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College Savings 101

Take notes on the pros and cons of 529 plans.
June 1, 2003
URL: http://www.entrepreneur.com/article/61914

If you're the parent of a child younger than 18, odds are you've noticed a lot of talk about 529 plans lately. Every state now offers at least one of these college savings programs (named for the relevant section of the tax code), and starting last year, the federal government made withdrawals tax-free if the cash is used for higher education. The total value of dollars tucked into 529 accounts has increased tenfold since the end of 2000, and states, mutual fund companies and financial advisors are tripping over themselves to pitch various plans.

Like Roth IRA accounts, money in these state-sponsored plans grows tax-free and can be withdrawn sans tax. Doing Roths one better, 529 contributions also qualify in some cases for state tax breaks.

Plus, you can contribute to plans anywhere, and your future student can use the money at any accredited college in the United States. Finally, it's possible for parents, grandparents or other interested parties to contribute more than $100,000 in one shot without triggering gift-tax consequences-although the minimum initial contribution in virtually every plan is $1,000 or less.

But these plans aren't perfect. Just ask parents who have seen their kid's 529 account plummet with the stock market over the past two years. Another risk is the plans can reduce financial aid for lower- and moderate-income families because distributions count as student income in most college aid formulas.

Still, sticking money into a 529 plan offers higher investment returns over the long haul than the old standby, U.S. Savings Bonds. Plus, it allows for bigger savings than Coverdell education savings accounts (formerly Education IRAs), and it has the tax savings custodial accounts lack.

If you're interested in 529s, start by boning up on your own state's plan. The first thing you'll want to know is whether you can deduct contributions from state taxes. If you can, it's a bonus. You'll also want to check out the local plan's investment options, flexibility and expense ratio, and compare the results with popular alternatives sponsored by states such as Iowa, Massachusetts, Nebraska, New York and Utah at www.savingforcollege.com.

Don't get caught up in investment performance as you compare notes, since 529 plans have only been around for a few years. Better to pick a plan with a known quantity running its funds, such as Fidelity, TIAA-CREF or Vanguard. And be wary of plans sold through financial advisors because added fees can negate tax savings. Keep in mind some states offer advisor-sold plans and no-load plans-the former providing hand-holding and the latter lower fees.


Scott Bernard Nelson is a financial writer at The Boston Globe.