How to Choose the Best 529 Plan for You

529 plan rankings tend to be one size fits all. But, the 529 plan that is best for other people is not necessarily the best 529 plan for you. When choosing the best 529 college savings plan, the choice should be personalized to your family’s specific situation, such as your state of residence, your risk tolerance and your investment time horizon.

529 plans can also differ based on the choice of investment options. But, it doesn’t matter if a 529 plan offers six age-based investment options – such as conservative, moderate and aggressive portfolios based on passive index funds and actively-managed funds – so long as the 529 plan offers the particular age-based investment option you need.

Ultimately, your goal is to choose the 529 plan that maximizes the amount of money available to pay for college. This will reduce the amount of student loan debt and provide flexibility in college choice. However, there is often a tradeoff between 529 plan performance net of fees and state income tax breaks. The best 529 plans for you will depend on striking the right balance between the various options, based on the details of your family’s unique circumstances.

What is a 529 Plan?

A 529 plan is a specialized account for saving for educational expenses, especially college costs. Friends and family can give the gift of college by contributing to a child’s 529 plan.

529 plans have tax and financial aid advantages.

• Tax impact. Earnings in a 529 plan accumulate on a tax-deferred basis and distributions are tax-free if used to pay for qualified higher education expenses. 529 plans can also be used to save for K-12 tuition. Some states offer state income tax deductions and tax credits based on contributions to the state’s 529 plan.

• Financial aid impact. If a 529 plan is owned by the student or the student’s parent, the 529 plan is reported as a parent asset on the Free Application for Federal Student Aid (FAFSA). This reduces the student’s eligibility for need-based financial aid by at most 5.64% of the asset value. In contrast, if the 529 plan is owned by anybody else, it is not reported as an asset on the FAFSA, but distributions count as untaxed income to the beneficiary, reducing aid eligibility by as much as half of the distribution amount.

529 plans are invested in a mix of stock and bond mutual funds, including ones that shift the mix of investments according to the child’s age and the number of years until college matriculation. The age-based investment glide paths use a more aggressive mix of investments (a higher percentage invested in stocks) when the child is young and become more conservative as college years approach.

A 529 plan has only one beneficiary. The account owner of a 529 plan can change the beneficiary to a family member of the original beneficiary. So, one could theoretically use a single 529 plan for multiple children. However, in practice it is best to have separate 529 plans for each child, so that one can customize the asset allocation according to each child’s investment time horizon. Having separate 529 plans per child may also yield greater state income tax benefits, if the state is one of the 18 states that provide a state income tax break with limits per beneficiary as opposed to limits per taxpayer.

There are no annual contribution limits for 529 plans, other than gift tax considerations. There is a cumulative contribution limit based on the highest cost of college in the state, ranging from $235,000 to $529,000.

Criteria for Picking the Best 529 Plan

Thus, the criteria for choosing the best 529 plan may vary depending on the details of the state 529 plans and the family’s needs. Some of the most important criteria for choosing a 529 plan include:

• Performance. What is the annual return on investment for the 529 plan?

• Cost. What fees are charged by the 529 plan, both sales charges and the asset-based expense ratio? Look at the 529 plan fee study.

• Direct-Sold vs. Advisor-Sold 529 plans. Direct-sold 529 plans tend to charge lower fees than advisor-sold 529 plans. Direct-sold 529 plans do not charge sales commissions, while some advisor-sold 529 plans do. For example, advisor-sold 529 plans offer several share classes, with Class A shares charging a sales commission and lower annual expense ratios while Class C shares don’t charge a sales load but have higher annual expense ratios.

• Tax Benefits. Earnings in a 529 plan accumulate on a tax-deferred basis. Distributions from a 529 plan are tax-free if used to pay for qualified higher education expenses. Contributions to a 529 plan can avoid gift taxes and provide estate planning benefits. In addition to these tax breaks, more than two-thirds of the states provide state residents with a state income tax deduction or tax credit based on contributions to the state’s 529 plan, depending on the state. Seven states provide the state income tax break for contributions to any state’s 529 plan (Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana and Pennsylvania). Not every state offers a state income tax break on contributions to the state’s 529 plan. Nine states don’t have a state income tax (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming) and seven states have a state income tax but don’t offer a state income tax deduction or tax credit (California, Delaware, Hawaii, Kentucky, Maine, New Jersey and North Carolina).

• Investment Options. 529 plans offer a limited selection of investment options. The choice of investment options varies by 529 plan. Some 529 plans offer static and multi-fund portfolios based on passive index funds, while others offer portfolios based on actively-managed funds. Some 529 plans offer FDIC-insured investment options. Some 529 plans offer exchange-traded funds (ETFs). Some 529 plans offer more than one age-based investment option, differentiated by risk tolerance.

• Minimum Contributions. The minimum contribution in some states can be as high as $250 to $3,000 (e.g., Alaska, Arizona, Indiana, Montana, Nevada, New Jersey, Ohio, South Dakota, and West Virginia). In other states, the minimum contribution is as low as $15 or $25 per month in an automatic investment plan.

These criteria for selecting the best 529 plan may lead to tradeoffs, where a superior rating along one dimension may correspond to an inferior rating along another dimension.

For example, there is a tradeoff between return on investment and fees. The 529 plans with the best return on investment may not necessarily have the lowest fees, or vice versa, so one has to evaluate the net return on investment after subtracting the fees. The net return on investment can vary depending on the investment time horizon, since a longer investment time horizon is necessary for a lower annual expense ratio to cover the cost of the sales load.

The benefits of a 529 plan may differ for in-state and out-of-state investors in the 529 plan. For example, there may be a tradeoff between lower fees in an out-of-state 529 plan and a state income tax break for an in-state 529 plan. The tradeoff may vary depending on the number of years until the student enrolls in college, reaching an inflection point around the time the student starts high school. Some 529 plans may provide seed contributions, matching contributions and lower fees for state residents.

How to Pick the Best 529 Plan

Families can invest in almost any state’s 529 plan, regardless of whether they are a state resident or not. 529 plans can be used to pay for any accredited college in the U.S. and more than 400 approved foreign colleges. Most states offer several 529 plans, including a direct-sold 529 plan and perhaps one or more advisor-sold 529 plans. So, each family will have to choose the 529 plan that is best for them.

To pick the best 529 plan for you:

• Start by considering your home state’s direct-sold 529 plan, if your state offers a state income tax break and other benefits for state residents.
• Also consider the direct-sold 529 plans of low-fee states and the 529 plans with the top overall ratings.
• Filter the list of 529 plans based on whether each 529 plan offers the investment options you need. More than two-thirds of families choose an age-based investment option.
• Also filter the list of 529 plans based on whether you can satisfy the minimum contribution requirements.
• Among the remaining 529 plans, prefer your home state’s 529 plan if the fees are less than 0.50% or if your state offers a state income tax break and your child is in high school.
• Otherwise, prefer the 529 plan with the best combination of high return on investment and low fees.

Savingforcollege.com provides a 529 plan comparison tool that has detailed data on all the state 529 plans. This can help you identify the best 529 plans. You can also review a detailed profile of each state’s 529 plans.

The Best 529 Plans

Both Savingforcollege.com and Morningstar periodically rate the best 529 plans. The best 529 plans for each are shown in this table.

Morningstar does not consider state tax breaks in its ratings, while Savingforcollege.com has separate ratings for state residents and non-residents. All of the best 529 plans listed for Savingforcollege.com have a 5-cap rating for residents and a 4.5 or 5-cap rating for non-residents and are sorted by combined raw scores for performance and costs.

All of the top-rated best 529 plans for Savingforcollege.com have a state income tax break except for Alaska, which doesn’t have a state income tax. For Morningstar, all of the best 529 plans but California have a state income tax break.

Note that past performance is not necessarily predictive of future performance.