How to Pick the Best 529 Plan For You
Many parents want to start saving for future educational expenses for their kids as soon as possible. One popular way to do so is through a 529 plan, otherwise known as a qualified tuition plan. A 529 plan allows parents to save for their kids’ school costs in a tax-advantaged account. However, there isn’t just one kind of 529 plan, and it can take some effort to find the right one for you.
Here’s our guide on how to figure out the best 529 plans for your unique situation:
The best 529 plans for you
When it comes to 529 plans, there are two main types you’ll need to consider:
Education savings plans
This type of account places your post-tax contributions in an investment portfolio that grows tax-free until the beneficiary is ready to enroll at any school, public or private. The funds can then be used for qualified expenses including tuition, fees, room and board.
There are several investment choices, from mutual funds and ETFs to principal-protected bank products, and strategies can vary as well. For example, you might choose an age-based investment strategy that works like a target-date fund, becoming increasingly less aggressive as your child gets closer to college age. As with any kind of investment plan, you can lose money if there is a downturn in the financial markets. You also can’t change your investment allocations whenever you want.
Education savings plans are run by states and managed by financial services companies, and they include varying degrees of investment flexibility. Broker-sold plans might include more choice but generally carry higher fees. These plans can go toward educational costs at the elementary and high school level as well, for up to $10,000 annually.
Prepaid tuition plans
This type of plan involves a large lump-sum payment (or a series of them) that will cover future tuition costs (not room, board and other fees) at participating colleges for today’s lower rates.
You can think of this kind of plan as a hedge against inflation. You aren’t given investment options, as you are for educational savings plans. Instead, the money is put into long-term investments by the programs, with the goal of meeting or exceeding expected tuition increases. If you live in one of the states offering these plans, you can prepay tuition at a specific school, or even target multiple public schools within your state.
Most of these plans have state residency requirements for the saver and beneficiary, and it’s possible you could lose the money you put in if the sponsor has a shortfall. The prepaid tuition may pay out less as well if the beneficiary doesn’t end up attending a participating college, although you can often transfer the funds to be used at other schools. However, your benefit may be a lot less if your child ends up attending an expensive private school rather than the state school you were planning for. That said, there are also private prepaid 529 plans available for participating institutions. Unlike with the traditional educational savings plan, you typically can’t use prepaid funds for future tuition at elementary or secondary schools.
Most states have at least one 529 plan offering, but you don’t have to just pick what’s available from where you live; you can pick an out-of-state plan as well. While this might complicate your choice, it also increases your freedom.
Construct your ideal 529 savings plan
It’s always best to consider what you want in a financial product before you start shopping around for it. This way, you know what you’re seeking.
So first, you will want to consider the different features of the savings and prepaid plans. A prepaid plan might be the best option for you, for example, if you are a bit less risk-averse, because you won’t be choosing a direct stock market investment plan. It also might make more sense if you think you have a good idea of where your child will ultimately go to school — say, the state school you attended, or your private school alma mater.
That, of course, can be close to impossible to predict, particularly when your child is just a baby. The prepaid option is also not as easy to get as the traditional educational savings plan, as there are fewer options overall.
Consider elements of the plans you are looking at, including:
- Income tax incentives for making contributions
- Proven track record of investment growth
- The fees charged
- Whether the plan is directly offered by the state, or whether it’s offered by an asset manager such as Vanguard or Fidelity, and whether the investment gains in an advisor-sold fund outweigh the potentially higher fees
- Whether the plan features an easy-to-use website with responsive customer service
- What special features the plan may offer
- The amount of the minimum required deposit
Here is more about some of the important features to consider in a 529 plan — specifically:
Best tax incentives
529 savings plans grow tax-free, and you will not have to pay taxes when you withdraw the money, as long as it goes toward the intended educational expenses.
You don’t get a federal tax deduction for a 529 plan, as you do for a 401(k) plan. However, depending on which state your plan originates, you may qualify for an income-tax deduction.
Several states offer tax credits, deductions or contributions to residents. And six states — Arizona, Kansas, Missouri, Minnesota, Montana and Pennsylvania — offer deductions even if you invest in another state’s plan, according to asset manager BlackRock.
Of course, those deductions are especially worthwhile if you live in a high-income-tax state. But if your state’s income taxes are low or nonexistent, or if your plan doesn’t offer attractive tax incentives, you might be better off prioritizing another state’s plan.
On the other hand, your state’s incentives could be too good to pass up. That might be the case, for example, if you’re a taxpayer in Indiana, which offers up to a $1,000 credit for $5,000 in contributions.
If you have other bank accounts, you already know the first rule about fees — it’s best to avoid them, or at least minimize them as much as possible. When you choose a 529 plan, it’s wise to minimize fees, and go in with your eyes open.
The two main types of 529 plans have different types of fees overall. For instance, a prepaid tuition plan might charge an enrollment/application fee, as well as regular administrative fees. Education savings plans may have more types of fees, as they include a wide array of investment options.
So along with the enrollment/application and account maintenance fees, you may pay program and asset management fees. Some of these will be collected by the plan’s state sponsor, and some are levied by the plan manager. Asset management fees will depend on what kind of investments you choose. If you use a broker, you may pay additional fees.
When you are looking at plans, make sure you have a full understanding of all the fees you’ll be expected to pay.
Best independent ratings
It can’t hurt to take a look at how experts rate a variety of 529 plans. Saving for College and Morningstar have ratings systems and do a lot of the research for you. Saving for College, for example, tracks the 10-year performance of plans. On Morningstar’s list, you can compare multiple plans rated by issuing state, which includes gold, silver, bronze and neutral. The featured plans might run the gamut from Virginia’s Invest29 plan to Nevada’s Vanguard option, to Ohio’s BlackRock College Advantage 29 offering.
Again, there are a lot of options to choose from, so you can look at this process in the same way as shopping from a very large catalog.
Don’t just take any rating list’s word for it, however. Review the methodology of any of these “best” lists to confirm the features you care about are taken into account.
Making the 529 plan choice
There are many features offered by different state plans that may help you make your 529 decision. For example, New York’s plan has a special feature called UGift. Ugift allows you to share a code for your child’s plan with family and friends, who can then make digital donations. You may find this more efficient (and less awkward) than having to ask potential donors to write out a check.
Other factors, large or small, could sway you toward or away from one of your top-choice plans. You might be blocked from picking one, for example, if you don’t have the cash to meet its minimum required deposit. Some plans ask you to fork over $1,000 to open the account. There are many factors to consider, so it pays to do your homework. You should know as well that it is possible to fund more than one 529 plan for one child, so you may not have to stick to only one option.
Getting started is the most important thing. Saving for college now could help you lessen your family’s reliance on federal or private student loans down the road. And choosing the right savings vehicle is also paramount. It could give your child a leg up when they’re ready to start their college career.
That said, it helps to know the pros and cons of 529 plans in general, so you can turn to our list here. You can also go here to read about five other options for paying for your kids’ education.