Too many options make selecting the right 529 plan a challenge for parents.
Sky-high college tuition costs continue to be a significant roadblock for parents hoping to provide a college education for their children. While the pace of tuition increases at public institutions slowed slightly this past year (2.9 percent according to Collegeboard.org), many parents continue to be unprepared for the financial strain college costs can cause.
For those looking to make inroads in the college savings battle, a 529 plan can be a powerful tool. While they are not an end-all solution for everyone, 529 plans continue to grow in popularity with over $181 billion dollars in assets according to Morningstar.
However, with each state offering from one to four different college savings plans and parents having the option to use any state plan (nearly 85 in total), the excessive number of choices has left many parents unsure of which plan to choose.
Understanding the most important criteria in the selection process can help empower parents to make the most appropriate choice for their children.
So why consider a 529 plan? Unlike custodial accounts, which are taxable based upon income and capital gains, funds used for qualified education expenses grow federally tax-free within a 529 plan. In other words, more of your college savings will be used for tuition and less may end up with Uncle Sam. Additionally, 529 plans are considered an asset of the parent for financial aid purposes, which may be better than other investment alternatives held in the name of the child. These attractive features do not come without a cost. Keep in mind that if the funds are not used for a qualified tuition expense, a 10 percent penalty and tax on any investment gains will be assessed to the account — so be careful not to overfund the plan.
From federal and state tax deductions to investment choices and fees, there are many details that should be reviewed before determining which plan is right for you. One of the first places to start is to determine whether your state offers any income tax deductions. While all 529 plans are federal tax free, not every state offers tax deductions or credits for contributions. If you are lucky enough to live in a state that offers a deduction or credit for contributions, you may want to use one of your resident state’s plans. For example, New York offers an annual deduction of $10,000 for those filing married/joint who utilizes the New York plan. Pennsylvania offers up to $28,000 in deductions for contributions to any state plan — not just Pennsylvania’s plan. However, New Jersey only offers its residents a small scholarship of up to $1,500 with no state tax deductions for contributions — not a great deal for parents. Despite the fact you may lose the small scholarship opportunity, the lack of tax incentives means that there is really no advantage to using an N.J. 529 plan and parents have the option to utilize any state plan. If no state tax deductions or credits are available, the decision of which plan to use will be based upon other criteria such as investment choices, fees and other features.
529 plans are administered by various investment companies with many investment choices available. From age-based options that get more conservative as the child ages to static individual choices, the investment options available can have a significant impact on your plan over time. Reviewing reports from Morningstar.com and Savingforcollege.com on your own or with an adviser can help determine which plan may have the right mix of investments for your individual risk tolerance and time horizon. Remember, the older your child is, the less time you have to recoup investment losses so take extra care when determining the proper investment mix.
While the investment choices within a plan are critical, investment management fees must also be closely reviewed. Enrollment fees, maintenance fees, sales charges and underlying investment fees can add up. A visit to Savingforcollege.com can help highlight the range of fees that each plan may charge.
Since excessive fees can take a bite out of investment returns in the long term, be sure that you are receiving value for any expenses paid.
Finally, you may want to review other features such as investment minimums and systematic savings plans. Initial deposits can range between $0 to $3,000 to begin a plan. Often times, 529 plans with no or very low minimums require that you commit to a monthly savings plan of as little as $25 per month. This can be a great option for parents or grandparents without significant funds to get started.
With college costs continuing to rise along with overall student loan debt, providing for a child’s college education is not getting any easier. Developing a game plan to determine how much to save and where to save it can help you to better pursue your college funding goals. Consider speaking to your tax and financial adviser to determine the right approach for your unique circumstances.
Kurt J. Rossi, MBA, is a Certified Financial Planner Practitioner & Wealth Advisor. He can be reached for questions at (732) 280-7550, kurt.rossi@Independentwm.com or www.Independentwm.com. LPL Financial Member FINRA/SIPC.
