529 Plans: Saving for College is Simpler Than You Think

It seems like not that long ago that my main concerns for my son were potty training and preschool. Suddenly, he's in middle school, and time is marching forward faster than I can say "SATs, anyone?"
College costs are marching along, too-upward. And parents need to be prepared, says Ron Goldner, a fee-based financial planner with Wealth Strategies Group, Inc. in Memphis, Tennessee. A 529 plan can help, he says. And while these are tough financial times, even a $25- or $50-per-month contribution can add up to a nice college nest egg over the years, thanks to compounding of interest.

What Are 529 Plans?

These plans offer tax-deferred savings for future college costs. They're sponsored by states, including California, or educational institutions and are authorized by the Internal Revenue Service. Utah, Nebraska, Massachusetts, Virginia and New York are known for having particularly good plans, according to Russell Wild, a fee-only financial advisor (meaning that he advises clients but sells no investment products himself) in Allentown, Pennsylvania (www.globalportfolios.net).
"Parents can save up to around $300,000 in a 529 plan, depending on each state's plan," says Goldner. Each plan has a cap. You are not required to invest in the plan from your state, he adds. Not all 50 states sponsor plans. Goldner notes that, while the best time to start such a plan is when your child is born, it's never too late to start, even if your child is already in college.

A 529-plan account can't be owned by both parents jointly, Goldner notes. It must be listed under just one owner. But you can always buy more than one account per child. There are two types of 529 plans:

Pre-Paid Tuition Plans

These plans allow parents to purchase credits at participating colleges and universities for future tuition and, in some cases, room and board. Most are sponsored by state governments and have residency requirements. Many states guarantee investments in their pre-paid tuition plans, according to the U.S. Securities and Exchange Commission (SEC).

College Savings Plans

These plans allow parents to establish an account to save for their child's eligible college expenses at any college or university. Parents can choose among several investment options, which include stock mutual funds, bond mutual funds and money-market funds. While the plans are state-sponsored, parents don't have to sign up for the plan in their state.
Goldner notes that parents can set up age-related 529 plans that become more conservative as the child gets closer to college age. "The portfolio would be aggressive (with a higher percentage in stocks) from birth to around age 8, moderate from age 9 to around age 15 and conservative (with a higher percentage in bonds and cash) from age 16 on," he explains.

Coverdell Education Savings Accounts

Questions to Ask Before Investing in a 529 Plan

Keep this list of questions handy when choosing a 529 plan:

Is the plan available directly from the state or the plan's sponsor?
What type of college expenses are covered?
What types of investment options are offered?
Does the plan offer special benefits for state residents?
If my state's plan charges higher fees than another state's plan, do the tax advantages or other benefits offered by my state outweigh the benefit of investing in another state's less-expensive plan?
What limitations apply to the plan? When can I change investment options, switch beneficiaries or transfer ownership to another account holder?
What fees are charged?
Are there withdrawal restrictions?

These are a bit different from 529 plans. Coverdell ESAs may be appropriate for families that wish to save for elementary- and secondary-school expenses in addition to college, says Goldner. Even if you buy a 529 plan, you can still contribute to a Coverdell account, notes Savingforcollege.com (www.savingforcollege.com), a website that offers independent information about saving for and paying for college. Check out their terrific college-costs calculators and 529-comparison charts.

Why Are 529 Plans So Important?

There are several advantages to these plans, our experts say:

Everyone is eligible. Generally, there are no income limitations or age restrictions.
Parents get tax breaks. Contributions aren't deductible on your federal tax return, but your investment grows tax-free, provided that the distributions are used to pay for your child's college costs. Also, most states allow deductions on your state taxes when you sign up for your own state's 529 plan, says Wild.
The parent controls the purse strings. Your child has no rights to the funds. You decide when withdrawals are taken and for what purpose. Most plans even allow parents to reclaim the funds for themselves any time they desire, no questions asked. (However, the earnings portion of the "non-qualified" withdrawal will be subject to income tax and an additional 10-percent penalty tax).
It's an easy, hands-off way to sock away college dollars. According to Savingforcollege.com, once you decide which 529 plan to use, you complete an enrollment form and make your contribution or sign up for automatic deposits. Your investment is managed either by the state treasurer's office or by an outside investment company hired as the program manager. You may change your savings option annually (program permitting) or you may move your account to a different state's program every year.

Penalties, Fees And Restrictions

"Costs matter greatly," says Wild. You can save a lot of money over the long haul by carefully choosing your plan. Prepaid tuition plans typically charge enrollment and administrative fees. Broker-sold plans will include commissions. And college-savings plans may charge enrollment fees, annual maintenance fees and asset-management fees. Make sure you thoroughly understand the plan you've chosen before signing up. Savingforcollege.com has information on the fees associated with various plans.

What If You've Waited-And Waited-To Get Started?

What if you've been saving for college with mutual funds or a savings account-but you never got around to starting that 529 plan? Should you sell those mutual funds (and pay capital-gains taxes-ugh) to kick-start your 529 plan with a chunk of money? "Yes, says Wild. "Take the hit," he advises, noting that "you'll have to take it when you withdraw the (regular mutual fund) money for college, anyway."
The age of your child when you buy a 529 plan also will have some bearing on the type of plan you buy, of course. If your child is within five years of heading off to a dorm, you'll probably want to choose a plan that offers that state tax deduction (assuming there's a plan available in your state), as that will mean more to your bottom line than will the long-term performance of the plan, Wild says. But if your child is more than five years away from starting college, you'll probably care less about the tax deduction and more about the long-term costs and performance of a particular plan.

Just Do It

If you've been putting off buying a 529 plan because the whole thing seems overwhelming, it's time to put those fears aside. "It's really simple," says Wild. "Choosing one is not that difficult with the help of websites like Savingforcollege.com. Buying a 529 plan isn't rocket science," he adds. "In fact, it's not even paper-airplane science."

Writer Kathy Sena frequently covers parenting issues. Her son starts high school next year. Yikes.