Question: I am thinking about setting up a 529 college savings plan. My research tells me that they are available from all 50 states and the District of Columbia. Can I get a deduction on my income tax return for the money I put in?
Answer: While every state’s 529 Plan grows tax-deferred and allows tax-free qualified distributions, some states allow the account owner or contributor a current income tax deduction on contributions. Unfortunately, California does not. And contributions to a 529 plan are not deductible on a federal tax return.
What investments are available in a 529 Plan?
You will want your contributions in a 529 Plan to grow and compound, which means you will need a plan with good investment options. The selection process can be a daunting task. If you are not well-schooled in how to select and manage investments, you will probably want some help. Some state plans let you pick and choose your investments and others offer “canned” options. I will use Virginia and California plans as examples, because they offer the two extremes.
In Virginia you need a financial advisor to invest in the CollegeAmerica 529 plan, which allows you to select from 25 different mutual funds within the American Funds group. The plan also has seven target-date funds and multi-fund portfolio funds. You and your investment advisor can build a well-rounded, diversified portfolio that suits your investment objectives, time horizon, and risk tolerance.
On the other hand, you can enroll directly in California’s Scholarshare College Saving Plan without going through a financial advisor. Tuition Funding Inc, a subsidiary of TIAA-CREF which currently manages California’s plans, offers age-based, multi-fund, and single fund portfolio strategies that allow you to build a custom strategy. Scholarshare offers both actively managed funds and passively managed index funds.
What are the fees?
Fees vary by plan. However, because of increased competition among 529 plans, fees are trending lower, and some of the more expensive plans are now shut down. Still, make sure you do your due dilligence and understand all the fees you will be paying. You will need to know any administration or management fees charged by the 529 plan and/or the financial company managing the plan, and also the fees charged by the investments in the plan.
How do I research fees and other features of 529 Plans?
Here are a few articles and websites to start with:
IRS' Fact Sheet 2009-12 article that describes 529 plans
“529 Plans: Questions and Answers,” on the IRS' website
SEC’s publication: “An Introduction to 529 Plans.”
What are the best and the worst plans?
Morningstar, a Chicago-based investment research company, reviews 529 plans annually. In their latest report just published last week, their analysts identified 29 plans that are likely to outperform their peers on a risk-adjusted basis over a long period of time.
Seven plans earned Morningstar’s top Gold or Silver rating. They were: Arkansas’s T. Rowe Price College Savings Plan, Maryland’s T. Rowe Price College Investment Plan, Utah’s Educational Savings Plan, Nevada’s Vanguard 529 College Savings Plan, Ohio’s CollegeAdvantage Plan, Virginia’s CollegeAmerica American Funds Plan, Michigan’s TIAA Education Savings Program, and Virginia’s Virginia529 inVEST Plan. The 2014 Morningstar picks for the worst plans were South Dakota’s Allianz CollegeAccess 529, Arizona’s Ivy Funds InvestEd 529 Plan, and Kansas’sSchwab 529 College Savings Plan.
Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning. Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA93940 or email them to email@example.com.