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College Savings – 529 Plans

October 28, 2011

Now things get a little more complicated, but just a little.  And don’t worry.  That’s why I’m here – to remove the complication, and leave you with answers.  We’ve already addressed Prepaid Tuition and the Coverdell ESA.  Today we close up with 529s.

529s are named after the equally numbered IRS code that allows for these plans.  They are savings plans developed by state governments or institutions to provide a tax-advantaged savings vehicle for higher education.  They are similar to ESAs in that they provide for tax-free disbursements for qualified higher education expenses, but there are a few differences…

The ESA would be my first choice if you qualify, but a 529 is a close 2nd.  Because 529s are offered by all 50 states, there can be a little confusion when choosing one.  Here are a few FAQs to help out:

1.  Do I have to invest in my resident state’s plan?

No.  You can invest in any state’s plan.  If your state has income tax, there is typically a tax-benefit for investing in your own state.  However, if you live in Florida, the choice is yours.  No state income tax means there’s no benefit for staying in-state.  Choose whatever plan you want.

2.  Does my child have to go to school in the state of the plan I choose? 

No.  Almost every college or university is eligible, regardless of what plan you choose.  So you can live in Florida, invest in Utah, and go to school in Connecticut.

3.  Who manages my money?

The state’s treasurer is ultimately responsible, but each state usually offers mutual funds from a respected investment firm, such as Vanguard, Schwab, T. Rowe Price, etc.

4.  If all 50 states offer plans (many more than one), how do I choose?

First, be sure to invest in a DIRECT plan, meaning you as the consumer are investing directly –  not going through a broker, therefore not paying additional fees.  Secondly, each state’s fees vary, so choose a state with low fees and good investment options.  There are a number of “rankings” out there, but the states that seem to consistently be at the top of the list are as follows (in no particular order)…

Utah, Virginia, Kansas, New York, Iowa, Nevada, Ohio.

5.  How do I decide which funds to invest in?

Many states provide an age-based option that will invest appropriately based on your child’s age.  For example, if you child is 16 with just one more year before college, you don’t want to be in 100% stocks.  If we experienced a market crash like we did a few months ago, your investment would take a significant hit.  However, if you’re opening an account and your child is 3, you can be more aggressive in your choices.  Allow the fund manager to do his/her job and manage this time risk for you.  **NOTE – This is one of the few areas I disagree with Dave Ramsey.  He would say to maintain as much control as you can.  Given college savings is a medium-term investment, the risk needs to be closely managed and I believe it calls for less aggressive investing. That being said, he does make a lot more money than I do.

So to wrap-up, remember…

1.  Investing in your child’s college education should NOT be in your top 3 priorities.

2.  Avoid pre-paid tuition plans

3.  If you qualify, start with an ESA.

4.  After the ESA, go with a DIRECT 529 plan.

5.  Go Noles!

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