Advice on Choosing a 529 College Savings Plan
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OK so you know you need to start saving for college now. Let’s try to radically simplify the process of picking a 529 plan. You can choose a plan in just three steps that will take you less than five minutes. After you pick your plan, enrolling might take a half hour or so.
1. First, check out the 529 plan in your state. More than half of states offer a state income-tax deduction or income-tax credit on residents’ contributions to their state’s own plans. This is the chief benefit of having so many plans to choose from – your state might offer an incentive to keep your money at home. The directory at savingforcollege.com is the best place to look up the specifics of your state’s plan and any incentives it may offer. If your state offers a tax break, it’s usually worth saving in your state’s plan in order to max out the tax deal. You remain free, however, to invest in any state plan. If your state doesn’t offer a tax break, there’s little benefit in choosing to stick with your own state’s plan.
2. Once you’ve chosen a state, you’ll have to pick between an investment plan and a prepaid plan.
- Prepaid Plans: As we mentioned in Section I, with these plans you pay for a year (or a portion of a year) of tuition ahead of time, effectively locking in the price.
The prepaid plan may sound enticing, but we think an investment plan is the better choice – especially for parents with younger children. One big problem with prepaid plans is that they generally only work for in-state, public universities.
If your kid ends up going someplace else, you can still get the money out. The problem is that the money you invested in the prepaid plan won’t have grown at anywhere near the rate it likely would have, had you put it in stock mutual funds in the investment plan. A prepaid plan grows at maybe a couple of percentage points a year – less than half of what a good collection of mutual funds would get over the same period. And really, how can you possibly know where your kid is going to want to go to school 10 or 20 years from now?
There is a way to prepay for private colleges, but it isn’t exactly the best of both worlds. It’s called the Independent 529 plan and it allows you to buy discounted chunks of private school tuition, years or decades ahead of when the account beneficiary will go to school. The problem is that not every private school in the country participates.
Prepaid plans make sense in one scenario: Let’s say your kids are in their teens, and all they’ve ever wanted to do is go to one of the great state universities nearby (or to a private school that participates in an Independent 529). Once you know that that’s what they want, then that’s the time to buy in, at today’s discounted rates. Then, you don’t have to worry about investment returns for, say, the next five or seven or nine years.
- Investment Plans: You’re in charge of your own investing fate with these funds. Start early, and get your asset allocation right, and your savings will grow into a healthy college fund.
If you decide to go this route, look for a state where the total program fees and fees for the mutual funds are lower than 0.75%. Fees can really eat into your returns and, if you start investing early, fees can really pile up. Again, you can search by state on savingforcollege.com to look up the fees.
Can’t be bothered to shop? Just use the Utah plan. We’re big fans of it, since fees are less than one half of one percentage point and Vanguard, a company that is generally very consumer-friendly, runs many of the mutual funds.
3. Once you’re in an investment account, you have to decide how to divide your money between stocks and bonds. One easy way: Invest in an age-based fund, which an increasing number of states offer. These funds may also be referred to as target-matriculation date funds. These funds create an investment mix of stocks, bonds, and other assets based on the date when your child will start college. The manager of the fund changes the mix so it gets more conservative as your kid gets close to college age. The advantage here is that you never have to tweak the mix yourself. We say a bit more about target date funds in our mutual fund guide.
OK - you’ve already done the hard work. Now here are three easy (and free!) ways to save some more:
1. Enlist the help of grandparents and other relatives.
In some states, they can contribute to the account you set up. In other states, they have to set up their own and name a child as a beneficiary (two siblings can’t share the same account).
2. Enroll in Upromise.
Upromise is a loyalty program: if you agree to shop online through its site (it redirects you to hundreds of other name-brand sites like Target and iTunes), you get a percentage of your purchase refunded. Then, you can move those refunds to a 529 plan (any plan you want, though it can be a bit easier if you’re in a 529 affiliated with Upromise ). You can also earn refunds based on where you eat out and what you buy at the grocery store. This costs nothing, and we can’t understand why every single person in the U.S. who has a child or grandchild isn’t enrolled.
3. Divert credit-card rewards into the 529 plan. Citibank has a card with Upromise, and American Express offers an especially lucrative card that puts 1.5% of every purchase into a Fidelity 529 (you have your choice of a few state plans, since Fidelity manages a handful of them on behalf of various states). True, frequent-flier miles offer more immediate gratification for credit-card shoppers. But those miles don’t earn returns the way money in a 529 fund would.
Honestly, just getting some money in a decent index fund or target-date fund before your kids start nursery school is our definition of success. Get started, get it mostly right, and focus in on the smaller details as your kids get older and the balances get bigger.
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The discussion on prepaid plans is weak and much of it regurgitates prehistoric thinking.
As we now see the stock markets decimated, those who followed the suggestions here ("The problem is that the money you invested in the prepaid plan won’t have grown at anywhere near the rate it likely would have, had you put it in stock mutual funds in the investment plan.") are now crying as most 529 mutual funds are down 25% to 50% in the past year alone. As a result of the financial crisis, we now have financial gurus coming out indicating that over the long-term, treasury bonds have outperformed the markets.
The benefit of the prepaid plans, the good ones, is that they are guaranteed to keep up with the pace of tuition inflation - which has been double the general inflation rate for many years now. Going forward, with the financial problems in the economy, many schools are going to be hiking tuition even further/faster. Those in prepaid plans for any length of time have hit a grand slam keeping their money out of mutual funds and the markets.
529 saving plans are simply another government/Wall St investment concoction to allow states, fund managers, and investment advisors the ability to make money off of the people who are looking to save money. For any student close to college, saving money in CDs instead of their 529 savings plan/mutual fund would have produced better results, even with state tax benefits considered.
The "one scenario" indicated when prepaid plans make sense is also off the mark. Many state prepaid plans are now charging premiums for buying in today - charging a fair amount more than the current tuition rates. If you have a teenager, it is probably too late to buy in and expect that what you pay today will be significantly less than what their tuition cost will be in a few years (there is no guarantee that your cost today will even be less). Additionally, some plans have stipulations preventing purchases past a certain point in time - five years before the money is needed in the one I am particularly knowledgable about. In this case, money needed for freshman year could not be contributed past the end of 7th grade.
As far as the child wanting to attend a school outside of the prepaid plan - this is where parents need to step in and tell their children where they will go to college. It doesn't need to be a specific school, but a set of choices that makes sense financially. A college education can be looked at, in essence, as a financial product. You need to consider how much investment you are going to make, what the margin/loan rate is that you're willing to pay on it versus buying it outright, and how much will that investment pay off in the future.
More than ever, we are seeing the articles questionng the value of attending one school over another. It is easy to google for horror stories of students attending top tier/expensive schools, having to finance a large portion, and end out in bankruptcy when they cannot get a job to cover their loans...and student loans cannot be forgiven in bankruptcy. Part of a parent's job is to educate their kids, and directing them to the right school to go to, one which can easily be afforded with minimal financing, if any, is probably the best a parent can do for their kids in getting them off on the right foot.
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I agree with Howard. After contributing to the Massachusetts 529 plan for more than 10 years for my two daughters, each account is currently worth about $5,000 less than the amount of total contributions. I am now switching to CDs in the Ohio Advantage plan. I realize that CDs don't have the potential upside of mutual funds, but at this point, I just want the certainty of knowing that I will have X dollars when the time comes to start paying those college bills (in about 6 years).
One thing that has baffled me is that most experts say that if you need your money in 5 years or less, you shouldn't have it invested in the stock market. Why then do many age-based 529s for near-college-age kids have large allocations to stocks? Makes no sense, and I'm sure those who got burned last year would agree.
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I strongly disagree that we should all think of a college education as a financial product. It certainly is an investment in the child's future, but not a product. After all, college graduates expect a return on their investment to be sure. However, to boil the entire college experience down to an ROI (return on investment) calculation seems at once clinical and cold.
I agree with the idea that parents should set realistic expectations with their kids about what the budget can handle versus the child's proclivity towards certain avenues of learning such as engineering, liberal arts or trade skills.
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