Saturday, February 27, 2010

529 Plans

Even though I have two children - and one who is already in college - I have always been a little wary of 529 plans.

I have several concerns:

First, the cost of many plans is pretty high (sometimes well north of 1%);

Second, the investment choices often are limited;

And, third (and most importantly), there is not necessarily a guarantee that the funds will actually be available when needed. What if the market is down at the time money is needed for a tuition payment? For example, what if a parent needed funds in early 2009, when the market was off more than 50% from the levels in the fall of 2007?

None of these concerns, by the way, are necessarily fatal. I have several clients who have put money aside for young grandchildren in Vanguard 529 plans (my preferred provider due to their low costs). If you have a long enough time period (more than 10 years) it seems like a pretty good bet that a gift today will offer considerably more money a decade from now.

Today's Wall Street Journal had a column about 529 plans that indicated that I am not alone in my concerns (I have edited the article; full link is below):

'529' Plans: Why So Many Flunk Out

After posting dismal results during the market downturn, operators of "529" college-savings plans have been cutting expenses and adding lower-risk investment choices in hopes of making their plans more attractive.

The changes are welcome. But they only go so far to improve a savings option that seems to have promised more than it delivers.

[GETGO] Mark Matcho

Inherently, saving for college is challenging because we only have a fixed number of years before the bill is due. So no matter how disciplined we are, timing and luck will play a big role. But that often is ignored by investment firms and state and federal policy makers, who have pushed 529 plans as the answer to soaring tuition costs.

Investors use after-tax dollars to fund 529 accounts, which typically offer a range of funds and other products. Distributions and earnings are tax-free, as long as they're used for higher education.

Here are some common sales promises about the plans—and the starker reality:

529s are a simple way to save for college.

Hardly. Every state offers its own plan, and many offer multiple plans. Within each plan, you may have more than a dozen different investment combinations to choose from, including conservative, aggressive and moderate options that vary widely based on your child's age. Altogether, says Joe Hurley of, there are more than 3,000 possible investment options.

The tax breaks on 529 plans are lucrative.

True, you won't pay federal taxes on investment gains if the money is used for college expenses—but that is a meaningful benefit only if you have meaningful gains. People who invested their 529 money in stocks in the last two or three years may still have losses right now and wouldn't owe taxes anyway. And with a top capital-gains tax rate of 15%, you need to record impressive gains for your tax savings to be significant.

529s are a good fit for everyone.

The longer you wait to save for tuition, the less valuable stock and bond funds are. If you start socking away money regularly before your child is out of diapers, you will have 15 to 20 years to weather the natural volatility of markets and build up decent savings.

But if you start when your child is 12 or older, you have little time to recover from a bad stock market—and we have seen a few lately.

529s are the best college savings option.

Arguably, the best way to save for college is to set aside money regularly, starting as soon as possible, and to mix up your investments. If you plan to save a lot, a 529 plan should be part of the mix. But since it is fairly inflexible—-you can only change your investment choices once a year, for instance—you also may want to buy some municipal bonds, designate some of your regular investments for tuition and keep a college savings account.