As summer winds down and we are all bombarded with ‘back to school’ information, I am reminded how fast time passes. Our oldest son is entering his last year of grade school and I find myself surprised at how quickly this has come. As we juggle financial priorities between life’s needs and wants, I reflect back on the choice my wife and I made in our son’s first year of life (and subsequently his brothers), to make a monthly investment in a 529 Plan for each of them. As tuition costs climb, saving early for education is one of the most important financial decisions parents can make. Tax-advantaged 529 savings plans, offered by states for almost 20 years, are now one of the most popular options for making sure school expenses will be covered when your child reaches college age.
What is a 529 Plan?
A 529 Plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for qualified educational expenses including tuition and books, and for students attending at least half time, room & board. Eligible institutions include most accredited colleges and graduate schools, including professional and trade schools. Foreign schools with attending students who receive federal financial aid also qualify. There are two types of 529 plans to consider:
- The Savings Plan
This is similar to a 401K or IRA, in that you invest in mutual funds or similar investments from well established companies such as Vanguard, BlackRock, TIAA-CERF and others. Plans usually offer several investment options and your account will increase or decrease based on the performance of the option(s) you select. Colorado’s Direct Portfolio College Savings Plan was ranked 8th in Saving For College’s 1-year performance rankings and 11th of 43 plans over the 5 & 10 year performance periods.
- Prepaid Plans
These plans let you pre-pay all or part of the costs of an in-state public college education, allowing you to lock in the current costs of tuition in place of future prices, which generally rise every year. There are a few drawbacks to the prepaid plans including the money put into this plan often may only be applied to tuition & fees at in-state public schools and may not included other expenses such as room, board and books.
The Cost of a Higher Education
In it’s most recent survey of college prices, the College Board reports that “A ‘moderate’ college budget for an in-state public college for the 2014–2015 academic year averaged $23,410. A moderate budget at a private college averaged $46,272.” Additionally data from the College Board shows that college prices have been rising approximately four percent annually (2.9% average at 4-year public universities & 3.7% a 4-year private colleges.)
If you look at an in-state school like CSU, the cost of tuition, room and board, books and other expenses for the 2014-15 school year was approximately $23,531. For a 4-year degree, with a 4% increase per year, you would be looking at a total cost of $99,923. That same education 18 years from now (if your child was just born) would cost $202,427 over a four year period.
529 Plan Benefits
The tax incentives of 529 college savings plans are the most obvious reason consider this type of college savings plan, but here are some of the many other benefits to keep in mind…
- While contributions are not deductible, earnings in a 529 plan grow federal tax-free and will not be taxed when the money is taken out to pay for college. In addition to the federal tax savings, 34 states, including the District of Columbia, currently offer residents a full or partial tax deduction or credit for 529 plan contributions.
- The account holder retains control of the funds regardless of the beneficiary’s age, so you can be assured the money will be used for its intended purpose.
- The beneficiary can be changed at any time to another member of the beneficiary’s family.
- As mentioned earlier, the funds can be used at any eligible institution in the country.
- Many states offer maximum contribution limits of $300,000 or more. Colorado’s limit is a $350,000 cumulative amount for all accounts for the same beneficiary.
- Assets within 529 plans are protected from bankruptcy.
Any U.S. citizen or resident alien at least 18 years or older can open a 529 account. Usually, the beneficiary is a child, grandchild or younger relative. However, an adult can also open a 529 plan to save for his or her own higher education costs; there are no age limits.
No two 529 plans are exactly alike and residents are not limited to investing in their own state’s plan. While in most cases, residents do choose an in-state plan, consider whether your state offers an income tax deduction (Colorado does). It usually makes the most financial sense to claim the tax deduction from your in-state program. There are two ways to invest in a 529 plan:
- Directly With the 529 Plan Manager
You can enroll directly with a plan through their websites. Here is a list of 529 plans by state.
- Through a Financial Advisor
If you decide to use an advisor-sold plan, keep in mind that you will be charged a fee for his or her assistance in managing your 529 account in addition to the cost of opening and investing in the plan itself.
529 Plan Fees
In addition to the money you deposit into your 529 plan, there are a number of other fees that apply to your account. The good news is that as a result of more competition for investment dollars and cheaper investment options, average fees for these plans have dropped dramatically over the past twelve years. In addition to an advisory fee (if you choose to use an advisor-sold plan), there are some additional charges to keep in mind when comparing plans.
- Total Asset-Based Fee
This fee includes the most significant expenses for direct plans, usually consisting of the plan managers fee, the portfolio’s underlying expenses and other administrative fees. If you’re comparing plans, this is the best number to use. Most plans will give you an estimate of the total asset-based fee of the various portfolios in their documentation.
- Program Management & Administrative Fees
Most 529 savings plans hire outside firms to manage the program and its investment portfolios. These firms receive a percentage of the assets as compensation for their services. The state agencies responsible for administering 529 plans will usually receive a share of this fee to cover their costs. In a few states, program management is done in-house through a state agency and not out-sourced to vendors.
- Underlying Investment Fees
This is the expense ratio of the mutual funds that most commonly make up a 529 plan’s portfolio. Passively-managed funds typically have a expense ratio below 0.15%, where as actively-managed funds, which are more common in advisor sold plans, have a higher expense ratio, sometimes greater than 1%.
- Account Maintenance Fee
Some 529 plans charge a minimal ($10-$25) quarterly or annual account maintenance fee. In some plans the fee is waived for in-state residents or account balances over a certain amount. In addition to maintenance fees,fees may be charged for items like returned checks or rollover requests.
A word of caution: This article is an introduction to 529 plans and is not all inclusive of the many factors your should consider before investing in a 529 plan. Below are some links to consider for further research. Remember, savings intentions and plans are suited to your specific life situation, and the tax laws are complicated. We strongly advise you to consider talking with your banker, tax consultant, or a financial advisor for the specific rules and implications to your decisions. If you are in need of some assistance, we are happy to recommend some professionals to help you!