I think I can speak for most parents when I say that we want our children to have a better life with less struggle than we had as children and young adults. By no means have I had a rough life, but there are some things that weren’t available to me or that my parents didn’t know how to provide that I would love to give to my daughter. One of those gifts is financial help with a college education. I think the best way to save for higher education is with a 529 college savings account, but which 529 plan is the best?
What Are 529 Plans?
529 plans are similar to Health Savings Accounts except the money is used for college expenses instead of health care. You don’t get any immediate federal tax breaks, but money contributed to eligible plans earns interest and can be withdrawn, tax free, if it’s used for tuition, fees, books, room and board, or other qualified education expenses.
There are two basic types of 529 plans. Self directed plans allow you to use contributions toward any accredited college or eligible education institution. Prepaid tuition plans allow parents to pay today’s dollars for future tuition credits at in-state or select private school.
In Colorado, we no longer have prepaid tuition plans, and it seems those are becoming less available as states shut down plans or close them to new enrollment. Besides, I don’t want to decide where my daughter goes to school. Hopefully, we will have some input, but that decision is one we can’t make for her.
The Best Plan Depends On Where You Live
The best 529 plan for your child depends on where you live. You can contribute to any state’s plan, but your home state might offer tax savings. In 33 states plus the District of Columbia, contributions to an approved 529 plan qualify for a state tax deduction. Check your state to see if its plans are eligible and how much the maximum tax credit might be.
If you don’t have state income tax or if your state doesn’t allow deductions for a 529, then you can choose a plan from any state, preferably one that has low fees and good investment options. Savingforcollege.com has tons of information about all eligible state 529 plans.
Watch For Fees
You’d hate to choose a plan and notice that a huge chunk of the contributions are going toward paying advisors or administrative costs. I like direct sold plans because they cut out the middle man and allow you to choose which funds you’d like to invest with. There are other plans that are run by financial advisors, but fees can be much higher. Ideally, you should look for a plan that takes less than a half percent in fees.
When deciding on a plan, it’s important to see what type of funds are available. While you can choose something as safe as a money market, you won’t get the growth from compound interest that comes from stock investments. If your child is young and has more than five years left before college, there really is no reason not to have a sizable portion of their 529 plan in stocks. The plan we have in Colorado uses Vanguard funds, which are low cost and easy to research.
If you don’t want to worry about rebalancing as your child gets older, choose a target date fund that coincides with the year your child will graduate from high school. It starts out heavily in stocks when your child is small and shifts to more conservative investments as he gets closer to college age.
Currently, we have an 80% stock, 20% bond mix for our daughter’s plan. It was 100 percent stocks until about a year ago. I’m OK with the ups and downs because she still has 10 years before college.
When In Doubt, Choose Utah?
Many investment sites will tell you to choose Utah’s plan if your state does not offer tax breaks or plans with low fees/good investment options. Utah offers multiple fund choices through Vanguard, and the fees are less than .25% annually. Some other good state options include New York, Wisconsin, Nevada, and Illinois.
Is a 529 Plan Better Than a Roth For College Savings?
Roth IRA’s have a provision that allows parents to withdraw contributions, tax and penalty free, for college expenses if they have owned the Roth for at least five years. Any amount of withdrawal greater than the contributions before age 59.5 is subject to taxes and penalty.
Roth’s have the benefit of flexibility. If your child doesn’t seek higher education, the money can be used for retirement. With 529 plans, if money is withdrawn for non-educational reasons, there is a 10% penalty plus income tax. A Roth might be a better idea if you think there is a good chance your kid won’t go to college.
A couple of downsides are that Roth’s are capped each year as far as contributions and only the account owner can contribute. For 2015, the Roth contribution is $5500 if you are under age 50, and the ability to contribute phases out at higher income levels.
With 529 plans, grandparents, aunts, uncles, or strangers on the street can contribute up to some pretty high limits. In Colorado, we can put in as much as we want until the account reaches $350,000. We would be nuts to have that amount in a 529, but it’s nice to know we can sock away as much as we feel comfortable with.
Don’t Choose College Savings Over Retirement
As much as we want to help our kid with college, we won’t sacrifice retirement to do so. If she has to take out loans, so be it. Both her Mom and Dad took out loans, and we turned out OK. I think any child would be much happier not supporting her parents because they blew all their money or went into debt to give her a degree. Don’t save for your kids until you are comfortable with what you are saving for your own retirement years.
Do you have a 529 plan for your kids? If so, how did you choose it? Do you think parents should help with college?