Covering your kids' college tuition is an admirable goal, but before you start socking money away, you may want to take a crash course in the dizzying array of education savings vehicles.
Among the most popular are those known as 529 plans, but shopping for them is no simple task. The plan or plans offered in your state may have tax savings, but do the math carefully: Depending on the fees and investment options, you may find a better deal somewhere else.
Part of the reason 529 plans seem so complicated is that they are relatively new and, as with any unfamiliar product, there's a learning curve for everyone, from state officials and financial planners to participants.
The earliest versions, introduced in the 1990s, were simply prepaid tuition plans that allowed participants to lock in today's education rates. Usually they were good only in the state where they were purchased.
The more modern 529 plans, popularized after a 2001 tax law change, are simply savings vehicles. Contributions are allowed to grow tax-free, and the resulting nest egg can be spent anywhere, as long as the funds are used for qualified education expenses. This type of plan is offered in the District and every state but Washington. Some states offer more than one version, sometimes aimed at different types of investors. This has left consumers with more than 80 choices, but not all of them are good, said Kerry O'Boyle, an analyst with Morningstar Inc.
In general, it makes sense to start shopping close to home, because you could get a state tax break on your contributions. All 529 plans qualify for federal tax breaks, though how well you'll do depends on your bracket and how much you contribute. Look over your home state's plan carefully before committing to it. Lofty fees and less-than-stellar fund management can easily eclipse any tax savings.
"Tax breaks may not be enough to warrant going into a high-priced or mediocre to lousy plan if that's all your state offers," O'Boyle said. "Maybe it's worth it to stay home for a decent or even mediocre plan, but if the tax breaks aren't that significant, and the investment options aren't that great, it pays to do some research and go to another state."
Whatever 529 plan you choose will be only as good as the fund shop that administers it. And while you may lose some state tax incentives by shopping around, you could gain a lot in terms of performance with a solid plan administered by a low-cost provider. Because these investments are held for many years, expenses can really add up over time.
For do-it-yourselfers, there are excellent direct-sold plans, such as those managed by T. Rowe Price in Alaska and the Vanguard Group in Utah, O'Boyle said. For investors who prefer going through a broker, one of the better options is the plan administered by American Funds in Virginia.
As with any investment, it pays for the buyer to beware. Last month, Ameriprise Financial Inc., a brokerage and insurance unit recently spun off from American Express, was fined by regulators for not properly supervising the sales of its 529 education plans. Ameriprise was also ordered to compensate more than 500 customers whose accounts were hurt in the case.
If your financial adviser or broker is shepherding you into a specific plan, find out why. If you're being encouraged to purchase an out-of-state plan, ask if you'll lose out on tax breaks. If you will, figure out whether it's worth the loss.
Once you've found a 529 plan you're comfortable with, you'll need to figure out which investments you should hold. You'll want a mix of assets appropriate for your time horizon, and you should be prepared to adjust it to a more conservative allocation over time. A portfolio that's being begun for an 11-month-old should look different from one being started for a 13-year-old.
If you're not comfortable making decisions about which investments you should hold, check to see if your plan offers an enrollment-based portfolio. This works much like a target-retirement fund; it's targeted to the student's age and will automatically adjust to a more conservative allocation as time goes by.
Online calculators can help you decide how much to save. A free calculator on T. Rowe Price's Web site can help you figure out the average cost of public school versus private school, depending on how many children you have. This should not be viewed as an all-or-nothing scenario, said Stuart Ritter, a certified financial planner with T. Rowe.
The idea is to help your child pay for college, not necessarily to fund the entire endeavor. It's also important to remember, as you juggle this with your other financial obligations, that there are no scholarships or financial aid for retirement.
"Figure out a general ballpark of what you'll need, then, knowing that number, decide, balancing it with retirement, how much you can commit, knowing there will be other options for your kid when they go to school," Ritter said.
"Don't get so overwhelmed by the decisions you have to make that you don't make any. Recognize that saving something is better than saving nothing, but make sure you balance any savings in a 529 plan with the goals you have for yourself in terms of retirement."