What are the best states for a 529 education savings plan? What problems are there with these plans? These are tax-advantaged programs, sponsored by states, that allow your investments to grow tax-free and be spent without a tax bite for educational expenses. Stephen Nelson, a wealth manager at Aldrich Wealth in Carlsbad, Calif., tells us how to pick the right one for you:
Larry Light: Let’s say I’ve decided to start contributing to a 529 plan for my kid’s education. Now what?
Stephen Nelson: 529 plans are the best way to save for college due to the tax-free growth and tax-free withdrawals if used for college expenses. However, the decision doesn’t end there. There are some more hidden hurdles with 529s that many people are unaware of that could hurt their savings growth or make the withdrawal process frustrating when it actually comes time to pay for college.
Light: What are some of these obstacles that people aren’t thinking about?
Nelson: First thing, direct sold savings programs versus broker sold savings programs. Many people don’t know the difference when they sit across from an advisor and are discussing setting up a 529 Plan.
Broker sold programs are 529 plans set up through an advisor or broker. You can’t enroll in these programs on your own. But direct sold programs can be enrolled in directly through each state’s plan manager and done from your home computer. Most people don’t realize that the direct sold programs are better and less expensive than the broker sold kind. The fees and sales charges on broker sold programs are so high, you’d be better off not even funding a 529 plan.
Light: How do you know if it’s a broker sold program?
Nelson: If your advisor can provide you the paperwork and submits it on your behalf, it is one. Instead, insist on getting guidance on a direct sold program or sign up yourself at home. A good advisor can walk you through setting up a direct sold program on the computer and save you a whole lot on fees.
Light: What other problems are lurking?
Nelson: The second hidden hurdle is in the administration of the plans themselves. Imagine you’ve saved up all this money for your kid’s school, but then when it comes to pay the tuition bill, the check never arrives at the school from the 529 plan. One of the most frustrating things to deal with as a parent trying to pay for college is when the administrators for the 529 drop the ball on getting checks disbursed on time.
Many people don’t think about the process of actually distributing the funds when it comes time to pay for college. Not all plans are the same, since they each have their own administrative teams. I would generally advise against choosing a plan that has had gone through recent updates, especially if you are planning on using the funds for K-12 education or Junior will be attending college in the next few years.
Light: What states have had recent program changes?
Nelson: States that have had substantial changes in their plans in the past five years and may still be struggling with getting the administration of the plans up to speed: Washington, Texas, Oregon, Mississippi, Montana, Kentucky, Illinois, Washington D.C. and Rhode Island. I would look for a plan with a long tenure with the same plan administrator.
Light: OK, say I’ve chosen my plan but picking the investments is making me nervous. How do I go about selecting investments for my child’s future?
Nelson: It’s easy to do, but don’t overthink this. The simplest solution will do much better than trying to continually make adjustments along the way. When you set up your plan, you’re usually presented with three options:
Age-based portfolios, which have investments that start out aggressive, often more concentrated on stocks, and then slowly become more conservative as the child ages, meaning usually more bond-heavy. Second are static investment portfolios, whose investments will always stay the same. The third type isn’t pre-packaged. You build your own. That is, you can select your own funds and assemble your own portfolio.
The simplest solution is an age-based portfolio. The fund will automatically be diversified and the de-risking of the investments as your child approaches college will be handled for you. You can then focus your attention on saving rather than trying to adjust the allocation dials.
Given this, even with a newborn child, 18 years isn’t a very long time for an investment horizon, so I caution against an overly aggressive age-based portfolio. In general, a moderate or balanced portfolio—one not too tilted toward stocks—matches better with the time horizon of when these funds will be needed.
Light: What specific 529 plans do you recommend?
Nelson: If your state doesn’t offer a tax deduction or credit for contributions, my favorite plans are with Utah’s My529, Nevada’s Vanguard 529, and California’s ScholarShare 529. These are all low-fee plans with high-quality investment options.
