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Study up for the best college-saving deal
Popular 529 plans are now offered in all 50 states, so shop around -- especially if you want to open more than one plan.
By Timothy Middleton
There's no better way to save for college than a 529 plan. And now that all 50 states have them, there's no better time to shop for the two or three best.
I'm due to become a grandfather in March, and I expect to open an account for that child in the NJBest 529 College Savings Plan. It's an excellent plan with a bonus for us New Jersey residents: a so-called scholarship worth $1,500 if the child attends college in the state.
About half the states offer some kind of incentive for their residents in their 529 plans. But most plans are unduly expensive or have other disadvantages, so most of us will benefit from opening multiple accounts.
In my case, my grandchild will qualify for that scholarship once I've put $3,200 into the plan. After that, I'll open a second account in a state with cheaper and better investment options. One candidate is Ohio's CollegeAdvantage Plan, where annual expenses are half the New Jersey level.
"Max out your benefit from that scholarship, but if you have more money to save for college, then other state programs can be compared on more of an apples-to-apples basis," says Joseph Hurley, chief executive of Savingforcollege.com.
If I pick Ohio for a second plan, it won't be because I expect my grandchild to attend school there. Aside from prepaid tuition plans and specific incentives for state residents, 529 plans are completely portable, with no restrictions on where parents live or students attend school.
Going national
Indeed, New Hampshire has the nation's fourth-largest plan -- 100 times the size of neighboring Vermont's -- only because the Granite State's investment manager, Fidelity Investments, markets the plan to investors nationwide.
These 529 plans have made other ways of saving for college obsolete. The original scheme was outright gifts made under the Uniform Gift to Minors Act. Then came the IRA-like Coverdell education savings accounts. But they have an annual limit of $2,000 and, as with gifts to minors, the money belongs to the kid when he grows up, whether or not he goes to college.
Funds in a 529 plan belong to the giver and can be reclaimed if desired, or necessary. Contribution limits are far more realistic; at least $250,000, in most states, and more than $300,000 in some. Earnings compound tax deferred, and escape taxes altogether if they're used for educational expenses. Contributions are deductible in some states.
When you open a 529 plan you designate a beneficiary -- mine will be that grandchild -- but you can subsequently change that to another family member if the first one decides not to go to college. Family members include cousins and nieces and nephews, not just children and grandchildren. You can become your own beneficiary if you decide to use the money to learn to paint (at an accredited school).
Contributions are considered a gift to that beneficiary, meaning if you put in more than $11,000 annually ($22,000 for a married couple), you could owe gift taxes. You can, however, pre-fund a plan by putting in five years' worth of contributions ($55,000 to $110,000) at once and making no further contributions until the sixth year.
In the Sunshine State
Most 529 plans allow the money to be spent at any accredited college or university, although some states have prepaid tuition plans strictly for their own schools. The prepayment option is very popular; Florida's plan has assets of more than $4 billion and is the nation's third-largest, according to College Savings Plans Network, an association of state treasurers.
For purposes of financial aid, assets in a 529 plan are treated as belonging to the parent or grandparent (or aunt or uncle) and don't weigh heavily against getting scholarships, grants and loans. Assets held by the child, such as accounts set up under the Uniform Gift to Minors Act, do weigh heavily.
Most 529 plans allow a variety of investment options, from all-equity to all-cash to age-based portfolios that become more conservative as the child approaches matriculation.
Many states offer plans that are sold only through brokers and use funds such as those of Putnam, Franklin Templeton and Merrill Lynch, which charge sales commissions. But if they do, most allow state residents to invest in the same funds without paying commissions.
Brokerage customers on average will pay about 1% a year more in expenses than direct investors in 529 plans. Expenses will total something above 2%, compared with about 1.2% for no-load investors.
The first place to look is at home. Utah, for example, allows residents to deduct as much as $2,940 in annual contributions from their state income tax. Also, beneficiaries of Utah plans who relocate out of state but return for their education are charged in-state tuition.
The options
If nothing else, states that use load-fund families to administer their 529 plans often allow their residents to buy no-load versions of the same funds. West Virginia's Smart529 plan, administered by Hartford Life Insurance, charges commissions on the broker-sold product, available nationally, but no commissions on the direct-sold plan, available only to residents.
My state, New Jersey, does that, too, and also offers the scholarship. My investment options aren't bad -- no-load versions of Franklin Templeton mutual funds. In the 12 months ended Sept. 30, the age-based option for young children returned more than 14%. Total fees, a combination of fund expenses and administrative charges, range between 0.85% and 1.28%.
These plans are long-term commitments, however, and as I've written before, long-term investments are best made in index funds, not the kind of actively managed funds offered by Franklin Templeton (and almost everybody else).
The reason is that today's managers could be gone in five years, and today's management company could be sold to a German insurance company that immediately hikes expenses. Index funds don't have that kind of manager and management risk.
So once I've captured the New Jersey scholarship, I'll put future contributions into another plan, probably Ohio's CollegeAdvantage plan. It offers Vanguard index funds such as 500 Index (VFINX) and Extended Market Index (VEXMX) and charges total expenses in the range of 0.39% to 0.53%.
Thrifty savings
A number of states offer plans with above-average choices for below-average cost. In Alaska, T. Rowe Price charges 0.8% or less. TIAA-CREF, an economical management company, handles plans for at least 11 states, including California, Michigan and Georgia. Vanguard is available in half a dozen states, including Colorado and New York.
Hurley's Web site, Savingforcollege.com, is the best place to begin researching these plans. State treasurers run a site called Collegesavings.org, and both have links to the sites of individual states.
Whatever you decide to do, start early and save hard. My state's Web site tells me that by the time my grandchild will be ready for college, four years at Rutgers University will cost $179,000. The average private school will cost $283,000.
No middle-class family can pay for that out of a cookie jar, let alone regular cash flow.
And if all your heirs turn into louts and drug addicts, 529 plans allow you to simply take your money back, paying taxes and a 10% penalty on the investment earnings. Better that than buying a new car for your granddaughter's boyfriend.
At the time of publication, Timothy Middleton didn't own any securities mentioned in this article.
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