment research firm has expanded from mutual funds into 529 plans, parents will benefit from its reliable data and usually reliable advice. The site includes commentary about how to choose a plan and extensive data about each state's offerings. Sortable charts show each plan's investment limits, investment management company, total assets, fees and expense ratios, state tax status, and other useful information. But pay no attention to Morningstar’s references to its four- and five-star funds -- those ratings of funds' past performance aren’t a reliable predictor of future returns.

College Savings Plan Network. No value judgments here. This network, created by the National Association of State Treasurers, provides an overview of states’ 529 Plans (which it labels simply “savings plans”) and prepaid tuition plans (also authorized by Section 529, but

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a completely different type of program). The site also provides links to each plan’s Web site.

A strategy for choosing

Kiplinger's magazine has two recommendations to help parents sort through the daunting range of 529 Plans:

1. Maybe stay at home. Stick with your own state's plan if state income taxes are high and you can deduct 529 Plan contributions, as in New York and Michigan. The SavingForCollege.com site lists each state's laws on state-tax-deductible or non-deductible contributions and on state-tax-exempt or non-exempt withdrawals.

2. Four good ones. If you're looking out of state, Kiplinger's suggests the following four 529 Plans as strong possibilities to consider, because they offer a healthy combination of flexible investment options, appropriate risk management, and low expenses. 

  • Kansas Learning Quest Education Savings Program.
  • College Savings Plan of Nebraska.
  • New York's College Savings Program.
  • Utah Educational Savings Plan Trust.

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