How to Choose The Best 529 Plan

High fees for higher education are a worry for many parents and students. Average payments made for tuition and other college fees are a whopping $31,000 a year. Scholarships, grants, and tax credits help to lower these costs, but for many parents, the expense is still hard to cover.

529 plans can help parents manage the cost of higher education. 529’s are saving plans that make higher education affordable by providing tax and other advantages. The Motley Fool talks about how you can grow tax-free money in a 529, along with the other financial advantages.

What are 529 plans?

Created in 1996, 529 plans are compelling college savings options for several reasons. For starters, money in a 529 plan grows tax-free, and distributions taken to pay for qualified education expenses are not taxed, either. Better still, many states offer tax breaks for their residents who sock money away in the state 529 plan — and thanks to a tax-parity agreement, some states offer tax breaks for money saved in another state’s plan. That’s helpful because you’re not restricted to your own state’s 529 plan — you can park your money in another state’s plan if you like it better.

The parent or guardian is the owner of a 529 plan set up for a child, which is advantageous when it comes to financial aid applications, as there are lower expected contribution rates for parents than for the students themselves. Meanwhile, many 529 plans sport generous contribution limits of up to $400,000 over a lifetime, and they have no income limits for contributors, either, so high earners are not locked out of taking advantage of them.

The main drawback of 529 plans is that once the money is in the account, it’s expected to be spent on education, and isn’t easily withdrawn if you suddenly have another pressing need. Another downside is that many plans charge fees that are higher than those of good mutual funds. Still, with the tax breaks, these plans can be worth it.

How to choose the best 529 plans

There’s no single plan that’s best for everyone, so you’ll need to shop around for the plan that most suits your needs. Note that within any state’s offerings, you’ll likely have to choose between a prepaid plan or an investment plan.

With a prepaid plan, you’re paying for a year (or part of a year) of tuition before you have to, locking in a price. If you do so many years before Junior matriculates, you may save a lot. On the other hand, you can also get locked into a public state college and may leave your child with less flexibility — unless you withdraw it and realize gains that are smaller than what you would have earned in an investment plan. The investment-plan variety of the 529 plan offers more flexibility and control.

With any plan, you’re considering, check to see what tax breaks it would offer you. Be sure to review the investment options each candidate plan offers you. For example, see whether you like the index funds or mutual funds available to you in a plan. Assess the fees, too. If you’re expecting an annual return of around 8% but are going to fork over 2% in fees, you’re shrinking your expected return by a quarter.

If the fees wipe out the tax benefit, then take that into consideration, as well. You should be able to find good plans with fees of 0.75% or less, if not 0.50% or less. Also, think twice before opting for advisor-sold plans, as they can charge much higher fees than direct-sold ones that you sign up for through a state’s plan’s website.

Standout 529 plans

You can research plans at savingforcollege.com, getting details on fees, performance, and tax breaks, and some Googling will turn up lists of top-rated plans. Below are four plans that were deemed “Gold-Rated” by the folks at Morningstar last year. Each is direct-sold.

• • The Maryland College Investment Plan
  • Alaska’s T. Rowe Price College Savings Plan
  • Nevada’s Vanguard 529 College Savings Plan
  • The Utah Educational Savings Plan

Morningstar cited reasonable fees and “compelling” investment options for the Maryland and Alaska plans, both of which are managed by T. Rowe Price. Nevada’s plan is managed by Vanguard, long known for low fees and solid index funds. Utah’s plan also offers Vanguard funds. New York and Virginia plan also get mentioned on some lists of top 529 plans.