Smart Strategies For 529 Savings Plan Investments

A 529 plan is a savings plan that can be used to cover college and other eligible education costs. It helps reduce taxes and offers flexible and versatile investment options. There are two types of 529 plans: a college savings plan and a prepaid tuition plan. The former allows you to invest in potentially high-return assets such as stocks, while the latter lets you prepay tuition at an in-state school. The plan is designed to provide tax-free investment growth and withdrawals for qualified education expenses. It is important to note that there are rules and restrictions regarding 529 plans, such as the requirement to use the funds for qualified education expenses to avoid penalties.

Choosing the right 529 plan for your needs

• Performance: Evaluate the annual return on investment offered by different 529 plans.
• Cost: Consider the fees associated with the plan, such as sales charges and the asset-based expense ratio.
• Direct-Sold vs. Advisor-Sold 529 plans: Direct-sold 529 plans typically have lower fees than advisor-sold plans. Direct-sold plans do not charge sales commissions, while some advisor-sold plans do.
• Tax Benefits: 529 plans offer tax advantages, including tax-deferred earnings and tax-free distributions for qualified education expenses. Additionally, contributions to a 529 plan may provide gift tax avoidance and estate planning benefits. Many states also offer state income tax deductions or credits for residents contributing to their state's 529 plan.
• Investment Options: 529 plans offer limited investment choices, including static and multi-fund portfolios based on passive index funds or actively managed mutual funds. Some plans offer FDIC-insured investment options or exchange-traded funds (ETFs).
• Minimum Contributions: The minimum contribution requirements vary by state, ranging from as low as $15-$25 per month in some states to higher amounts like $250-$3,000 in others.
• State Tax Benefits: Consider whether your state offers a state income tax break on contributions to its 529 plan. If not, compare the fees and investment options of out-of-state plans to determine the best option.
• Risk Tolerance and Investment Time Horizon: Assess your risk tolerance and how long you plan to invest. Some plans offer multiple age-based investment options differentiated by risk tolerance.

When choosing a 529 plan, weigh the trade-offs between factors like return on investment and fees. Additionally, consider your state's direct-sold 529 plan and whether it offers competitive fees or state tax benefits. Research and compare plans from other states as well, especially those with low fees and top overall ratings. Ultimately, select the plan that offers the best combination of high investment returns and low fees, while also considering any applicable state tax benefits.

Understanding the different types of 529 plans

There are two main types of 529 plans: education savings plans and prepaid tuition plans.

Education Savings Plans

Education savings plans are the more common type of 529 plan. They offer tax-deferred growth, and withdrawals are tax-free when used for qualified education expenses. These plans remain under the control of the donor, who can be a parent, grandparent, relative, or friend. The account holder contributes money to the plan, which is then invested in a preset selection of investment options, usually mutual funds.

Many 529 plans offer target-date funds, which adjust their assets as the years go by, becoming more conservative as the beneficiary approaches college age. Withdrawals from a 529 savings plan can be used for college and K–12 qualified expenses, including tuition, fees, room and board, and related costs.

Prepaid Tuition Plans

Prepaid tuition plans are offered by a few states and some higher education institutions. They allow account owners to lock in current tuition rates for future attendance at selected colleges and universities. Given the rising costs of tuition, this generally means locking in lower prices for college later on. Prepaid tuition plans are not available for K–12 education.

Unlike 529 savings plans, prepaid tuition plans do not cover the costs of room and board. They may also place a limit on which colleges they can be used for. Additionally, the money paid into a prepaid tuition plan is not guaranteed by the federal government and may not be guaranteed by some states.

Completing the 529 plan application

Once you've chosen a 529 plan and owner, the next step is to apply for the account. You can use an online tool such as Enroll Now to open an account. To enrol in a 529 plan account, you will need the account owner's and beneficiary's names and specific personal information, including social security numbers, date of birth, addresses, and phone numbers.

It's important to note that you will need to know the child's date of birth, social security number, and what investment choices you want before you start the application process.

After you've completed the 529 plan application and it's been approved, you can start depositing money into the account. There are a few different ways to do this, including initial contributions, ongoing contributions, and rollovers from other accounts. You can also set up automatic contributions from your bank account to make managing your 529 plan easier.

Selecting 529 plan investments

When selecting a 529 plan, it is important to consider the investment options available to you. There are two primary 529 plans: education savings plans and prepaid tuition plans.

Education Savings Plans

These are tax-advantaged investment accounts designed for education savings. They work similarly to a Roth 401(k) or Roth IRA, where your after-tax contributions are invested in mutual funds or similar investments. You can choose from a range of investment options, including various mutual fund and exchange-traded fund (ETF) investments and a principal-protected bank product.

Education savings plans also offer static fund portfolios and age-based portfolios (target-date portfolios). Static fund portfolios maintain the same mix of investments over the life of the plan, while age-based portfolios automatically adjust their assets over time, becoming more conservative as the beneficiary approaches college age.

Prepaid Tuition Plans

Prepaid tuition plans allow you to lock in current tuition rates for future attendance at selected colleges and universities. They are typically offered by a few states and some higher education institutions. Prepaid plans are not available for K-12 education and do not cover room and board costs.

Factors to Consider

When selecting a 529 plan, there are several factors to consider:

• Tax benefits: Different states offer varying tax benefits for 529 plans. Consider the state tax deductions or credits offered by your state and compare them with other states' plans.
• Fees and expenses: Understand the fees and expenses associated with each 529 plan, as they can vary significantly. Consider enrollment/application fees, annual account maintenance fees, program management fees, and asset management fees.
• Investment options: Evaluate the investment options available within each 529 plan and choose one that aligns with your investment objectives and risk tolerance.
• Performance history: Review the historical performance of the 529 plan to assess its potential for growth and returns.
• State residency: While you are not limited to your home state's plan, investing in your state's plan may offer additional tax benefits or incentives.

Funding the 529 plan

Funding a 529 plan is a relatively straightforward process, with a few key considerations to keep in mind. Here are the steps to funding a 529 plan:

Choose a 529 Plan:

Firstly, you'll need to decide between a savings plan and a prepaid plan. While you can open a plan with any provider, it's recommended to prioritise the quality and cost of the plan over any potential state tax benefits. Every state offers a 529 plan, and it's possible to open multiple plans in multiple states. However, each state's plan has its own advantages, and some may be limited to residents. It's essential to research and compare the plans to find the one that best suits your needs.

Choose a Beneficiary:

The beneficiary will likely be your child, but it's important to remember that you can change the beneficiary at any time without penalty. The beneficiary must be a US citizen or resident alien and have a Social Security number or tax identification number. Most plans have age-based options, so it's best to open an individual account for each child. Anyone can be the beneficiary, and there are no restrictions on whose name can be on the plan.

Open an Account:

Most 529 accounts can be opened online, and some plans may require a minimum deposit. Be sure to review the information required to open an account, which may include details such as Social Security number, date of birth, and address for both the account opener and the beneficiary. Keep an eye out for any associated fees, such as annual fees, account opening fees, or asset management fees.

Build Your Portfolio:

A 529 plan functions similarly to other investment accounts, offering various investment strategies such as age-based, conservative, moderate, or aggressive investment mixes. You can also set up automatic investments. If you choose a savings plan, you can select your preferred investment options, including actively and passively managed investments. Target-date funds are a popular choice, as they automatically adjust the asset allocation based on the child's age, becoming more conservative as the time to withdraw funds nears.

Contribute to Your 529 Plan:

Many states have no minimum contribution requirements, while others have relatively low minimums. You can set up automatic contributions, which usually have minimum amounts. While there are no annual contribution limits, it's important to be mindful of the gift tax exclusion to avoid tax implications. Additionally, each state has an aggregate contribution limit for 529 plans, ranging from $235,000 to over $550,000. A good rule of thumb is to aim for saving about one-third of your projected future college costs.

Frequently asked questions