Personal Finance > College

The 529 solution
How to pick the right plan
August 20, 2002: 11:57 AM EDT

Which is the best 529 for you? No two programs are alike - they differ dramatically in many ways, from investment choices to costs to tax breaks.

Your first step should be to look at your own state's plan (if it has one). In some states you may qualify for a matching grant or scholarship. More important, many states give residents a tax deduction on 529 contributions and most exempt the earnings on withdrawals.

If your state taxes are high and your local plan offers generous tax benefits, you can stop reading here: You're best off staying at home. But if you live in a state with low or no taxes, or with limited tax breaks, then it's time to shop around. Use the following three rules as guidelines.

Shop for a manager, not a performer. Given the short track record of 529 plans, you can't glean much from the funds' performance history. So stick with plans run by investment companies with successful records managing retail mutual funds and pension plans, such as Vanguard, Fidelity, and TIAA-CREF.

  graphic  The 529 Solution  
1. Introduction
2. Who should get one?
3. How to pick the right plan
4. The 10 most frequently asked 529 questions

Stick with low-cost plans. Expense ratios vary considerably, from less than 0.3 percent to more than 2 percent. Some states' plans are sold by brokers, which layers on additional costs. You could also pay other fees. Several states charge to open an account and tack on $25 or so in annual fees. The less you pay in fees, the more your contributions can work for you.

Look for the right investment choices, not the most. The typical 529 menu is still fairly limited. In most plans, the key offering is an age-based portfolio, which gradually shifts the asset allocation as your child ages. For children under three, for example, some 80 percent of the portfolio may be stashed in stocks. As your child grows, the equity portion shrinks so that by the time he or she is 18, the assets are held mainly in bonds or cash.

Increasingly, states are adding conventional stock and bond funds. But because you can't switch your money around freely the way you can in a 401(k), a vast number of choices isn't much of an advantage -- and is potentially riskier.

For most investors, the best choice is an age-based portfolio. In the past, these funds were criticized for being too heavily oriented toward fixed-income assets, even during the child's youngest years. But a conservative strategy is often a sensible one.

"People forget that they usually have fewer years to save for college than for retirement -- most often 10 years or less, since they tend to start late," notes TIAA-CREF vice president Timothy Lane. "If you lose a lot in the early years, it's very hard to make it up."

You can also create your own stock and bond mix by opening more than one account in the child's name -- one for each asset class -- and controlling your own allocation by the amounts you invest in each.

Another strategy: If you don't like the asset mix designed for your child's age, find out if you can use a portfolio for a different age. Some states let you pick your own starting point.

Next: The 10 most frequently asked 529 questions  Top of page

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