He may be 46, but Bruce Sneed still remembers the faces of his mother and father the day he graduated from college, just as if it were yesterday. His dad was a master sergeant in the Air Force, his mom a homemaker, and Bruce—now a financial planner in Woodbridge, Virginia—was part of the first generation of his family to ever don a cap and gown. “They were just so proud,” he says, recalling the day he left undergrad life behind at St. Mary’s University in San Antonio. “It was their ultimate sense of accomplishment.”
That’s why when Bruce and his wife Ursula, look at their own children, they plan to be bursting with the same kind of pride. The couple is busy saving up for the education of their son Laurence, 8, and daughter Kendall, 4. They already have around $28,000 put aside for Laurence and $22,000 for Kendall. “Our goal as a family is to build on each generation and raise the bar a little bit higher,” Bruce says. His eldest son, Marques, 25, a graduate of Virginia’s Norfolk State University, entered college prior to 529 plans hitting his father’s radar.
Given the spiraling costs of higher education, it’s a good thing the Sneeds have a running start. In 2006, the average annual cost of tuition, room, and board at an in-state public university was $12,796 according The College Board. And at private universities? You don’t want to know. (Or if you really do, it’s $30,367.) That’s in addition to all the other daily expenses you’re shouldering, from the monthly mortgage to your own retirement kitty.
That’s why, to get within shouting distance of these figures, they would be well advised to consider one of the most popular college savings vehicles out there: The 529 plan. Thanks to tax-free earnings (just recently made permanent), expanding investment options, and burgeoning state tax benefits, 529s are getting more attractive all the time. “A 529 plan is to college savings what your 401(k) is to your retirement,” says Jacqueline Williams, chair of the College Savings Plans Network, which oversees state-sponsored plans around the country. “The two biggest concerns families have are saving for retirement and saving for their kids’ education. So the 529 is really critical.”
And they’re proving irresistible to fretful parents. There’s now more than $100 billion in total plan assets tucked away in some 9.5 million accounts nationwide, a 31% increase from 2006. Here’s how they work: Parents, grandparents, or anyone for that _matter, can set up a 529 account, usually under their names with the child as the beneficiary. They then make contributions—maybe every paycheck, or maybe once a year—and direct those funds into investments of their choice, depending on their risk tolerance. That money grows until the child reaches college age, whereupon it’s withdrawn to cover costs like tuition, room and board, and _textbooks.
The good news? Any earnings on that money, if used solely for educational purposes, are entirely tax-free. The better news? Recent tax law changes have removed the sunset provision which would have cancelled that tax-free status as of the end of 2010. And perhaps the best news of all? For your contributions, the majority of states serve up juicy tax breaks that can help enormously. So while contributions are made with after-tax money, unlike a 401(k), you will get some help on your annual state tax return. In New York, for instance, an individual can write off up to $5,000, a couple, up to $10,000. Heck, some states even chip in matching funds. It may not be a huge sum—Colorado, for instance, matches dollar-for-dollar up to $500 annually for lower- to _middle-income state residents. But hey, it’s free money.
To take full advantage of these provisions, though, you can’t delay saving too long. “Start as early as possible, and make it a part of your budget just like your mortgage or car payments,” says Kevin Pritchett, head of Kevin Pritchett & Associates Retirement Planning in Westchester, Illinois. “But not all 529 plans are the same, so you need to do your research.”
The State of Saving: Where to open a 529
Your plan isn’t at all constrained by where you live. A _California resident, for example, could invest in Utah’s 529, or Florida’s, or any other state’s plan. But tax deductibility and other benefits are almost always for in-state participants, so “first look to your own state’s plan,” suggests Williams. (Exceptions offering deductibility for out-of-state contributions include Kansas, Maine, and Pennsylvania.) Ideally, your state will boast a strong-performing roster of funds in its 529. But even if performance is only middling, it probably still makes sense to stick with it
Atlanta’s Sam and Kesia Hudson ended up opting for Georgia’s 529, because it made the most sense for them. First, it has racked up decent performance (its mutual funds are all rated three stars or higher by Morningstar) and is steered by respected firm TIAA-CREF. And second, Georgia offers a state income tax deduction for residents up to $2,000 per beneficiary. With two future college grads under their roof—daughter Sierra, 6, and son Sam, 4—they couldn’t pass that up. “These days, a 529 is pretty much mandatory, not even optional anymore,” says Sam, 37, an engineer. “But with the state tax deduction and only a small amount—$20 per week, per child—coming out of my paycheck every week, it’s worked out really well.”
If your state’s 529 doesn’t feature such nifty tax benefits, then feel free to start shopping around. At the popular information site Savingforcollege.com, you can peruse the relative performance of every state’s investment offerings. To help you narrow the search, mutual fund researcher Morningstar puts together an annual report of the nation’s 529s, which is available at Morningstar.com. Top performers in its most recent report: Colorado Scholars Choice, Maryland College Investment Plan, Nebraska College Savings, Utah Educational Savings, and Virginia CollegeAmerica.
Lagging as the worst, on the other hand, are the Alabama Higher Education 529, Alaska John Hancock Freedom 529, Missouri MOST 529 Advisor, Nebraska AIM College Saving, and two separate plans from West Virginia: Cornerstone SMART529 and Leaders SMART529. Typical reasons for the underper_formance include chunky management fees and _sluggish
Stocking Up: Picking the right investments
Once you choose your plan, then it’s time to figure out your ideal investments. In general, think of it as a miniature retirement plan: You’re going to need ready cash when your kid reaches college age, in about 16 years if you’re starting at birth. As such, start with a riskier equity-heavy portfolio when the student-to-be is still young and there’s plenty of time to get over any market slumps. Don’t get too conservative too early, or you could possibly miss out on higher returns of stocks. After all, you’ll need every little bit of appreciation.
Then as your child gets closer to college age, you can shift into safer investments like bonds or money market funds, which won’t tank just as your child is heading off to college. “The less time you have until your child goes to college, the less aggressive your portfolio should be,” says Pritchett. To make things simpler, most states offer an age-based fund option, which does the shifting automatically for you after you enter your child’s birth date, similar to target-date retirement funds, which have become the one-stop shopping option of the investment world.
If your needs or risk tolerance change, you can always change your investment selection once a year, notes Joe Hurley, founder and
CEO of Savingforcollege.com. But whatever fund options you choose, here’s a nice bonus: Competition is pitting every state’s 529 against every other one, and that’s working in your favor. Says Hurley: “Fees and expenses are significantly lower than where they used to be.” Some plans have cut their enrollment fees and lowered the fees charged for management expenses.
The Home Stretch: Tips on reaching the finish line
A few key strategies from the experts: If possible deal directly with 529 plan providers, such as—Vanguard or T. Rowe Price—rather than outside brokers who might charge commissions. Know that your 529 savings are not considered the student’s assets in calculations for grants and loans (another recent tax-law change, notes Hurley). Because it’s a parental resource, it won’t cripple your child’s ability to qualify for some forms of financial aid. “You’re not going to be penalized for saving,” says Williams of the College Savings Plan Network.
In addition, there are hard 529 maximums that you can’t surpass. The amount varies by state, but if the cap is say $250,000, then your contributions can’t exceed that. But if your 529 grows itself beyond that ceiling, then the total amount is still eligible for tax-free withdrawals.
Finally, don’t neglect your own future just so your kids will graduate debt-free. You have to be putting a little cash aside for your golden years at the same time; as the saying goes, you can borrow for school, but you can’t borrow for retirement. A handy rule of thumb: Plan to cover college costs with an equal mix of 529 funds, current income (including your kid’s part-time job), and financial aid. “Look at it that way, and it all becomes more achievable,” says Williams.
As for Bruce Sneed, he feels that those hefty college bills will be within striking distance when the time finally comes. He’s combining 529s with Coverdell Education Savings Accounts, Roth IRA-type vehicles that let you put away $2,000 a year for each child. Put all those savings together, and Bruce feels the educational futures of little Laurence and Kendall are pretty secure. “We want to help them as much as we can and keep them out of debt,” he says (he’s also thanking his lucky stars that his eldest son secured a track scholarship). “You can do it, but you need to live below your means, set aside what you can—and start early.”
Which Plan is Best?
There are two types of 529 plans. In addition to savings plans, many states also offer prepaid tuition plans that allow participants to purchase tuition credits, based on today’s rates, that are paid out when the beneficiary is in college. The tuition is based on the rates charged by in-state public colleges, so there are some
| Â | College Savings Plan | Prepaid Tuition Plan |
| College Costs | No preset target for college expenses | Protects against inflation by locking in tuition prices |
| Investment Options | Plans provide a variety of options | None |
| Covered Expenses | All qualified education expenses, such as tuition, room and board, fees, and books | Limited to tuition and mandatory fees; a limited number of plans provide additional coverage |
| Contribution Limit | Most plans permit contributions in excess of $200,000 | Payment schedule and limits are determined by plan’s contract |
| Investment Risk | Investment returns are not guaranteed | Typically guaranteed by the state |
| Tax Advantages | Earnings not subject to federal tax if used for qualified education expenses, many states offer state tax benefits | Withdrawals not subject to federal tax if used for qualified education expenses, many states offer state tax benefits |
| Penalties for non-qualified withdrawals | Withdrawals could be taxed as ordinary income, plus a 10% penalty on earnings | Withdrawals could be taxed as ordinary income, plus a 10% penalty |
—Evan Mynatt
529 Plan Resources
- College Savings Plans Network, www.collegesavings.org: An affiliate of the National Association of State Treasurers, this site offers details of the plans offered by all 50 states and the District of Columbia, including their investment strategy, risks, and fees.
- Investment Company Institute, www.ici.org: A Guide to Understanding 529 Plans is downloadable on the Investor Education Resources page of the site. The booklet provides a useful overview and includes a checklist of what to look for when searching for your college savings plan.
- Morningstar, www.morningstar.com: The Chicago-based mutual fund tracker provides an annual list of some of the nation’s best and worst 529 plans.
- FINRA, The Financial Industry Regulatory Authority, www.finra.org: Click on the Investor Information tab on the home page to find a link to the College Savings Center that includes a range of background material as well as a 529 college savings plan expense analyzer.
- Savingforcollege.com: Provides a wealth of information on 529 plans as well as other alternatives and investment tools. Site is run by Joseph Hurley, author of The Best Way to Save for College: A Complete Guide to 529 Plans (Savingforcollege.com L.L.C., $22.95).