Home » Understanding College Savings Plans

Understanding College Savings Plans

If you or your children have higher education in the future, then you probably also have headaches over rapidly rising college costs.

The average price tag for a four-year, in-state college degree is running around $50,000. And it’s increasing an average of 7.2% per year.

To get ahead of this steep curve, millions of Americans are investing in 529 Plans, state-sponsored savings schemes earmarked for education expenses. There are more than 80 such plans on the market today, most of which are the so-called College Savings Plans.

How do 529 College Savings Plans work?

Somewhat akin to a 401K, a college savings plan is a managed investment portfolio.But unlike the retirement savings vehicle, your investments are made with post-tax dollars. You earnings are tax-deferred, however, and a withdrawal for approved expenses is also tax-free.

Also like a 401K, your can pick your portfolio according to your risk tolerance. You can even adjust that tolerance according to age of the beneficiary with an actively managed fund. For example, when a student has years to go until college starts, the portfolio can invest aggressively; when college is right around the corner, the plan can switch to a more conservative tact.




Sounds great, but what is the downside?

As alluded to above, college savings plans are just one type of 529 Plan – the most popular type, in fact. The other kind of 529 Plan is a prepaid tuition plan. With a prepaid tuition plan, you lock in today’s rate of tuition for tomorrow’s college degree. The return on your investment is therefore guaranteed – you know what you are going to get and when you are going to get it.

With a college savings plan, the risk is slightly higher in that you are not guaranteed the final payout. If the stock market grows faster than tuition inflation, you could do much better with a college savings plan than a prepaid plan. But if your growth does not at least keep pace with the rising tuition costs, then you will not fare as well.

Keep in mind that you can increase the long-term value of your fund by investing early – and investing often. The earlier you start your college savings plan, the longer your monies have to earn the coveted double-digit returns.

I’m still not convinced.

If a greater potential return does not sway you, then consider this: College savings plans offer students greater freedom and more choice. Two essential qualities for the prospective college freshman!

As the beneficiary, you can apply the value of your college savings plan to the costs of your education at any college or university in the United States. Private, public, in-state, out-of-state, even many programs abroad – the choice is yours to make.

You never need to worry about penalties for going out of state, or for picking a different school than you or your parents originally invested in. Yes, prepaid plans offer some flexibility – but often at the price of losing part of their value.

Another benefit of a college savings plan is the freedom to direct the risk level of your investment.




What are the tax benefits of a 529 College Savings Plan?

Investments in a 529 College Savings Plan are tax-deferred until it is time to for university. Your withdrawal is also tax-free (if used for approved educational expenses). For plan holders, a 529 College Savings Plan will reduce your state income tax burden by the amount of your investment – or a portion thereof.

Which states offer a 529 College Savings Plan?

Every state in the Union and the District of Columbia offers at least one college savings plan. Several states offer three or more plans, with differing fees, structures and risk levels. There are currently 38 broker-sold savings plans and a total of 61 direct-sold plans.

With so many 529 College Savings Plans on the market today, how do I know which one is right for me?

Unfortunately there is not an easy answer to that question. Sure, plan A might consistently outperform Plan B. But Plan B offers a significant tax break on your state income filing.

Picking the right plan for you depends on several factors:

1. Do you want to make this decision alone? Or do want an adviser to help you weigh your options?

There are a host of no-commission (also known as no-load) funds, many of which have great performance records. But a no-load fund requires you to do the legwork in determining whether that investment meets your needs.

An adviser, on the other hand, will cut your work done to nothing but signing the enrollment forms. You will, however, pay a commission for that service – sometimes as hefty as 3-4%.

2. How has the fund performed so far? What are its projections for the future?

Here is where an agent can cut the work for you. If you do decide to go it on your own, though, look to the fund’s historical returns and predicted volatility. You’ll also want to examine your risk tolerance and the age of the beneficiary.

3. What are the associated fees?

All funds have enrollment fees (usually modest) and some have annual fees (usually a percentage of earnings, but sometimes a flat fee).

4. What are the plan’s terms?

Be sure to check the fine print: time limits, maximum contribution allowances, state tax breaks and allowable expenses.

 

Prepaid Tuition Plans >>>