How to Pick the Right College Plan
Congress gave parents an extraordinary gift last spring--tax-free earnings as they save for college. Before this, money earned in Section 529 college-savings plans simply grew tax-deferred. It didn't take long for brokers and financial planners to begin hawking them. All families are eligible regardless of income. No wonder the amount in the plans jumped to $8 billion by yearend, almost doubling in six months.
Brokers and planners bring new layers of fees and charges, so it's important to know you don't have to use them. You can usually invest directly with a state or its investment manager. BusinessWeek's Guide to College-Savings Plans--one of the most comprehensive and up-to-date compilations you'll find--can help you find the best plan for you. We show you which states offer plans, what investment options are available, and how the fees add up. There's also an expanded version of the table at www.businessweek.com.
Forty-one states now offer savings plans, and most of the others, plus the District of Columbia, should launch by yearend. Also, you're not restricted to your own state's plan. All but three plans welcome dollars from nonresidents or will soon (albeit sometimes at extra cost or minus the state tax perks). Plus, investment options at the states are growing. Rhode Island offers 15 choices, and Ohio has 14. A few states have even rolled out more than one plan, providing savers with a pick of investment managers, say, or additional ways to buy.
All this gives parents more control when tailoring a plan to their needs. But it complicates a decision that for many was already daunting. "Sometimes, it's like going to a restaurant that has a 10-page menu," says K.C. Dempster, a financial consultant at College Money, a Marlton (N.J.) firm specializing in education planning. In some states, prepaid plans are an option, too.
Brokers and financial planners can help parents sift through the state plans and decide how to divide their contributions among a chosen plan's investment options. But while a plan bought directly from a state or its investment manager might charge 0.65% to 1.80% in annual fees, one purchased through a broker or financial adviser is apt to cost twice as much, says Joseph Hurley, founder of Savingforcollege.com, a Web site that provides information on 529 plans.
Many parents are familiar with front-end loads (sales charges levied at the time an investment is purchased) and back-end loads (those charged if the investment is cashed in early) from mutual funds. But that still leaves the task of comparing the mix of loads, annual administrative fees, and special account fees--then deciding which deal is best given your situation.
Saving for an infant? Class A shares, which impose a front-end load but have lower annual expenses, make a lot of sense. Have a teenager? C shares might be best. The annual fees are higher, but there's usually no entrance or exit charge. And you're only going to be paying those annual fees a few years. With Class B shares, the back-end loads may never be charged if you stay in six or seven years, and annual expenses are lower than with C shares.
Be aware that brokers may not tell you about a good plan that's right in your backyard if they get no fee from doing so. Diana Cantor, chairwoman of College Savings Plans Network, which represents the states' 529s, is also executive director of the Virginia College Savings Plan. She says her state added a broker-sold product after watching local planners steer residents to more aggressively marketed out-of-state plans despite Virginia's tax benefits and lower fees.
Start by checking out your own state's plan. Twenty states offer tax deductions of varying generosity. A deduction can be worth a lot in a high-tax state like New York.
Also keep in mind that, while the feds won't tax your earnings, the states might. California and Massachusetts say they'll tax the earnings portion of any money withdrawn. Six other states will tax residents who invest in an out-of-state plan. A reminder: The law allowing that federal tax-free status sunsets in 2011 unless Congress extends it.
After weighing the value of any state tax incentives, compare plan costs. A look at our table shows that the state with the worst-returning fund in 2001 (Arizona, with a 39.6% loss in one of its tech-stock funds) also had a double-digit expense ratio.
Then look at the number and type of investing options. The new rules let you switch between state plans and investment options within the same state once a year without changing the name of the beneficiary, as required before. Plans now offer mutual funds in addition to the old funds of funds and age-based portfolios that move from more aggressive investments to conservative ones as college approaches. And to soothe nervous parents who watched junior's college savings shrink last year, eight states now have a guaranteed-return option.
The 529s still aren't perfect. These funds count more heavily against financial aid eligibility, so families who think they will qualify for need-based aid might consider mutual funds held by parents. And while rules for moving money between 529s have been eased, some parents may still feel they give up too much investment control.
For most parents who know they'll have to pay for college, these plans simply can't be beat. Tax-free earnings regardless of your income? Where else can you get that kind of deal?
By Carol Marie Cropper and Brian Hindo