How to Choose the Best Plan, How to Invest
It’s hard for the parents of a newborn to imagine that tiny baby heading off to college. But parents should plan for that as soon as the little one arrives, or even when it’s on the way.
Saving for college requires an organized, disciplined approach. A 529 plan is the best way to start saving for college as soon as you’re able.
The earlier you begin, the more you’ll benefit from tax-free growth. A baby brings lots of bills, so starting right away may not be possible. But consider starting out small. The minimum to open a plan is usually just $25 to $50.
You can start a 529 plan at any time in your own name. As soon as your baby has a Social Security number, you can name him or her the account’s beneficiary. Each child will need a separate plan.
Once the plan’s set up, anyone can contribute to it. Consider asking for contributions as baby shower or birthday gifts to help kick off your savings.
Savings Plans Beat Prepaid Tuition Plans
There are two types of 529 accounts: the college savings plan and the prepaid tuition plan. The latter allows you to prepay for future college courses at current prices—in other words, get the 2018 rate 18 or 20 years from now. That sounds great, but there are major drawbacks.
The prepaid plan guarantees to cover the full amount of tuition only if your child attends an in-state public college. Otherwise, the plan typically will pay out an amount equal to the average of your state’s public colleges’ tuition to a private or out-of-state public college of your choice.
We don’t recommend prepaid plans. They force parents to rely on the state’s future ability and willingness to meet its financial obligations, which is a risk. Prepaid plans also may have time limits, such as using the assets within 30 years of opening the account. College savings plans normally don’t have such limits.
With either type of plan, your child doesn’t own or control the assets, so he or she can’t withdraw the money and buy a sports car. Assets in a 529 plan may reduce financial aid, but for most, this is a relatively minor disadvantage. Earnings accumulate without taxes, and withdrawals are completely tax-free.
The beneficiary can use the funds at any accredited trade or vocational school, college, or graduate school in the United States or abroad. Qualifying expenses include tuition, books, and room and board. (Non-qualified withdrawals are subject to federal and state income taxes and a 10 percent penalty.)
A Plan with Low Fees, Good Funds
Every state but Wyoming sponsors a 529 plan, and different mutual fund companies provide the investment funds. You can choose any plan you like. Focus on finding a plan with low fees and sound investment options. A plan that lets you choose a diversified portfolio while minimizing expenses will permit greater growth.
Administrative fees for 529 accounts range from 0 to 0.99 percent of assets. Some plans charge an enrollment fee, usually $50 or less. Some also charge annual maintenance fees of around $10 to $25 per year. If your account is set up for automatic contributions, many plans reduce or eliminate this fee, especially for residents. Avoid plans with maintenance fees.
Investment management fees are subtracted from the account funds, just as with other mutual funds. Management fees may be as high as 1 percent, though they’re usually lower. International and specialized funds have the highest fees; index funds have the lowest.
My529, the Utah program, offers quality investment options, flexibility and minimal fees. For most people, it’s the best choice, unless you’ll get a significant tax benefit by choosing your home state’s plan.
Most states offer state income tax deductions for 529 contributions. For example, married couples living in New York who use the New York 529 plan can deduct up to $10,000 annually, and thus may save several hundred dollars in state taxes. Single filers there can deduct up to $5,000.
Except in seven states, you have to choose your own state’s plan to get this deduction. This may sometimes give your state’s plan the edge, but you will have to do the math. Seven other states don’t offer a deduction for contributions at all.
If you don’t like your current plan, you can change plans via a rollover once every 12-month period.
Investing: start out aggressive, end up conservative
Because stocks offer higher long-term returns, we recommend maintaining a 100 percent stock allocation for younger beneficiaries. Spread your investments among funds that invest in large, small and foreign companies.
Around age 12, start shifting 10 percent of the portfolio to bond funds each year. This “glide path” will result in a 100 percent conservative allocation in money market and short-term bond funds by your child’s last year of college in a four-year program.
What will happen if you save “too much” and your account balance exceeds what you’ll need? What if your child doesn’t go to college or drops out?
There are ways to use the excess funds without triggering tax consequences. For instance, the remaining assets can be used for graduate school tuition. You could roll over the funds into a sibling’s plan. Your child could eventually name his or her own children as successor beneficiaries.
If your child decides not to go to college or drops out, you can change the beneficiary as long as the new beneficiary—such as a sibling, nephew or first cousin—is related.
There are many advantages to opening a 529 plan as soon as you can, and few if any disadvantages.
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Jeremy Dym is a client service associate with Palisades Hudson Financial Group in Stamford, Connecticut. Palisades Hudson is a fee-only financial planning firm and investment manager based in Fort Lauderdale, Florida, with more than $1.4 billion under management. It offers financial planning, wealth management, and tax services. Its Entertainment and Sports Team serves entertainers and professional athletes. Branch offices are in Stamford, Connecticut; Atlanta, Georgia; Portland, Oregon; and Austin, Texas.
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