How to evaluate 529 plans
Dear Joe, My husband and I want to start 529 plans for our two boys. How do you decide which plan to choose? I am not very financially savvy and am unclear what to look for and what types of questions to ask. Thanks for your help. -- Jennifer
The first decision you must make in selecting a 529 plan is whether to do the research on your own or seek the recommendation of a financial professional.
A large number of parents and grandparents, who are not confident in their own investment skills, who desire help in integrating their college planning with retirement and estate planning, or who simply do not want to devote the time necessary to conduct a thorough search, will decide to pay for professional assistance.
The professionals and plan types
Investment professionals generally fall into two categories: brokers who earn commissions on the sale of 529 plans and other investment products, and fee-based financial planners who typically charge on an hourly basis when it comes to 529 plans. Of the largest 529 plans, in terms of total assets, many are exclusively broker-sold.
You can reduce the expense involved in choosing and investing in a 529 plan, but not necessarily guarantee better results, if you search for a direct-sold (i.e., nonbroker) 529 plan on your own. If you decide on this approach, my suggestion is to begin by looking at the 529 plan offered in your own state, because special incentives might be available to residents.
For example, 27 states currently offer a state income tax deduction or credit for contributions made to their own 529 plans. However, none of these states allows for deducting contributions made to out-of-state 529 plans. This will change in 2007 when two states, Maine and Kansas, provide their residents with tax deductions for contributions to out-of-state 529 plans. Several other states are considering similar legislation.
In addition to a state income tax incentive, other benefits may be attached to your home-state 529 plan. Look for matching contribution programs, scholarships, special asset protections, state financial aid preferences, and fee and expense waivers. A few 529 plans even allow your child to lock in resident tuition status at the state's public university system.
Once you gain a thorough understanding of your home-state 529 plan, investigate the 529 plans offered by other states. Details of all the direct-sold plans, along with links to official Web sites, can be found in Savingforcollege.com's 529 plan comparison tool, powered by savingforcollege.com.
What to look for:
• Review the eligibility requirements. Some direct-sold 529 savings plans, and nearly all prepaid tuition plans, are off-limits to those who do not meet state residency requirements.
• Make sure you can meet the minimum contribution requirements. Most 529 plans will waive the required minimum contribution if you sign up for the automatic investment plan through bank transfers or payroll deductions. You should not be as concerned with the maximum contribution limits, as most 529 plans accept well over $200,000 per beneficiary.
• Evaluate the available investment options and be sure the program offers at least one option that meets your own investment objectives. Part of this evaluation involves an assessment of the quality and the mix of underlying mutual funds. Consider past performance, fund-expense ratios and asset allocations (the mix between stocks, bonds, money market investments and other asset classes). Like many 529 investors, you may decide to go with the age-based or enrollment-based option. These options reduce market risk by automatically shifting assets away from stocks and into fixed-income and money market investments as your child gets closer to college age.
• Compare program management fees and account maintenance fees. These are the fees typically charged by 529 plans above and beyond the underlying mutual fund expenses. Any fund-level or program-level expense will obviously reduce your returns. Some 529 plans will waive the account maintenance fees if you sign up for automatic contributions.
• Check for other limitations. These may include age or account-duration limits, restrictions against nonowner contributions or changes of account ownership, or lack of online access to your account.
Most importantly, don't let the process of comparing 529 plans prevent you from getting started with your college savings. If you decide later on that a different 529 plan is best for you, you'll be able to change 529 plans as often as once every 12 months and even more frequently if you are willing to switch your children around as beneficiaries.