If you have a child, you’ve probably put some thought into their future. And a big part of that future, at least for many kids, will be a college education.
When we calculate the future cost of a four-year education at an in-state public institution for a newborn, we are finding that it’ll take nearly $250,000 for them to earn a bachelor’s degree. Talk about expensive!
Luckily, children have multiple ways to fund education either through part-time jobs, grants, scholarships, or student loans and they have many earning years ahead of them to afford financing education.
However, you can begin saving toward their education now to help pay for some of those future expenses and reduce the amount of debt your child will have to incur.
While there are many ways to save for your kid’s education (savings accounts, UGMA & UTMA accounts, Roth IRAs), my opinion is that a 529 plan is the best.
What is a 529 Plan?
A 529 is an education savings plan. It allows you to invest money into an account, let it grow tax-deferred, and then withdraw it for qualified education expenses without having to pay taxes on it. It’s a pretty sweet deal.
There are two types of 529 plans: prepaid tuition plans and education savings plans. This post will focus solely on the education savings plans as they can be used for any qualified college or university.
Select My State’s Plan or Shop Around?
Contrary to popular belief, you can use almost any State-sponsored 529 plan. Not just the state you live in. With so many choices, it can be hard to decide whether to use your own State’s 529 plan or another one’s.
There are a few things that you should consider when determining which State’s plan is right for you: the investment options that are available to you, the fees associated with the plan, and any tax incentives that your State offers.
Investments
You might hear a lot of emphases put on evaluating the past performance (3-yr, 5-yr, 10-yr average annualized returns) to determine if you should go with a plan. While you do want a plan that has a good track record, this backward-looking metric has no indication of how well the funds will perform in the future.
Instead, you’ll want to focus on the managers of the funds themselves and the way they are positioning the funds for long-term financial gains. This will help you determine if the plan has viable investment options that are suitable for you to achieve your goals.
Fees
Probably more important than the performance numbers are the fees for the plan. Fees have a huge impact on ending account value. The higher the fee, the less money you have in the future. Carefully evaluate the overall fees for the plans you are comparing.
It isn’t always wise to select the cheapest option either. It is possible that the plan manager is offering a higher level of investment management, which aligns more closely with your investment style, making the higher cost worth it to you.
Tax Incentives
Many states offer tax incentives to its taxpayers who contribute to 529 plans. For example, in Indiana, taxpayers are eligible for a state income tax credit of 20% of contributions to its 529 accounts, up to $1,000 credit per year. That means you’ll need to contribute at least $5,000 per year to take full advantage of the credit.
Tax incentives shouldn’t really be a factor when determining which State’s plan to go with if you won’t be contributing enough to get it in the first place.
Always Direct.
No matter which State’s plan you go with, you are going to have the option to go through a broker to open the account (advisor-sold) or do it yourself (direct-sold). You’ll always want to go with a direct-sold plan. The advisor-sold plans have higher annual costs because the broker is getting paid a commission for doing the same work that you can easily do.
If you have questions about selecting the right 529 plan, or how to evaluate a plan’s fees and investments, I recommend seeking out a fee-only financial advisor for help. They’ll be able to help you determine a savings goal and then evaluate which State’s plan matches your needs.