More on 529 College Savings Plan

Q: A few weeks ago you wrote about various ways to save for college and said that a 529 plan was by far the best. Could you give more information about these plans and how to start one?

A: 529 plans are by far the best way to save for college, and I write about them every couple of years to keep readers up to date. This week I will describe why you need one and what they are. Next week I'll talk about how to choose a 529 Plan, and the week after that I'll discuss the estate planning benefits — including the "have your cake and eat it too" advantage that 529 plans offer grandparents.

A college education is expensive, but not out of reach if you plan ahead. You can pay for college using savings, scholarships, gifts, employment income and financial aid (mostly loans). The best way to accumulate college savings is with a 529 College Savings Plan.

The term "529 Plan" is a qualified tuition program created by Congress in 1996 that refers to a college savings plan sanctioned by Section 529 of the Internal Revenue Code. All 50 states and the District of Columbia offer at least one 529 Plan. In most cases, you don't have to reside in a state to participate in that plan. A California resident can sign up for a plan in another state. Some states encourage their residents to save for college by allowing contributions to be tax-deductible. For example, if you live in Virginia and contribute to a Virginia College Savings Plan, you can deduct up to $4,000 on your state income tax return. But California residents receive no income tax deduction, so they have no tax incentive to not shop around. Some state plans are sold by advisers at brokerage firms using mutual fund companies that allow the financial adviser to sign you up and help you select the best investment allocation to meet your goals and tolerance for risk. Other states use direct-purchase mutual fund companies that allow you to work directly by mail and telephone.

Two years ago California's Scholarshare College Savings Plan switched managers from Fidelity Investments to TIAA-CREF's Tuition Financing Inc. Benefits of the switch include lower expense ratios and access to index mutual funds from TIAA-CREF and managed mutual funds from Pimco, T. Rowe Price, and Dimensional Fund Advisors.

You can change the beneficiary of a 529 plan at any time. The IRS allows 529 plan owners to change their asset allocation whenever the owner changes a beneficiary or once a year if there is no beneficiary change. All College Savings Plans grow tax-deferred, and when the child uses the money for qualified college expenses, the withdrawals from the plan are tax-free. Unlike custodial CUTMA accounts (California Uniform Trust for Minor's Act) accounts, parents who open 529 Plan accounts keep control over the accounts even after the child turns 18 and 21. Next week I'll tell you what to look for and how to choose a 529 plan. I will also report on which plans Morningstar, the Chicago-based investment research firm, rates as the best and where California's 529 plan stacks up in their ratings.

Kenneth B. Petersen is an investment adviser and principal of Monterey Private Wealth Inc. in Monterey. Send questions concerning investing, taxes, retirement or estate planning to 2340 Garden Road, Suite 202, Monterey 93940 or