When it comes to selecting a 529 plan from the dozens that exist, there’s no one-size-fits-all formula.
Ultimately, it depends on your savings goals, tolerance for risk and time horizon for your child heading off to college.
Bob Mecca, a certified financial planner in Mt. Prospect, Ill., says those looking to participate in a qualified tuition program (529) should start by exploring the plan available in their home state.
“Look first to see if there are any state incentives for going with your own plan,” he says. “It’s great to get that extra tax break.”
Many states, for example, let residents deduct a percentage of their contributions – or waive state taxes on withdrawals for qualified educational expenses (matching the existing federal tax break.)
Of course, you’ll still need to evaluate such factors as the fund manager, the kind of investment options available and expenses.
Though 529s got a bad rap early on for charging excessive management fees, expense ratios have come down “quite substantially” on most plans, said Joe Hurley, a certified public accountant and founder of savingsforcollege.com.
“You can find a number of very low cost 529 plans, where your total expenses including underlying mutual fund expenses may be .30 percent or less,” he says.
For its part, savingforcollege.com provides a comparison of the lowest and highest ten-year expense totals for all direct-sold 529s on its Web site.
The College Savings Plans Network also provides a tool that helps parents compare plans.
And mutual fund tracker Morningstar provides a comprehensive summary of individual 529 plans, highlighting fund managers, expense ratios, annual maintenance fees and the percentage of funds available in the 529, which have earned at least a four- or five-star rating.
Keep in mind that while performance history gives some general guidance, like any investment, it’s never wise to chase past returns – particularly good advice where 529s are concerned since many have a short track record.
According to Mecca, the age-based investment option, which starts off aggressive and becomes more conservative as your child reaches college age, is a wise choice for most parents.
“If you’re not in the profession, it’s hard to try be your own asset manager or try to time the market,” says Mecca. “Many times people guess wrong. Age-based funds do the work for you, becoming more conservative over time.”
One exception, he notes, is parents who open a 529 when their child is already a teen. “If your child is 16 years old and you didn’t do any planning for college, I would probably do a balanced fund or choose an asset allocation of your own instead [that would be more aggressive to help make up for lost time.]”
Finally, while 529s help many families save for higher education, there’s some downside in the unlikely event your child doesn’t attend college.
If he or she decides not to go, you can always transfer the funds to another child or beneficiary, but if you have only child or you don’t use the money for qualified education expenses in the end, you will get stuck paying taxes on the earnings plus a 10-percent penalty.
“If you’re fearful of paying taxes and a penalty if your child doesn’t go to school, then you should still set aside a specific amount as if they are going to school but not necessarily into a 529,” says Mecca.
He recommends a “good solid growth-oriented mutual fund.” Profits and dividends are taxed as ordinary income, but you’re still saving. (If you’re worried little Johnny might squander the money, keep the fund in your name.) Plus, if it later becomes clear your child is college material, you can transfer those assets into a 529.
“The 529s are really the only way to go if you have a high degree of confidence that your child will go to school,” he said.