by Ben Kaplan, The Scholarship Coach
If you have ever shopped for vitamins at your local supermarket, you know that trying to compare the key ingredients and varying health benefits of each product can be more than a little confusing.
The same can be said for shopping for a 529 college savings plan.
Named after Section 529 of the Internal Revenue Code that put them into law, these plans enable parents, grandparents and others to save and invest for a young person's college education in a financially advantageous way. Earnings grow tax-free, and so long as the funds are used for approved higher education expenses, federal income taxes won't be due on any eventual withdrawals.
But with a cornucopia of state-sponsored plans currently available—yes, you can participate in plans from other states—trying to understand the fine print and figure out the best plan for your circumstances can be especially perplexing.
Fortunately, it doesn't have to be. By asking yourself the following three key questions about each plan that you evaluate, you will be able to take a deep breath, quickly eliminate plans that won't work, and hone in on the ones that are most advantageous.
1. Are there any in-state benefits?
Here's the good news: Currently, 31 states plus the District of Columbia offer an upfront tax break for participating in a 529 savings plan.
In most cases, you must enroll in one of your home state's 529 plans in order to claim this state income tax benefit. But in states like Pennsylvania, Kansas, Maine, and Arizona, residents can qualify for a tax break even when they invest in another state's plan.
The form this tax break takes can vary: Many states offer savings plan participants a tax deduction—a reduction in your total income subject to taxes—but states like Indiana, Vermont and Utah offer tax credits that reduce dollar-for-dollar the total amount of taxes due.
One important caveat: The maximum size of this tax break may be limited. In Oregon, for instance, residents may claim an annual state income tax deduction only up to $4,000 per tax return (or $2,000 per person if married and filing separately), although excess contributions in a given year may still be claimed as deductions during the following four years. But in Colorado, South Carolina, West Virginia and New Mexico, there is no cap.
Finally, keep in mind that other potential in-state benefits go beyond just taxes: Some states will permit the college savings plan assets of in-state residents to be omitted from need-based financial aid calculations. Other states even offer plan participants bonus scholarships or "matching grants" that effectively multiply each contribution you make.
2. What are the fees and expenses?
While the future earnings of a college savings plan cannot be guaranteed, one component of your investment return is pre-determined: the annual fees, expenses and commissions that are deducted.
College savings plans assess fees in various ways, including asset-based fees (normally a percentage of the annual account balance), administrative fees, and sales commissions.
For example, on the low side, some 529 plans charge fees totaling less than 0.5 percent. On the other end of the spectrum, more pricey plans may charges fees upwards of 3.5 percent.
Over time, fees and expenses can eat away many thousands of dollars from your bottom line.
3. What are my investment options?
No matter how low the fees or how large the state tax benefits, a 529 plan is ultimately only as good as the underlying investment options.
If you have experience investing in mutual funds or bond funds, make sure that a given plan has options that match your preferred investing style.
If you don't have much experience, look for the availability of "index funds" (investments that try to mirror the overall return of the stock market as a whole) and "age-based" portfolios (that automatically adjust the risk composition of your investments over time to match your child's age). Such investments require the least amount of ongoing monitoring and maintenance on your part.
One final note: Just as you would schedule an annual doctor's checkup, get in the habit of reviewing your savings plan at least once a year to assess your investment return and any changes in the plan's rules and regulations. If your account's financial fitness isn't as strong as you had hoped, you can always exercise good judgment and roll your accumulated savings into another plan.
Investments in 529 college savings plans are neither FDIC insured nor guaranteed and may lose some value. Some states offer favorable tax treatment to their residents only if they invest in the state's own plan. Investors should consider before investing whether their or their designated beneficiary's home state offers any state tax or other benefits that are only available for investments in such state's qualified tuition program and should consult their tax advisor.
Please note the plan's disclosure document includes investment objectives, risks, fees, expenses, and other information associated with municipal fund securities that you should read and consider carefully before investing. You can obtain plan disclosure documents from each 529 plan. You can obtain a copy of the plan document from each 529 plan sponsor.
Known as "America's Scholarship Coach," Ben Kaplan is publisher of the www.CityofCollegeDreams.org website and the winner of two dozen college scholarships worth $90,000. For more details on this topic, visit his College Savings information page.