So you’re sold on the 529 plan, but now you have to pick one from like 50+ choices since every state sponsors at least a prepaid and/or savings 529 plan. Thinking about which 529 plan to choose may be as overwhelming as a foreigner in a ham shop. I know weird analogy but I had to tie this in to my picture. You just got through picking which way to save for college and now you have to make yet another decision. But no problem, just answer the following question below to help you narrow down which 529 plan to pick.
First, recap. What is a 529 plan again? It is an educational savings plan sponsored by a state or state agency that allows the money you contribute (after-tax money, non-deductible from taxes) to grow tax-free and later be used tax-free for qualified higher education expenses. There are actually two types of 529 plans, a savings plan and a prepaid plan. The most commonly referred to plan is the 529 savings plan.
Some basic features of a 529 plan:
- Examples of covered expenses are tuition & fees, books, limited room and board, equipment deemed necessary by the school and just recently computers.
- Individual states may also offer a state income tax deductions if you contribute to their state plan, which translates into more benefits and savings for you, especially higher your income tax bracket.
- You’ll be hit with taxes and a 10% penalty on the growth of the investment if you don’t use it for qualified higher education expenses, but you can roll it over without penalty to a sibling or just about any relative, including yourself or your spouse if your beloved little Madison or Ethan decides they aren’t going to college or grad school.
- The account holder (you the parent) retains control over the 529, not your child (the beneficiary).
- 529’s do count against your child’s financial aid, but it is considered a part of the parents’ assets and therefore counts significantly less than if it was categorized as a child’s assets (maximum of 5.64% vs 20% reduction in financial aid).
Do you live in a state that gives you an income tax deduction if you contribute to your state’s 529?
Yes. Then you probably should invest in your state’s 529. 34 states and the District of Columbia gives a partial or full tax deduction. Check to see if you live in such a state and the amount of your state’s deduction here at Finaid.org. The higher the deduction, the more compelling reason to choose your own state’s plan.
No. Or you live in one of six states that offer a deduction for contributions to any state’s 529 plan. Lucky! These 6 states are Arizona, Kansas, Maine, Missouri, Montana and Pennsylvania. Then go with the plan that has the lowest fees and best rating, which incidentally probably coincides. I live in California, which does not offer a state income tax deduction. As if living in California isn’t expensive enough as it is. Come on give us a break California! According to Morningstar (a company that provides independent research on investments, kind of like a Consumer Reports for stocks, bonds and other investment products), for 2015, they ranked these 4 plans a Gold Plan.
- Maryland College Investment Plan
- T. Rowe Price College Savings Plan (Alaska)
- The Vanguard 529 College Savings Plan (Nevada)
- Utah Educational Savings Plan
So if you don’t get a state tax deduction, then go ahead and invest in one of these four. We invest in the Vanguard 529 simply because we heavily invest through Vanguard and I like to keep all my accounts in one place (simplified), but Utah has some of the lowest fees of the 529’s and for those of my friends who don’t have any or much Vanguard investments, I usually recommend Utah.
A few other things to consider is the minimum to open an account and investment options. Vanguard’s minimum is $3000, Utah’s has no minimum and both the Maryland College Investment Plan and T. Rowe Price College Savings Plan have significantly lower minimums. If you don’t have a lot of cash saved up for your kid’s college fund yet, that might be another reason to pick one of the other 3 Gold plans. Also 529 plans have limited investment options in general but they do differ from plan to plan.
So there you go, invest in your state’s 529 or one of the Morningstar’s 4 Gold Plans. Pretty simple right? If you’re looking for more details and guidance on chooseing a 529 you can read this well written, but heavily detailed Morningstar report on how to choose a 529. Now go open one up and relax your brain a little. Pass me some sangria! ??