Last time I took a close look at 529 college savings plans, it was 2010.
I can still hear the faint echoes of “California Gurls” and “Bad Romance,” probably because DJs won’t stop playing those songs.
Since my last 529 checkup, the news is mostly good for college savers.
There are still bad plans out there, but more states have lowered costs and minimum investments, and state tax deductions are still common.
In other words, it would be harder today for me to get away with a catchy headline is “Is your 529 plan robbing you blind?”
Read on and I’ll give you a few top picks and tell you how to avoid a college-savings stinker.
A quick 529 recap
529s have become the most popular way to save for college. As of 2012, Americans have stuffed $166 billion into them, according to a recent report by Morningstar.
By my calculations, that could buy almost three years of Harvard (sorry).
People like 529s because they have high contribution limits and, like a Roth IRA, let you withdraw the money tax-free as long as it’s used for qualified education expenses.
If your kid gets a scholarship, you can withdraw that amount from the 529 without a penalty, and if you don’t use all the money in your 529, you can change the beneficiary to another child, even a niece or nephew or grandchild.
And if you’re not already laughing at the idea of having money left over after paying for college, is it because you’re crying?
But 529s are still confusing, because every state runs its own plan, and sometimes two or three.
That would be easy if you were required to invest in your own state’s plan, but you’re not: if you live in Hawaii, you can put your money in Alaska’s plan, or most of the dozens of plans available nationwide.
That’s not the only source of confusion.
Most 529s are investment-based, containing the same types of stock and bond mutual funds you have in your IRA or 401(k).
A few, however, are prepaid tuition plans. These are controversial and tend to be restricted to state residents, so I’m leaving them out of this roundup.
(I’ve written about them before, however.)
Finally, investment-based 529s are sold in two ways: direct and through financial advisors.
This is easy: never buy an advisor-sold plan. You pay and pay in higher fees and expenses for something you can easily do yourself.
Get the deduction
The first thing to look at when choosing a 529 plan is your state tax deduction.
Many states give you free money in the form of an income tax deduction for contributing to your own state’s 529.
Nobody seems to maintaining a good master list of these deductions any more, so just Google “[your state] 529 tax deduction.”
If you’re eligible for the tax deduction, take it, even if your state’s 529 isn’t the greatest.
It’s like a 401(k) match: even a lousy 401(k) is no excuse for giving up free money, and later you can move the money to another plan without incurring a penalty.
Check the price tag
What makes one 529 plan better than another?
These plans are offering a boring commodity product: index mutual funds.
Most offer an age-based option that adjusts your investment mix as your child approaches college age.
None of this is investing rocket science, and you shouldn’t be charged NASA space toilet prices for it.
And here’s where the confusing tableau of state plans is a good thing: as long as your money keeps chasing the low-fee plans, states that overcharge will feel the pressure to stop gouging.
Last time around, I recommended five low-cost plans. This time, there are too many to list, so I’ll just hit a few highlights.
The most important price tag on a 529 plan (or any mutual fund-style investment) is the annual expense ratio.
This is the percentage of your money that will be invisibly deducted from your account to pay the investment manager, state recordkeepers, and other functionaries.
An expense ratio under 0.25% is excellent. Anything over 0.5% is unconscionable.
Here are a few great plans, with the approximate expense ratio for a moderate-risk age-based plan.
South Carolina’s plan is exceptionally cheap and also offers a great state tax deduction, but is open only to SC residents.
Maybe I should move. I hear the shrimp and grits are awesome.
The rest of the plans on the list are open to all US residents.
- South Carolina Future Scholar (state residents only): 0.11%
- New York: 0.17%
- California ScholarShare: 0.19%
- Nevada: 0.21% (I use this one)
Utah, Wisconsin, and Michigan are also excellent.
And don’t overthink this: expenses are important, but a few hundredths of a percentage point aren’t going to make the different between community college and Princeton.
If you’re not eligible for a state tax deduction, just pick one of these and start saving.
Now let’s call out a few plans with high price tags:
Alaska’s T. Rowe Price College Savings Plan charges about 0.75%, and I couldn’t find the price on their website; I had to check the Morningstar report.
Montana charges 0.88% for almost exactly the same Vanguard portfolios available from Nevada for 0.21%. That’s four times the price for the same investment.
Sure, small states are at a disadvantage when negotiating 529 plan fees with investment companies.
When your brokerage gets a call from the state of California, you say, “How can I help you, Mr. Terminator, sir?” (If Schwarzenegger is no longer governor of California, please don’t tell me.)
Editor’s note: Sorry, Matthew. He’s not.
But these plans exist for the benefit of families who live in the state.
If Montana can’t run a plan at a fair price, they should just advise their residents to send their money to, say, Utah instead.
That’s not a crazy idea: until establishing its own plan, Tennessee advised its residents to use the Georgia 529, and Wyoming (which doesn’t have a 529) used to have a special deal with Colorado.
Finally, remember the most important step in saving for college: Tell Grandma how to make contributions to your 529.