Making sense of 529 plans

If you have young children like I do, you might be wondering what you should do about your children’s college education.  My son is still years away from going to college, but because the cost of a college education has skyrocketed in the past decade, we already need to start thinking about saving for his college education.  We checked out a variety of investment plans for our son and any other future children we will have.  The choices are complicated.  There are many different investment vehicles to consider, and there are many plan to choose from when setting up a college fund for your child.  You can open a traditional IRA or Roth IRA for them, you could set up a Coverdell education savings account (ESA), or you could open a 529 savings account.  Most people choose to open a 529 account because it has some excellent tax benefits.  We chose a 529 plan because it offers the greatest flexibility of any option.  For one, the capital gains on after-tax money invested is tax-free if the money is spent on the beneficiary’s (i.e. your child’s) education.  Secondly, you can invest up to $230,000 in a 529 account for each beneficiary.  Unfortunately, there are also a couple of drawbacks to consider when thinking about opening a 529.  First, the money you have saved in a 529 account will count against you when your child applies for need-based financial aid.  FAFSA will count your 529 portfolio towards your net worth when it calculates how much financial assistance your child needs.  Second, there is currently a sunset clause on 529s, and they are scheduled to expire in 2010.  Fortunately, the current session of Congress is debating whether to eliminate the sunset provision and will likely eliminate it in the near future. 

Choosing a college savings plan for your child is also complicated by the fact that there are many 529 plans available nationwide.  Each state has one or more 529 plans to choose from.  Unfortunately, not all plans are created equal.  It’s not enough to simply choose the 529 plan offered by your home state.  We used to research the various 529 plans.  We were disappointed to find that our home state of Washington offers a mediocre 529 plan (high fees and low returns).  Alaska and New York currently offer the best plans as measured by minimum investment requirement, investment manager, portfolio options, management fees, account maintenance fees, residency requirements, and tuition benefits.  We chose the New York State 529 plan for our child because it offers maintenance fee free accounts with minimal required investment.  Its fees are a bit higher than Alaska’s, but it offers far more investment choices.  We also do not have to be New York state residents, and our son is not obliged to go to college in New York State when he heads to college.  Vanguard, a reputable investment firm, manages New York’s 529 plan.  If you are thinking about starting a college fund for your child, consider opening a 529 account with a state such as New York that provides maximum flexibility.

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