Parents who want to save for their children’s college expenses tax free face a growing array of choices. As of the end of last year, according to a Morningstar report, there were 83 tax-free 529 college savings plans offered by 48 states. How does one choose from among them? Following are three tips for making a decision.
• As with all investment decisions, cost matters, especially over time. Plan costs primarily include program management fees as well as mutual-fund annual expenses.
Interestingly, Morningstar found that in most plans the fund expenses were higher than the expenses for the equivalent open-ended publicly traded funds. But that disadvantage has been decreasing over time and is offset by the tax advantages of owning 529 plans.
Morningstar rates 529 plans annually, primarily with an eye toward costs. For the latest report, visit news.morningstar.com/articlenet/article.aspx?id=436794.
• Be aware that there are two types of plans: those that are direct-sold – you can sign up yourself online – and those that are broker-sold. For the latter, you typically pay additional fees to the adviser recommending the plan, which can make them more expensive.
Unless you need a lot of advice from your adviser on your 529 investments, I’d recommend sticking with the cheaper direct-sold plans.
• Determine your investing strategy. If you’d prefer to actively manage the assets in the account, select a plan that offers high-quality funds across a broad range of asset classes (e.g., large-cap U.S. stocks, small-cap U.S. stocks, foreign stocks, U.S. Treasury bonds, U.S. corporate bonds, foreign bonds, real estate, commodities). If the funds are publicly traded, so much the better – you’ll be able to track performance and obtain analyses through multiple sources. Keep in mind, however, that you are limited to changing your investments no more than once each calendar year.
If instead you’d prefer not to make any investment decisions, the ideal plan would allow you to specify upfront how to allocate your contributions across stocks, bonds and cash in such a way as to match your own risk tolerance. Even better would be a plan that automatically adjusts those allocations to reduce risk as the child becomes older, again following a model with which you are comfortable.
Most plans offer both capabilities, but the specific allocations are different. It’s important to select the one that’s right for you.
Find details of every 529 plan’s investment choices at www.savingforcollege.com (select “Compare 529 Plans,” “All Types,” “Compare By Features,” then click all the investment choices).
The burden of paying for college gets heavier as cost increases continue to outpace inflation by a wide margin. Your primary goal, regardless of the savings plan you select, should be to ensure that you are generating a reasonable but safe return on your college savings funds.
Artie Green, a Los Altos resident, is a certified financial planner and professional investment adviser. For more information, call (408) 747-1222. To read his blog, visit blog.pwjohnson.com.
