The 3 best 529 college savings plans
I generally dislike “best” lists, particularly when they rank colleges.
But when it comes to 529 college savings plans, some are clearly better than the rest, although you’ll have to vet an array of state tax incentives to see which plans offer the best aftertax savings for your family.
For years, I’ve been telling parents to save early and often in 529 plans. Offered by states, but managed by giant money management firms like Vanguard, iShares and T. Rowe Price, 529s allow you to pool money for college.
The best feature about 529 plans is that you can invest money and, in most cases, never pay taxes on earnings within the plans as long as withdrawn money is used for college-related expenses. You can cover room-and-board and even computers with 529 funds.
Within the plans, you’re offered mutual funds that invest in stocks, bonds and cash. You can either pick specific funds or “age-adjusted” portfolios that will automatically choose a group of funds for you.
The closer your child gets to college, the lower the stock-market risk in the age-adjusted portfolio. Managers select funds for you. That means a stock market shock as your child hits her teens shouldn’t significantly erode your balance.
I recommend the age-adjusted option for the vast majority of families because most of us choose badly when it comes to picking mutual funds and timing the stock or bond markets. That’s the route I took with the two 529 plans my family has funded.
You may even be offered tax breaks from your state for investing in your home-state plan. To see how plans stack up, use this comparison tool.
According to the College Savings Plan Network, 34 states and the District of Columbia offer either tax credits or deductions for investing in their programs. However, these tax breaks are why you should take the following “best” list with a grain of salt. The best possible plan for your family combines maximum tax breaks with low costs and solid management.
Of course, how much you can boost your aftertax contribution depends on your state’s tax incentive. Note: You won’t have any tax advantage if your state doesn’t have an income tax. So if you live in states like Texas or Florida, you have a greater reason to shop around.
But if your state does have one -- and it offers tax breaks for in-state 529s -- you can maximize your contribution. In Vermont, for example, you would reap $180 in tax savings for a $100 monthly contribution for two children. That’s for a couple making $100,000 and filing jointly, according to savingforcollege.com.
What else do you need to know?
First, check to see if a plan is “direct sold.” That means you can invest directly and not have to go through a broker-adviser, thus avoiding a commission. Overall plan expenses will be lower, meaning more of your money will be invested.
The three best 529 plans -- recently “gold” rated by Morningstar -- are all direct sold and low-cost, managed by large mutual fund companies. Here they are:
Of the 62 plans Morningstar analyzed, these programs were the cream of the crop because of best practices, solid management, state oversight and low costs. That doesn’t mean the “silver” or “bronze” plans aren’t worthwhile -- remember to check out state tax incentives as your first priority.
“In general,” said Morningstar analyst Leo Acheson, “the industry continues to take steps in the right direction, with a number of plans cutting fees, beefing up their asset-allocation resources and processes, or improving the quality of their investment lineups.”
That means you should look for plans that have low-expense funds with a broad choice of well-managed investments. That usually translates to passive, index funds within the plans, which offer the lowest total expenses.
While you can choose to invest in any plan from around the country -- you aren’t locked into your state’s plan -- look at the whole picture before you invest. And don’t get trapped into thinking that the plans with the best returns are going to repeat their stellar performance of last year.
One of the easiest questions to answer about 529 plans is when to invest in them: As early as possible. I opened up accounts for my two daughters when they were born. Although we weren’t able to contribute as much as we would have liked, the savings are going to cover a lot of expenses that we can’t cover out of pocket.
And what if you child doesn’t go to college? You can still use the funds for anything, including your own higher education. But if you withdraw the money for noneducational purposes, you’ll have to pay income tax it.
No matter which plan you choose, do the math to see how the potential power of tax breaks and low costs can add up. Ask your accountant to run some numbers, but start saving as soon as possible.