The College Board® says a year at a private four-year college, for tuition, room and board, now averages $35,636 and the same year at a public four-year college averages $15,213. The good news is that small amounts of money, if invested early, can become sizable investments through the remarkable power of compounding. For example, saving $200 per month at an 8 percent annual rate of return for a newborn child will accumulate to over $96,000 for college at 18 years old.
An increasingly popular choice is the 529 college savings plan, which bears the section number of the federal tax code from which it was created. These investment accounts aim to ease the financial burden by allowing withdrawals for college expenses to be made free of federal taxes. Each plan is sponsored by a state which can set its own guidelines, including offering state tax deductions or credits to residents.
Investors aren't limited to investing in their own state's plan. Then there are fees and tax breaks to consider with 529 plans. Add a mix of investment options that vary widely from plan to plan, and it can all get quite confusing.
Within an individual state plan, parents may face dozens of investing options, from conservative to moderate to aggressive portfolios, or selecting the mutual funds the account holds.
Many states, and the private investment managers that most hire to run their 529s, have responded with new options to shield college savings from the next crash. For example, Indiana just introduced an option that's FDIC-insured against losses, and earns a variable rate of interest.
You can enroll in plan on your own, or through a financial adviser at greater cost. With all the options, in many ways 529s have become more complex than 401(k)s, the workplace savings plans they're often compared to.
What to look for
When choosing a 529, consider:
- In state or out? Don't just sign up for your own state's plan, no questions asked. Many 529s are available no matter which state you call home. Find out what incentives your state offers beyond the federal tax perks. Uncle Sam extends to all plans. If your child isn't yet a teenager, choosing another state's plan with lower fees or better investment options may pay off over the long run. That's even if you miss any potential state tax advantage. If you're already in a plan but have second thoughts, you can roll the assets over into another 529, without penalty.
- Leave rebalancing to the pros? Most plans offer options where it's up to the investor to make any changes in the mix of investments the account holds. More popular are age-based 529s, similar to target-date retirement funds. They take a set-it-and-forget-it approach, automatically adjusting to fewer stock funds and more bonds over the years. With age-based 529s, the mix is typically more conservative and bond-oriented than with target-date funds. That's because a child has a relatively short span before college to recover from a stock market decline, compared with an adult saving for retirement. There's also less time for recovery in the few years a college student can expect to draw from the account, compared with the decades a retiree may need income.
- Bet big on stocks or small? Many 529s offer portfolios for different degrees of risk, but investors can only switch once a year. Yet one provider's aggressive portfolio may closely resemble another's conservative version. Vanguard, for example, doesn't include stocks in its three portfolios for beneficiaries who are 19 or older. At that point, the portfolios are entirely in bonds and short-term investments like money-market funds. Yet the plans in Georgia and Connecticut, run by TIAA-CREF, hold 20 to 30 percent in stocks for those 18 and older, depending on which portfolio the investor chooses.
- What's under the hood? To get a full picture, check what kind of stocks and bonds a plan holds, not just how much is in each asset category. One fund's stocks or bonds might be more volatile than another's — for example, one might hold more in emerging markets stocks offering strong growth potential, while another emphasizes steadier domestic, dividend-paying stocks. The plans hold multiple funds, so it's a research challenge.
|The road to a college degree is paved with money .... money that many families struggle to save. 529 Plans are one way to pay for qualified higher education expenses. Experts say 529 Plans offer parents a fairly simple way to save and often lower their tax bill.