Mention "college savings" to a financial professional and you'll likely be steered to a 529 plan.
In the decade since these investment accounts were created, they've become practically synonymous with college savings. Savingforcollege.com and the College Savings Plan Network are exclusively focused on 529 plans, for instance.
But many parents who have invested in 529s, counting on the market to help cover the soaring costs of college, would've been better off putting the money under their mattresses.
The plummeting stock market has erased many if not most gains. The balance could be less than the parents have contributed. And parents of older children, in particular, don't have much time to make up losses before they need to pay tuition.
Margot Black, a Los Angeles writer and publicist, put $15,000 into a 529 plan for her toddler son, only to see the account lose 40% of its value in less than a year.
"It was heartbreaking to watch," Black said. "The 529 plan is sold to parents as the no-hassle investing fund. . . . I honestly thought we had done such a good job upfront that we could relax."
Simply put, 529 plans don't live up to the hype. Though they remain a good choice for some, you should understand the trade-offs and alternatives before putting your college fund into one of these heavily marketed plans.
"People like to think they have a college savings account that will solve their college goal," said Tim Higgins, the author of "Pay for College Without Sacrificing Your Retirement." "But a majority of the people investing in these should be looking at other avenues."
What is a 529?
A 529 plan provides tax-free growth on money you've put away for college or technical school. You sign up for a 529 account on behalf of a beneficiary, typically a child or grandchild. You contribute after-tax dollars, but you pay no federal taxes on withdrawals for qualified college expenses."There are very few opportunities the government gives us to earn money tax-free. This is one of those," said John Gugle, a certified financial planner in Charlotte, N.C.
The plans are administered by state agencies and often managed by the same mutual fund companies that invest 401(k) and similar retirement plans.
Questions to ask before opening a 529 account:
- Do I have enough time before my children are in college to expect serious growth in this account?
- What are the fees and benefits associated with the state-run plan?
- Are there out-of-state plans with better underlying performance and lower fees?
- What are my options if my child doesn't go to college or I decide to close the account?
Each state determines how to structure its plan. Many offer a deduction from state income tax for annual contributions up to a specified amount.
If you opt for an out-of-state 529 plan, you forgo in-state benefits but still receive the federal tax exemption. (Several states also offer 529 prepaid tuition programs, which are different from the plans addressed in this article. In these, you pay for future tuition today, at today's prices.)
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Unlike other college-savings accounts, which are legally the property of the child, 529 plans are controlled by the adult who opened the account. You may change the beneficiary to another family member.
They've become incredibly popular, with 11 million accounts nationwide, said Chris Hunter, a spokesman for the College Savings Plan Network. Every state (and Washington, D.C.) offers at least one 529 plan, for a total of 85 savings plans. Assets totaled $129 billion as of June 30, up from $15 billion in 2001, according to data from the savings network.
The problems with 529 plans
Sound good so far? Unfortunately, 529 plans are neither simple nor problem-free. Here are the biggest drawbacks.- Investors in 529 plans pay at least two layers of fees. The 529 administrator gets one fee, and the manager of each underlying mutual fund receives a second. If you purchase a 529 plan through a broker, you pay a third fee. Many plans also charge an annual fee of $20 or so. Those are hefty charges compared with, say, a no-load mutual fund.
- 529 plans offer a limited range of choices. When you open an individual retirement account or a brokerage account, you can generally choose from a broad range of stock and bond funds, commodity investments, foreign currencies and bank products. Not so with 529 plans: You're limited to a few options the plan manager has chosen.
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529 plans: Pros and consMorningstar's Marta Norton discusses the basics, benefits and drawbacks of these college savings vehicles.
- You can change investment choices only once a year. In most other investment accounts, you can make multiple changes in your portfolio during a year. 529 plans restrict your ability to respond to market changes by revamping your investments.
- The options are often confusing. Of course, sometimes too much choice is difficult. Looking at the variety of 529 plans listed by Savingforcollege.com and the College Savings Plan Network can make you dizzy. Parents who've made it through the lengthy decision-making process may be less than enthusiastic about revisiting their plan and its investment allocations on an annual basis, as many financial advisers recommend.
- Colleges consider a 529 account a parental asset for purposes of financial aid. The money you save in a 529 plan counts against you when colleges calculate the family's expected financial contribution. "We have a family that needs financial aid but won't get it because they have a 529 plan," said Manuel Fabriquer, a college planner in San Jose, Calif.
- You escape federal taxes only on the account's growth. That's great if your investments soar, but if they decline, you get no break at all. This last point is the key right now.
Continued: No real tax benefit
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