Saving For College? These Plans Make the Grade
By Lori Schock, Director, Office of Investor Education and Advocacy, U.S. Securities and Exchange Commission
Parents looking for a way to save for a child's college education should consider investing in a 529 plan. Authorized by Section 529 of the Internal Revenue Code, these are tax-advantaged savings plan sponsored by states, state agencies and educational institutions, designed to encourage saving for future college costs.
There are two types of 529 plans: 1) pre-paid tuition plans; and 2) college savings plans. All 50 states and the District of Columbia sponsor at least one type of 529 plan.
Pre-paid tuition plans generally allow college savers to purchase units or credits at participating colleges for future tuition and, in some cases, room and board. Most pre-paid tuition plans are sponsored by state governments and have residency requirements.
College savings plans permit an account holder to save for a student beneficiary's eligible college expenses, and funds from these plans typically may be used at any college. Investment options for college savings plans often include stock mutual funds, bond mutual funds and money market funds, in addition to age-based portfolios that automatically shift toward more conservative investments as the beneficiary gets closer to college age.
Is a 529 Right for Me?
Before you start saving for college, consider your overall financial situation and other financial goals. Keep in mind that if you do not use the money from a 529 account for higher education expenses, you may face penalties or lose benefits.
The best way to make an informed decision about any college savings plan is to understand its terms. Read the plan's disclosure documents, which can be found on the plan’s website. The College Savings Plans Network provides links to most 529 plan websites.
An important consideration is whether investing in a 529 plan sponsored by your home state is best for you:
- Does my home state's plan offer tax advantages or other benefits?
- Do the tax advantages or other benefits offered by my state outweigh the benefit of investing in another state's less expensive plan?
- What happens if I change my state of residence?
- Will I pay recapture penalties for rolling money out of my home state's plan into another plan?
Investing in a 529 plan may offer tax benefits. Earnings are not subject to federal tax or (in most cases) state tax, if withdrawals are used for eligible college expenses.
However, if you withdraw money from a 529 plan and do not use it on an eligible college expense, you generally will be subject to income tax and an additional 10 percent federal tax penalty on earnings.
Some states also allow residents to deduct contributions to 529 plans from income tax returns for the state that sponsors the plan, but this benefit likely will be available only if you participate in a 529 plan sponsored by the state that is your state of residence.
Fees and Financial Aid
Fees and expenses will vary based on the type of plan. Prepaid tuition plans typically charge enrollment and administrative fees. Direct-sold college savings plans may charge enrollment fees, annual maintenance fees and asset management fees. Your asset management fees will depend on the investment option you select. You generally will pay additional fees if you invest in a broker-sold plan.
Investing in a 529 plan generally will reduce a student's eligibility to participate in need-based financial aid.
Don't Pay Too Much
Here are a ways you can reduce or avoid some fees and expenses when investing in a 529 plan:
- Invest in a Direct-Sold Plan. States offer a college savings plan in which residents and, in many cases, non-residents can invest without paying a "load," or sales fee. These plans can be purchased directly from the plan's sponsor or program manager without the assistance of a broker, and do not charge a sales fee that may apply to broker-sold plans.
- Make Regular Contributions. Some college savings plans will waive or reduce some of your fees if you participate in an automatic contribution plan.
- Consider Your Home State's Plan. If you are a resident of a state sponsoring the 529 plan, you may pay lower fees than non-residents. In addition, you may receive state tax benefits for investing in your home state's plan.
- Ask for a Breakpoint Discount: If you purchase a broker-sold college savings plan, you may be able to reduce sales fees if you invest or plan to invest above certain threshold amounts. These "breakpoint discounts" apply only to Class A shares, which charge an up-front sales fee when you invest in your plan.
If Needed, Consult a Financial Professional
Remember that there are many 529 plans and other options for saving for college. If you need help determining which option works best for you, consult your financial advisor, tax advisor, or broker.
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues upon the staff of the Commission.