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10 worst 529-plan blunders
Posted: 2009-08-28 - Erin Peterson is a freelance writer based in Minneapolis.
Saving for your child's education is one of the best investments you can make, and 529 college savings plans offer plenty of perks to make it an exceptionally attractive tool to do just that.
But like any investment, says Jane Bennett Clark, senior associate editor at Kiplinger's magazine, it's got its quirks. "They're not foolproof," she says. "You can make some mistakes."
We asked experts to share some of the common — and costly — errors people make when choosing, investing in, and withdrawing from 529 plans. Avoid these pitfalls and your 529 plan will help make getting an education just a bit easier.
Ignoring fees and expenses. There are a range of fees and other costs that come with investing. While they all may seem relatively minor — rarely rising above a few percentage points of your total investment — they add up over time. A $10,000 investment on your child's birth day will reap $39,246 by the time he or she is 18 years old, assuming an 8 percent return with 0.1 percent internal expenses. If expenses jump to 1.1 percent and all else remains the same, the return will dwindle to $32,746.
"That's free money you're just leaving on the table that could be spent on your child's education," says Brian Preston, a CFP for Preston & Cleveland Wealth Management in McDonough, Ga., and host of the Money Guy podcast. Look at all the fees — from brokers' commissions to annual maintenance fees to internal expenses — to see how they'll affect your returns over time.
Not considering your state's plans first. Every state offers 529 plans, and some are decidedly better than others. You're not required to use a plan from your state. However, if you reside in one of more than 30 states that offer a tax credit or deduction for 529 plans, you'll often come out ahead by using one of your own state's plans. If you live in one of the five states (Pennsylvania, Arizona, Maine, Kansas and Missouri) that offer tax parity, you can invest in any state's plan and still reap tax benefits. "People often don't take the tax benefits into consideration, but it's something you should take a close look at before you even consider going out of state," says Clark.
Forgetting to rebalance. Many 529 plans are age-based plans that rebalance automatically, but if you don't go that route, "set it and forget it" is not an option. "If you're managing your investment yourself, you've got to remember to revisit the investment," says Mary McConnell, director of college savings products at Charles Schwab. Annual rebalancing may be plenty; the goal is to start out with aggressive investments and ratchet down to more conservative investments over time. To prevent knee-jerk reactions to a volatile stock market, do your rebalancing at the same time each year, rather than when you see big jumps or declines in your portfolio.
Overly aggressive (or conservative) investing. Last year's stock market crash has knocked many formerly rational investors back on their heels. "A lot of people with newborns are so scared from last year that they're choosing stable-value funds, and that's a disaster," says Preston, noting that many investors will forgo thousands — and perhaps tens of thousands — of dollars of potential gains they could get with the more aggressive investments. If you have a decade or more before you make withdrawals, you have plenty of time to invest more heavily in stocks. Similarly, if college is in the near future, it's far too risky to have an all-equity portfolio. Your investment could make hefty gains, but the possibility that you could lose a big chunk of your investment with no time to make it up simply isn't worth the risk.
Sacrificing retirement for college savings. Parents want to offer their child the best possible opportunities, but if they fund a 529 plan before funding their retirement, they may be doing themselves — and their children — a big disservice. "It's been said many times: Your son or daughter can get a student loan, but a parent can't get a loan for retirement," Preston says. "You're going to help your children much more if you can ensure that you don't have to move into their basement once they get out their own. You want to be financially independent so you don't have to live off them down the road."
Failing to match expenses and withdrawals. You may know that your child's annual tuition and expenses will cost $25,000, but don't be too hasty in making withdrawals, says Clark. "You need to subtract scholarships and grants before you can apply the qualified education expenses," she says. "If you don't do that first, you may end up paying tax on the earnings because you didn't match them up right."
Dropping automatic investments in tough times. One of the smartest investment strategies is dollar cost averaging — automatically investing fixed amounts of money on a regular basis, such as monthly or quarterly. By investing a constant amount of money, regardless of the price of the share, you ensure that when prices are low, you buy more shares of an investment. When prices are high, you buy fewer with that same amount of money.
However, McConnell says, it's easy to want to stop investing when investments are doing poorly. Ironically, this is often when investments cost the least — and when you stand to gain the most. "While things like unemployment can affect funding for your long-term goals, we don't encourage clients to stop making contributions," she says. "Consider changing the amount you invest — it's better to invest a small amount sooner rather than waiting. And if you stop, remember that there are no penalties for starting up again."
Pulling money out before college. Steep losses can be discouraging for an investor, but you'll compound them if you pull money out of a 529 plan before your child enrolls in college. If you pull out the money and there have been gains, you'll face taxes on the earnings as well as a 10 percent penalty. "You don't want to lock in losses if you can help it," McConnell says. "Move to a portfolio that you feel more comfortable with and don't lose the opportunities you might otherwise have."
Assuming a scholarship renders 529 worthless. Your kid's a future football star, a violin virtuoso, or academic hotshot, so a full-ride scholarship is imminent and saving is pointless, right? Wrong, says Liz Weston, MSN Money columnist and author of "Easy Credit." Weston says, "Scholarships are not all they're cracked up to be. Full rides are rare, and it's not a good idea to count on your kid to make up for your mistakes." Save now and you'll have a backup plan if that scholarship doesn't pan out or isn't a full ride. Moreover, if your child's lucky enough to get his or her education paid for, transfer the account to a younger sibling, or consider using it for your own education. You can also withdraw the amount of the scholarship from the 529 plan without paying the 10 percent penalty — though you will have to pay taxes on the earnings.
Procrastinating because of investment complexities. The dizzying array of plans, costs, tax implications, and expenses can give anyone pause. But it's better to start investing now with a not-quite-perfect plan (which is easy to change later) than to avoid investing at all. "The biggest mistake you can make is not to save at all," says Clark. "A 529 plan is a great way to save, but if you put it off, you'll have to play catch-up. And with college so expensive these days, it's really important to start now with whatever you can manage."
Posted August 28, 2009