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My daughter can’t stop talking about kindergarten.
That’s because, in just a few days, she’ll load up her first backpack … grab her first brown bag lunch … and take her very first bus ride alone.
And while the thought of her going off to college still seems so far away, I know it’s coming a lot sooner than I’d like.
I’m also certain it will COST a lot more than I’d like!
After all, college tuition rates continue to soar. So much so, in fact, that I think we’re witnessing a huge bubble in higher education … one that calls into question the very value proposition of getting a college degree at all.
At the same time, I want my daughter to have choices. So I’m saving and investing on her behalf for that rapidly-approaching day when she might decide to load up an entire car full of gear and head off to university.
If you’re looking to do the same for someone in your life, there are plenty of ways to go about it — including savings bonds and Coverdell accounts. But the most popular options are 529 savings plans. So I want to spend a little time discussing them today …
529 Plans 101
A 529 plan is a tax-advantaged savings plan designed to help you save for a child’s future college costs. They are issued by individual states, either directly or through brokers.
Essentially, there are two types of 529 plans — prepaid tuition plans and college savings plans.
As their names suggest, prepaid plans lock in today’s tuition prices at eligible public and private colleges and universities. Many of these plans are guaranteed or backed by the issuing state, and the owner or beneficiary typically has to reside in the state.
The way I see it, prepaid plans are great if you’re fairly certain that a beneficiary is going to attend a particular school (or if you’re going to choose for them!). They might also be good for “belt and suspenders” types who want a rock-solid guarantee.
In contrast, regular 529 college savings plans are more like tax-deferred retirement accounts. They don’t lock-in college costs, but they allow you to sock away large amounts of money — some allow hundreds of thousands in contributions. Typically, you are then able to choose from a set menu of investments such as broad-based mutual funds.
Unlike a corporate retirement account, however, you can choose what plan you want to join.
Three Big Things to Look At
When Selecting a 529 Plan …
#1. Fees — It’s true of nearly any investment account: The fees you pay are going to greatly affect your portfolio’s performance. And despite recent crackdowns on egregious fees at some 529 plans, you can still find better and worse deals.
A general rule to follow is that you will likely pay more in fees and charges when you purchase through most brokerages than you would with a similar plan purchased directly.
#2. Investment Options — As you probably know, the quality of mutual funds varies greatly. Not just because of the fees they charge, but also because of their management and focuses. In general, I favor low-cost index funds, especially in long-term accounts such as 529s.
Also please note that — based on recent tuition growth — you’ll need an annual return of AT LEAST six percent just to keep pace … and a few percentage points more if you want to gain any ground. That argues for a more aggressive asset allocation.
#3. Tax Treatment — All 529 plans are treated the same way for Federal tax purposes. You get no upfront deduction, but your investment earnings grow tax-deferred and withdrawals for qualified education expenses are tax-free.
However, each state has individual rules about how it treats your contributions. Many allow upfront deductions with generous limits, but you will often need to choose your home state’s plan. A few states allow deductions no matter what plan you contribute to. And some states don’t offer a tax break at all!
If you’re getting the idea that choosing the right 529 plan is a highly individual choice, you’re right.
But I suggest you get started by investigating your home state’s treatment of contributions and the plans it offers.
Then, if you’re not going to get a tax break, look at other low-cost plans next.
One Other Advantage of 529 Plans? Total Control …
What’s especially nice about 529 plans is that they always remain the property of the account owner and NOT the account beneficiary.
That means YOU remain in control of whether or not to release the funds for the intended recipient, regardless of age, college acceptance, or other factors.
Most plans will let you easily transfer the plan to cover another recipient (practically any family member).
Alternatively, you can withdraw the funds and use them for something else. You’d just need to pay income tax and a 10 percent penalty on any earnings that have accumulated.
In the end, I definitely think it’s worth having real heart-to-hearts with our children and grandchildren about whether college represents a good return on investment for their particular needs, aptitudes, and interests.
However, I also realize that, practically speaking, there’s no way to delay preparing until children are old enough to have those conversations.
So that’s why if there’s even a small chance that someone in your family will attend college — and you want to pitch in some money to help them go — there’s probably no better time to get started than today.
Best wishes,
Nilus
