529 College Savings Plans—Do your Research Before Investing

by Edward Proenza

Every parent wants the best for their child. Investing in a 529 College Savings Plan is a great way to save for rising college tuition costs. In the past decade college tuition has increased on average by 5.2% and the current national average tuition cost at a public four-year university is $8,655 per year. With the 529 College Savings Plan, parents have an opportunity to prepare for their child’s tuition costs. The 529 Plan is a tax-advantaged savings plan designed to encourage saving for future college costs. There are two types of plans offered to the public, Prepaid-Tuition Plans and College Savings Plans. This article focuses on College Savings Plans and what information parents need to know in choosing the right plan.

There are two types of College Savings Plans: Direct-Sold and Broker-Sold. Direct-Sold differs from Broker-Sold because the plan is sold directly from a broker-dealer on behalf of the state and there are no sales people involved. Through the Broker-Sold Plan, you buy an interest in a College Savings Plan through an investment advisor, brokerage firm or bank, generally paying a sales load fee.

One of the greatest benefits of a 529 Plan is the federal tax advantages. Earnings grow tax-deferred and are tax-free if used for qualified education expenses. Moreover, depending on the state you reside in, some states provide tax deduction for contributions, tax-free earnings growth and tax-free withdrawals for qualified education expenses. However, if you withdraw money from your 529 Plan and do not use it toward eligible college expenses you generally will be subject to income tax and an additional 10% federal tax penalty on earnings. This is something to consider, especially if in the future you might need this money for other financial goals such as purchasing a home or saving for retirement.

Before seeking to invest in a 529 Plan you should check the fees and expenses associated with the plan. Fees may include: enrollment charges, annual maintenance fees, sales loads, deferred sales charges paid when you withdraw you money, administration and management fees, and underlying fund expenses. Broker-Sold Plans generally have more fees and expenses associated with the plan including: front-end sales loads, annual distribution fees, and service fees. Also, you must be aware of the type of funds the Broker-Sold Plan is investing in. For example, if the fund is invested in mutual funds, you may incur initial sales charges, additional fees and expenses. You are able to find this information by looking at the plan’s disclosure statements. FINRA has created a Savings Plan Expense Analyzer where you are able to compare investment plans and see the affect the fees have on your account. You can find this at: http://apps.finra.org/investor_Information/Smart/529/Calc/529_Analyzer.asp

The SEC has provided a list of questions you should ask before investing in a 529 Plan:

• Is the plan available directly from the state or plan sponsor?
• What fees are charged by the plan? How much of my investment goes to compensating my broker?
• What are the plan’s withdrawal restrictions?
• What types of investment options are offered by the plan? How long are contributions held before being invested?
• Does my state offer tax advantages or other benefits for investment in the plan it sponsors? If my state’s plan charges higher fees than another state’s plan, do the tax advantages or other benefits offered by my state outweigh the benefit of investing in another state’s less expensive plan?
• What limitations apply to the plan? When can an account holder change investment options, switch beneficiaries, or transfer ownership of the account to another account holder?

The 529 College Saving Plan is a great way to invest in your child’s future, but you must do your homework before deciding on the right plan for you. Make sure you understand the tax benefits, the fees and expenses, the risks and rewards, and the College Saving Plan’s limitations and restrictions. With the correct information you can make the best investment for you.