A 529 plan is a vehicle to save for future education expenses. Each state has its own 529 plan, but since there are no residency restrictions, an investor in Texas can sign up for the California-sponsored 529 plan, for example. With 50 different states to compare, an investor can face a challenge in picking the right plan. Because there are also no income limits and a wide-range of eligible education expenses, every person may be able to benefit in some way from a 529.
Pre-Paid Tuition Options
The first choice is what type of 529 plan is right for a given set of circumstances. Eleven states offer plans that are basically pre-paid tuition plans. A parent pays tuition at a given school in advance at today's price, rather than waiting to pay every year. Since tuition prices go up every year, this is an attractive option if a parent knows what school the student will attend. This can be tough to know with certainty though, since there are so many variables that go into which college someone ends up attending. Because of this, savings-based 529 plans are generally more popular options.
All 529 savings plans carry the same federal tax benefits. While there is no income tax deduction, savings grows tax-deferred and can pay for education expenses such as tuition, books, or a laptop tax-free. Because of the high cost of education, this can translate into substantial tax savings.
A key point of differentiation is state income tax treatment. Some states offer income tax deductions for using their state's 529 plan, which gives a saver a big financial incentive to use the local plan. Other states offer deductions for contributing to any 529 plan, so people living in those states can compare in other ways. Finally, some states don't have income tax at all. People in those states can also look outside their home state's plan for the best option.
Assuming that there isn't a tax advantage favoring one plan over another, another way to compare plans is on the investment choices they offer. A key consideration is the number of investment options, as a greater number of choices will mean more flexibility. In addition, the availability of target-date funds can also make investing easy. These funds are specifically designed to reduce risk as it gets closer to when the money is needed to pay for education. This increases the chance of savings being there when it is most needed.
Fees for the investments are also important. The lower the fee that a saver pays over time, the greater the return will be, all else equal. Also look at what level of fees the 529 will charge annually to have the account open. Again, lower is better.
Who Can Open an Account?
Another consideration is who can open the account. Some states have direct plans, which any individual can open. Others have plans that only a financial advisor can open. If an investor already works with an advisor, the later choice may be the better choice because of simplicity. However, if an investor does not have an advisor already, the direct plans make more sense.
Don't Choose Based on These Points
One metric that should not be used to judge between plans is the past performance of the investment choices. If an investment did well last year, there is no guarantee that it will do well again this year. In fact, there are studies indicating that the opposite may be true. A better way to select investments is to diversify and buy several different options instead of just the single option that did best last year.
Jessica Bosari is a freelance writer and blogger for various publications and her own blog. You can read more of Jessica's work here. If you have any comments or questions about SavingTools or about saving money, leave your comments in the form below or email firstname.lastname@example.org. Thanks!