A 529 Plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. In a nutshell – it’s money you would invest today that would accrue over time in order to fund your child’s college tuition and other higher education needs (room, board, books, etc).
The biggest benefit of a 529 Plan is the income tax breaks. There are tax breaks at both the federal and state level (depending on the state). At the federal level, you still get taxed on what you put in, but it grows at a tax-free rate. On top of that, most states offer additional tax cuts at the state level. Unfortunately, California (where I live) is not one of them. If your state offers tax benefits, it would make the most sense for you to choose a 529 Plan administered in your state. That way you will save at both the federal and state level. If you’re like me and live in a state that does not offer state tax incentives, I would shop around nationally to find a plan that fits your needs the best.
The catch is that the money you invest in a 529 Plan cannot be taken out except to fund your child’s education. If you take it out for any other purpose, there will be a 10% federal tax on earnings on top of your regular income tax. There are a few exceptions though – you can take out that money without any penalties if your beneficiary dies or becomes disabled, or if he receives a college scholarship. Another downside is that a 529 fund can possibly impact the beneficiary’s ability to qualify for loans or grants.
Despite the penalties, the 529 Plan has a lot of appeal because there is some flexibility in how the money is used. You are allowed to change the name of the beneficiary on the account once a year, so if the original beneficiary doesn’t take advantage of the money it can go to someone else. You can even use it for yourself as long as its for education purposes.
Why do we want to create a 529 Fund for my Baby? Because we want to help fund her college tuition. We don’t want to fund the whole thing – we believe she should work for some of it herself, but we would like to ease the burden. Despite the recent economic downturn, and the myriad of people questioning our higher education system, my husband and I still believe these institutions will be around 20 years from now. If anything, the need for higher education will continue to increase, along with the costs. The landscape may look different than it does today, but we are betting that higher education will provide a stronger competitive advantage than not. The money doesn’t have to be used for U.S. institutions either, it can be used for schools abroad.
In the end, we decided to go with the Utah Educational Savings Plan (UESP), with its low overall expenses, and no minimum contributions (the other two plans required a minimum of $250 to open the account, and a $25-50 monthly contribution). There is an account maintenance fee of $3 per every $1000 in the account (with maxes out at $15 annually), but that fee is completely waived if you choose to have electronic delivery of quarterly statements.
The low fees and solid returns really sold us. We also liked that we could open it directly without having to go through a Financial Advisor (which is what we would have had to do if we went with Virginia’s plan).
We did consult our Financial Advisor before making a decision though, and he thought all three were solid options. One thing worth noting is that Alaska and Pennsylvania are actively managed funds, but Utah’s is a passively managed index fund. I found no compelling evidence showing that the returns on actively managed funds were better, so we stuck with Utah.
Where to begin? This article provides a great breakdown of features you should consider when choosing a 529 Plan. The very first thing I would do is find out if your state provides extra tax benefits because if it does, it will narrow your search a lot faster!
Some resources I found beneficial:
- The Top Performing 529 Plans for 2012
- The Worst and Best 529 Plans
- Morningstar’s Best 529 Plans for 2012
- Comparison of direct-sold 529 Plans
Have you thought about college funding for your kid(s)? If you have a 529 Plan already, which one did you go with and why? If not, are you planning to open one? I would love to hear everyone’s reasons for or against opening a 529 Plan!