Parents may be able to accumulate more money to pay for college by investing in an out-of-state 529 plan. Yet many don’t even know it’s possible. Eighty percent of those who invest in a 529 choose the one in their home state, according to a study by the Investment Company Institute.
That is a potential blunder because some state 529 plans feature lower fees and higher returns that can make a difference in your college savings. For example, according to figures from NerdWallet.com, if you invested $5,000 in Oregon’s plan in 2010, five years later your account would have grown to $7,714. But if you invested the same $5,000 in Michigan’s plan, five years later your account would have grown to $10,017.
I should clarify that I am referring to 529 savings plans, not 529 prepaid tuition plans. 529 savings plans are individual investment accounts that grow tax-free as long as you use the money to pay for college costs. The 529 prepaid tuition plans allow you to lock in today’s tuition rates, usually at a public university in one of the 11 states that offer them. Perhaps because both types of plan have the term “529” in their name, many parents mistakenly believe they can start a 529 only in their own state or use it to pay for in-state tuition. Wrong!
“The good news is that 529 plans, in general, have improved in recent years,” said Liz Weston, a certified financial planner and NerdWallet columnist. But Weston acknowledges, “Costs can vary and so can investment performance.” Now that you know you can invest in an out-of-state 529 savings plan, here’s how you decide where to put your money: Weigh the tax deductions, if any, offered by your own state for investing in its plan against the lower fees and higher profits that may be possible in another state’s plan.
Twenty-seven states plus the District offer tax deductions or credits for investing in their own 529 plan. Nine states do not offer a tax deduction. Another nine states do not have an income tax so cannot offer a deduction against it. And five states will give you a tax deduction for investing in any state’s 529 plan. Here are the states — and the strategies — for each of these categories. (Verify for yourself before making a decision, as states change their programs frequently.)
States: Alabama, Arkansas, Colorado, Connecticut, Georgia, Idaho, Illinois, Indiana, Iowa, Louisiana, Maryland, Michigan, Mississippi, Nebraska, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, Utah, Vermont, Virginia, West Virginia and Wisconsin, plus the District.
Strategy: Assess how valuable your state’s tax deduction or credit really is. For example, the website SavingForCollege.com created a map that shows a couple making $100,000 a year and contributing $100 a month to their child’s in-state 529 plan would get an annual deduction of $360 in Indiana, but just $37 in North Dakota. If your state’s tax deduction is worthwhile, one strategy is to invest the maximum deductible amount in its plan and also invest in another state 529 plan to take advantage of low fees and high returns. This is also a way of diversifying your portfolio.
States: California, Delaware, Hawaii, Kentucky, Maine, New Jersey and North Carolina.
Strategy: Because there is no monetary incentive for staying in-state, you are free to choose a 529 savings plan with a good balance of low fees and high returns. Fees vary dramatically, from just 0.05 percent of your account balance for one Massachusetts 529 plan to 1.09 percent for one Alaska plan.
States: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.
Strategy: Because there is no monetary incentive for staying in-state, you are free to choose a 529 savings plan with a good balance of low fees and high returns.
States: Arizona, Kansas, Missouri, Montana and Pennsylvania.
Strategy: Because you’re going to get a tax deduction regardless of where you invest, choose a state 529 savings plan with a good balance of low fees and high profits.
It’s hard to figure out on your own whether your tax deduction is worthwhile and which state 529 plans offer the best balance of low fees and high profits. Fortunately, there are many resources online and I recommend looking at several, because no one site covers it all.
●Every year, rating service Morningstar ranks 529 plans either gold, silver, bronze, neutral or negative, but without listing their fees or performance, so consider this rating an overview.
●NerdWallet’s calculator asks you your state of residence. It then tells you whether your own state’s plan is worth looking at, plus other state plans to consider. NerdWallet’s tool tells you how its recommended 529s have performed over the past five years and how much they charge in fees.
●Finally, CollegeSavings.org offers the most detailed comparison tool. You choose which state plans you want to compare and the website displays them side by side, telling you whether they are sold directly by the state or by financial advisers (the latter can have higher fees), what those fees are, and even whether the state matches 529 contributions (a few states do this for low-income citizens.) This site also lists minimum starting contributions and maximum lifetime contributions.
Some states require only small minimum contributions, so if cash is tight, this could be a factor in your decision. For example, Utah’s 529 plan allows you to contribute as little as a penny, but one New York plan requires $1,000 to get started. Maximum contributions are another thing to look at, especially if you think your child will go to graduate school. One of Michigan’s 529 plans allows you to sock away only $88,000, whereas two of Virginia’s plans allow you to contribute as much as $500,000.
Still worried you won’t get it right? Take heart. Many 529 plans allow rollovers, giving you the chance to transfer your money from one 529 to another. Plus, investing in any 529 is better than investing in none at all. “The most important thing is to invest at least something,” Weston said. “And keep investing, because anything you save will help reduce your child’s future debt load.”
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