Three Tips for Choosing a 529 College Savings Plan
Parents who want to save tax-free for their children’s college expenses are facing a growing array of choices. As of the end of last year, according to a Morningstar report, there were over 80 tax-free 529 college savings plans offered by 48 states. If you feel that a 529 plan is the best choice for you, how do you choose from among them? Here are three tips for making your decision.
First, as with all investment decisions, cost matters, especially over time. Plan costs primarily include program management fees as well as mutual fund annual expenses. Interestingly, Morningstar found that in most plans the fund expenses were higher than the expenses for the equivalent open-ended publicly traded funds. But that disadvantage has been decreasing over time, and is offset by the tax advantages of owning 529 plans. Morningstar rates 529 plans every year, primarily with an eye toward costs. You can find their latest report at http://news.morningstar.com/articlenet/article.aspx?id=570349.
Next, be aware that there are two types of plans: those that are direct sold – you can sign up yourself online – and those that are broker-sold. For the latter you pay a commission out of your contributions to the advisor recommending the plan, which makes them more expensive. Unless you need a lot of advice from your advisor on your 529 investments, we’d recommend sticking with the cheaper direct-sold plans.
Finally, you should decide what kind of investment strategy you’d like to follow. If you’d prefer to actively manage the assets in the account, you should choose a plan that offers high-quality funds across a broad range of asset classes (e.g. large cap U.S. stocks, small cap U.S. stocks, foreign stocks, U.S. treasury bonds, U.S. corporate bonds, foreign bonds, real estate, commodities, etc.). If the funds are publicly traded, so much the better – you’ll be able to track performance and get analyses through multiple sources. Keep in mind, though, that you are limited to changing your investments no more than once each calendar year.
If instead you’d prefer not to have to make any investment decisions, the best plan for you would be one that allows you to specify up front how to allocate your contributions across stocks, bonds, and cash in such a way as to match your own risk tolerance. Even better would be a plan that automatically adjusts those allocations to reduce risk as your child becomes older, again following a model with which you are comfortable. Most plans offer both capabilities, but the specific allocations are different. It’s important to select the one that’s right for you. You can find details of every 529 plan’s investment choices at http://www.savingforcollege.com (select Compare 529 Plans, All Types, Compare By Features, then click on all the investment choices).
The burden of paying for college keeps getting heavier as college cost increases continue to outpace inflation by a wide margin. Your primary goal, regardless of 529 plan chosen, should be to ensure you are generating a reasonable but safe return on your college savings funds.