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As
the Occupy Wall Street protests draw attention to the
struggles of young adults, among others, some parents
are determined to spare their children the burden of
college loans.
Many
worry about the college funds they’ve been able to
build. Last quarter, the average mutual fund that
invests in stocks lost 17 percent. The average 529
college savings plan, which invests in a mixture of
stocks and bonds, lost 8.9 percent, according to a
recent Morningstar 529 plan study.
But if
you’ve been worried about your losses, you might have
more control than you think about the outcome if you pay
attention to a few details.
For
example, some 529 plans charge high fees and give you
little in return. And some require you to get help from
a financial adviser, but often parents and grandparents
can do better on their own simply by investing directly
in a top-quality 529 plan.
As
consumers become savvy about their 529 college savings
options, they are moving money from expensive and weak
529 plans into those that grow money more effectively.
During a recent 12-month period, plans sold by advisers,
which are often more expensive, lost more than a
percentage point of market share relative to those sold
directly to individuals, according to Morningstar.
But how
do you know if you are getting a good deal on a 529?
Start
your analysis by finding out from your state’s
department of education if your home state offers a 529
and whether you get a tax break by investing in it.
Some
states will allow you to invest in any 529 outside your
state and get a break on your taxes. But most give you a
tax benefit only if you choose the 529 in your state.
The usual benefit: You can subtract the amount of money
you invest in a 529 from your taxable income when you do
your tax return. That’s a good deal.
Some
states, however, are even more benevolent. Indiana gives
its residents a credit of 20 percent on the first $5,000
they invest a year in their state 529. People from
Indiana can save up to $1,040 on a $5,000 investment,
said Morningstar. Maine gives residents a $500 grant if
they open a 529 before their child’s first birthday.
Other states such as Illinois offer less — just $250.
And income requirements also must be met in some states
to qualify for tax benefits.
If you
live in a state that offers a sizable tax break, think
twice about going with a financial adviser suggesting an
out-of-state plan.
Financial
advisers are sometimes attracted to plans that pay them
the highest fees. Others have better motivations —
taking you to a distant state’s plans because the
performance is better than where you live. Truly
outstanding performance is sometimes worth passing up a
tax benefit.
But how
do you know? The star rating given to a 529 by
Morningstar can help. Those with three stars rank in the
middle of the pack, and those with four and five stars
are best. The rankings are based on three-year
performance averages. Usually the longer a plan has good
performance, the more reliable it will be. But be aware
that some states have had lousy managers who have been
replaced, so the performance of current managers isn’t
showing up yet in three-year records.
What
might surprise you as you consider performance, however,
is that it isn’t necessarily genius stock and bond
picking that makes the grade. Rather, Morningstar found
that the 529 plans that often rank among the best are
those that charge the lowest fees.
For
example, New York’s 529 Program and Utah’s
Educational Savings Plan use low-cost Vanguard index
funds, and they rank highly. Parents pay only about 0.25
percent to cover their required fees. Meanwhile,
sometimes a fund like New Jersey’s Franklin Templeton
ranks highly despite extraordinarily high fees of 1.7
percent. Try to pick a 529 with fees no higher than the
average of 0.87 percent, and bond funds should have
lower fees than stock funds.
Also,
realize that your mixture of stocks and bonds matter
too. While bonds have been the most friendly investments
lately, and you want to invest conservatively in bonds
if your child is within a couple of years of college,
you are likely — although not guaranteed — to amass
more money for college if you use some stocks in your
529 for young children.
According
to Morningstar, the average 529 plan invests 82 percent
in stocks for very young children. For a 14-year-old,
the average stock exposure is just 33 percent. At age
18, it’s down to 11 percent.
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