529 plans definitely fall under the heading of Not All Created Equal. The good news is, if you’re in a bad one, it’s pretty simple to make a change and the only cost should be your time to make the change.
Every state offers its own 529 plan. Many states also offer 529s that advisors can sell. In addition, there are prepaid tuition plans, most of which are 529s with some additional restrictions. You can invest in any state’s 529 and use that money at any institution that’s eligible for federal Title IV funds. This includes state universities, community colleges, private nonprofit and many private for-profit colleges and universities.
The first question to ask in choosing a 529 is, does your state offer a tax deduction for contributions to your state’s plan? If so, it’s usually hard to beat that guaranteed return so you want to contribute at least that much to your state’s plan. For example, Oregon offers a state tax deduction for contributions up to $4,750. With our state income tax rate of 9%, that means you get an automatic 9% return on your first $4,750.
The next question to ask is, what are the plan costs? If your state’s plan has very high costs, then you might add an account in a lower-plan-cost state like Utah or Nevada once you’ve maxed out your state tax deduction. And just because your plan offers Vanguard funds doesn’t guarantee that it’s low cost: the plan may add costs by increasing expense ratios or assessing account, enrollment or program management fees.
Investment choices matter too. The best plans have multiple age-based investment options from conservative to aggressive to accommodate different risk profiles.
If you’re considering an advisor-sold plan, you must also look at the fees. Many such plans charge front-end loads. These sales charges are often 5% or more of the amount you invest, meaning that for every $100 you contribute, your advisor pockets $5 and you only invest $95. Since your “normal” state plan will put you in an age-based portfolio and rebalance it for you based on your expected college start date, without your advisor getting involved, it’s difficult to see a scenario in which an advisor-sold 529 makes sense. (And I’m a financial advisor!!) Plus, most of those plans allow account balances to be reported back to your advisor if your goal is to be able to see everything in one place.
Prepaid plans work slightly differently and may or may not be appropriate at all. Under these plans, you get tuition credits for your investment, and those credits grow at the same inflation rate as tuition in the applicable plan. When states offer them, the growth rate is pegged to in-state tuition. The Private College 529 uses the average inflation rate for its member schools. Typically, funds in these plans can only be used for tuition, and if you end up going outside the network you might receive a different inflation crediting rate. So while they can provide a good hedge, they typically need to be paired with a regular 529 in order to cover a broader range of expenses and school choices.
If you’re in a bad 529, what can you do? Roll your account over to a better one. Savingforcollege.com has a comprehensive list of plans including details on state tax deductions, plan fees and more. Once you’ve chosen the right plan and opened your account, the new plan will assist with the rollover.