It’s that time of year. Throughout the country, coveted financial aid awards have officially landed in prospective students’ mailboxes and inboxes.
Every year, the realization hits home for many families: College is expensive, and isn’t getting any cheaper.
Fortunately, millions of well-organized parents were (and are) completely aware and opened 529 plans for their college-bound children or other designated beneficiary long ago. Cracking open the piggy bank to fund a 529 plan is an essential step to help tackle the expensive reality of higher education. And the earlier that piggy gets broken, the better.
What's a 529 plan?
By definition, a 529 plan is a state-sponsored, tax-advantaged investment account specifically designed to save for future education costs. Eligible educational institutions include any college, university, vocational school or other postsecondary educational institution.
The year 2018 spells out good news for parents of students in elementary, middle and high school. Through the recent tax Cuts and Jobs Act, you can now use a 529 plan for an elementary or secondary public, private or religious school. This means you can now take federal tax-free withdrawals (up to $10,000) to pay for K-12 tuition.
Within 529 plans in general, there are two different plan types: prepaid tuition plans and college savings plans.
Prepaid tuition plans
Prepaid tuition plans allow college savers to purchase credits to pre-pay all or part of the cost of an in-state public college education or private college education. (The Private College 529 Plan is a prepaid plan strictly for private colleges.)
College savings plans
College savings plans allow college savers to save for qualified higher education expenses, including tuition, mandatory fees and room and board. They work much like an IRA; as a college saver, you can invest in mutual funds or similar investments of your choice.
Most, but not all, 529 plans offer tax benefits for college savers, both at the state and federal level. State tax benefits will vary from state to state.
For example, in Iowa, taxpayers who invest with College Savings Iowa can deduct up to $3,239 in contributions per beneficiary account from their adjusted gross income. If you’re married with two children in Iowa and both you and your spouse contribute to separate accounts, together you can deduct up to $12,956 (for 2017).
Again, every state is different and you’ll need to check the 529 plan available in your state.
If you’re curious about how the tax deductions will benefit you, check out Vanguard’s state tax deduction calculator. It’s really easy to use, and based on your planned contribution amount, marital status and yearly income, can quickly tabulate your total net tax savings for the year.
Ultimately, the most rewarding tax benefit of all is the fact that the earnings generated in a 529 plan are not subject to federal income taxes, nor are you subject to state or federal income taxes when the funds are withdrawn from the 529 plan.
In addition to the tax benefits, there are some other benefits college savers may not know about:
- You can use another state’s plan if your state’s plan doesn’t meet your needs.
- Anyone can contribute to a 529 plan, including grandparents, aunts, uncles, friends, etc.
- Again, you can save for tuition at an elementary or secondary public, private or religious school as well. Up to $10,000 in annual expenses may be accessed.
- College savers who live in Arizona, Kansas, Missouri, Montana or Pennsylvania offer a tax break no matter what state’s plan you invest in.
How to choose a plan
Most states offer a couple of different types of plans: one you can buy directly from the state and one you can buy through a broker. It’s best to buy the plan you can use directly. It’ll be much cheaper than paying fees to a broker.
How to choose an asset mix
Traditionally, it’s easy for college savers to determine which blend of aggressive to conservative investments a beneficiary will require. Most states offer age-based portfolios (so they’re aggressive and flush with stocks when your child’s a baby and adjust to bonds and cash when he/she is closer to his/her first year of college.)
Best for low fees
New York’s 529 College Savings Program doesn’t charge account maintenance fees and its underlying fees are low as well. For example, you pay only $1.50 in fees per year for every $1,000 that you invest (0.15 percent total annual asset-based fee).
Best of all for out-of-staters, the plan doesn’t charge any additional fees for non-New York residents.
Best overall: Wealthfront
Wealthfront’s 529 plan brings college planning into the bigger picture of your family’s financials. Along with helping you estimate future tuition expenses based on data from the Department of Education, Wealthfront suggests realistic savings goals each month.
By taking into consideration projected future costs, financial aid, and other personal financial goals, Wealthfront keeps you on track to meet your plan’s goals. Also, they show how switching your monthly contribution would shift your plan’s savings in the long term.
Withdrawals made from Wealthfront’s 529 plan are exempt from federal taxes and, depending on your state, you may be able to take advantage of certain state tax benefits.
Best for performance
The Ohio CollegeAdvantage Direct 529 Savings Plan’s long-term performance has been excellent:
- One-year: 18.11%
- Three-year: 8.27%
- Five-year: 10.83%
- Ten-year: 6.84%
In addition, residents of Ohio can claim a large tax deduction, or $2,000 of contributions. In addition, fees are low for this plan. For example, total expenses are 0.23% to 0.47%.
Best fund selection options
The my529, formerly the Utah Educational Savings Plan, allows account holders to choose among 14 different investment options, including four age-based options, eight static options, and two customized options. All utilize a different strategy:
- The four age-based options automatically reallocate account funds from equities to fixed-income funds or FDIC-insured accounts as your beneficiary gets closer to college.
- Eight static options do not change asset allocations as your beneficiary ages. The allocation you choose stays the same, unless you request a change.
- Two customized options, age-based or static, can be designed to fit your needs.
Best for state tax deductions
Over 30 states, including the District of Columbia, offer full or partial state tax deductions for contributions to a 529 plan.
Indiana wins the award for highest tax benefits. Indiana offers three 529 college savings programs: The CollegeChoice 529 Direct, the CollegeChoice Advisor, and the newest Indiana 529 plan is the CollegeChoice CD, which offers FDIC-insured savings options.
The Indiana 529 state tax benefits for residents include a 20 percent tax credit on contributions up to $5,000 which can be claimed against Indiana income tax. The maximum yearly credit is $1,000.
The Vanguard 529 Plan is a Nevada Trust and has three excellent age-based options that do most of the work for you. They’re a preset mix of Vanguard investments that automatically adjust over time to become more conservative as your child grows.
It’s simple to choose which age-based option you want, as you have a choice between conservative, moderate and aggressive age-based options, and each are fairly intuitive. For example, a child aged three to four years in the conservative age-based option will have a growth portfolio which will include 50 percent stocks and 50 percent bonds. On the other hand, a child of the same age in the aggressive age-based portfolio will have a growth portfolio of 100 percent stocks.
The Vanguard 529 Plan also offers 20 individual portfolios you can mix if you prefer to build your own.
It’s easy to see why the Vanguard 529 Plan is excellent: low costs, easy-to-choose savings options and great customer service can all pave the way for many future college attendees.
One thing you don’t want to do with the money in a 529 plan is to use it for non-educational expenses. Say you need emergency cash or decide to use Junior’s college fund for a new RV instead. You’ll owe income tax and will incur a ten percent penalty on earnings (but not on contributions).
Also, your state’s tax deduction should not be your only consideration when deciding on a 529 plan for your beneficiary. Take fees, asset allocation, performance and even customer service into consideration when determining which 529 plan will work best for you.