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It’s hard to believe, but my four-year-old daughter is gearing up for yet another stint at the local preschool. And next year at this time, I’ll be dropping her off at a bona-fide elementary school!
So, yes, I’m painfully aware of how quickly time goes by … and there’s already a small — okay, a very large — part of me that’s dreading the day my little Vela goes off to college.
I say that not just because I’ll miss having her around the house all the time … but also because of how outrageous the bills are likely to be then, too!
In fact, if you want to see a truly parabolic chart, don’t bother looking back at the Nasdaq in 1999 or Las Vegas real estate prices in 2005. Instead, just plot out the average price of a four-year college degree over the last decade!
Heck, the College Board says tuition for in-state attendees of public four-year colleges jumped an astonishing 7.9 percent last year!
And this is during a time of widespread economic weakness and massive unemployment? No wonder we call them “higher education costs!”
In past columns I have made it pretty well known that I don’t believe the outlay is necessarily worth it anymore. But I will save a follow-up on that subject for another day.
Because, admittedly, I am still socking money away for Vela’s college education should she ultimately decide that’s the path she wants to take.
And with the back-to-school season in full swing, I wanted to take some time right now to talk about the most popular college savings vehicle around — the 529 Plan.
Save on Your Taxes Now …
And Pay for College Later!
A 529 plan is a tax-advantaged savings plan designed to help you save for a child’s future college costs. They are issued by individual states, either directly or through brokers. And since they were added to the Internal Revenue Code in 1996 they’ve become an extremely popular choice.
Essentially, there are two types of 529 plans — prepaid tuition plans and college savings plans.
As their names suggest, prepaid plans lock in today’s tuition prices at eligible public and private colleges and universities. Many of these plans are guaranteed or backed by the issuing state, and the owner or beneficiary typically has to reside in the state.
The way I see it, prepaid plans are great if you’re fairly certain that a beneficiary is going to attend a particular school (or if you’re going to choose for them!). They might also be good for “belt and suspenders” types who want a rock solid guarantee.
In contrast, regular 529 college savings plans are more like tax-deferred retirement accounts. They don’t lock-in college costs, but they allow you to sock away large amounts of money — some allow hundreds of thousands in contributions. Typically, you are then able to choose from a set menu of investments such as broad-based mutual funds.
Unlike a corporate retirement account, however, you can choose what plan you want to join.
Here Are Your Three Biggest Considerations
When Selecting a 529 Plan …
#1. Fees — It’s true of nearly any investment account: The fees you pay are going to greatly affect your portfolio’s performance. And despite recent crackdowns on egregious fees at some 529 plans, you can still find better and worse deals. A general rule to follow is that you will likely pay more in fees and charges when you purchase through most brokerages than you would with a similar plan purchased directly.
#2. Investment Options — As you probably know, the quality of mutual funds varies greatly. Not just because of the fees they charge, but also because of their management and focuses. In general, I favor low-cost index funds, especially in long-term accounts such as a 529. Please note that — based on recent tuition growth — you’ll need an annual return of AT LEAST 6 percent just to keep pace … and a few percentage points more if you want to gain any ground. That argues for a more aggressive asset allocation.
#3. Tax Treatment — All 529 plans are treated the same way for Federal tax purposes — no upfront deduction, but your investment earnings grow tax-deferred and withdrawals for qualified education expenses are tax-free.
However, each state has individual rules about how it treats your contributions. Many allow upfront deductions with generous limits, but you will often need to choose your home state’s plan. A few states allow deductions no matter what plan you contribute to. And some states don’t offer a tax break at all!
If you’re getting the idea that choosing the right 529 plan is a highly individual choice, you’re right.
But I suggest you get started by investigating your home state’s treatment of contributions and the plans it offers. Then, if you’re not going to get a tax break, look at other low-cost plans next.
One Other Advantage of 529 Plans? Total Control …
Look, in the end, there’s very little we can do about soaring college costs. But we CAN control how we deal with them.
That’s why I recommend starting to save early and often through the best plans available.
And what’s especially nice about 529 plans is that they always remain the property of the account owner and NOT the account beneficiary.
That means YOU remain in control of whether or not to release the funds for the intended recipient, regardless of age, college acceptance, or other factors.
Most plans will let you easily transfer the plan to cover another recipient (practically any family member).
Alternatively, you can withdraw the funds and use them for something else. You’d just need to pay income tax and a 10 percent penalty on any earnings that have accumulated.
In the end, I definitely think it’s worth having real heart-to-hearts with our children and grandchildren about whether college represents a good return on investment for their particular needs, aptitudes, and interests.
However, I also realize that, practically speaking, there’s no way to delay preparing until children are old enough to have those conversations.
So that’s why if there’s even a small chance that someone in your family will attend college — and you want to pitch in some money to help them go — there’s probably no better time to get started than today.
Best wishes,
Nilus
{ 1 comment… read it below or add one }
Nilus, thanks for the info but a couple of considerations. There are fees that eat at your principle, even low cost providers like Fidelity charge .5-1% depending on where you have the money. Even Fidelity has limited options on where you can put the money, either a stock/bond fund or bankfund or money market. Heres the problem with the 529 and being a Martin fan at the same time. I am not as negative as Martin but I do only have 40% of my portfolio in stocks, the rest is in a little gold ,goverment notes and bank CD,s. If you believe a crash is coming sometime in the next few years then having the college money in a stock fund paying fees and lose it all when the crash comes . What is the use of the tax exemption when you are negative and to top it off cannot claim the loss? The other options are the bankfund and money market that yield 0% and with fees can lose money also(Fidelity has waived fees in its money market this year ) . In a bull market with stock mutual funds giving you 10% returns it makes a lot of sense to open a 529 and let it ride for the next 15 years tax exempt, but if you believe a crash is coming a custodial account opened at a high ranking safe bank might be a more timely. Remember the first 800 dollars of interest are exempt in a custodial account . At least up to a couple months ago Hudson city was paying 21/2% for a five year cd, with the 800 dollar exemption thats means tax free. You also don’t have a 10% fee if you use it for something else, like a wedding or down payment on a house . Yes I know at 18 it’s their money and they can take a round the world trip, but hey if they are that irresponsible then they were not going to college anyway.