529 plans are one of the most popular ways to save for college, and for good reason. They offer tax-free growth and tax-free withdrawals for higher education expenses, making them essentially the Roth IRA of college savings.
The problem is that there are a LOT of 529 plans to choose from. Almost every state offers at least one 529 plan, and many offer multiple, and each one comes with a different set of fees, investment options, and features.
So, how can you choose the right 529 plan for your specific needs? Here are three big factors to consider.
1. State Income Tax Deduction
529 plan contributions are not deductible for federal income tax purposes, but some states offer a state income tax deduction IF you contribute to your home state’s plan. A small number of states – like Arizona, Kansas, and Pennsylvania – allow you to deduct your contributions no matter which 529 plan you use.
If your state offers an income tax deduction, that might be enough to make it worth using your state’s plan. For example, a 5% income tax deduction on $5,000 worth of annual contributions over a period of 10 years would save you $2,500.
You can figure out whether your state offers an income tax deduction here: FinAid – State Tax Deductions for 529 Contributions.
2. Investment Options
Most 529 plans are like 401(k)s in that you have a relatively limited set of investment options. They’re also like 401(k)s in that sometimes those options are good and sometimes they aren’t.
Ideally, you’d like to find a 529 plan with a solid lineup of low-cost index funds. Not only have index funds been shown to outperform actively managed funds, but lower cost investments tend to perform better than higher-cost investments. By combining those two qualities, you stand to end up with more money available for your child’s college education.
Let’s say that you contribute $5,000 per year and earn a 5% annual return over a 10 year period. By investing in mutual funds that charge you 0.10% per year instead of 1% per year, you would end up with an extra $3,232 in your 529 account.
3. Other Fees, Minimums, and Features
Some 529 plans charge annual account fees, administrative fees, transfer fees, and others. Some 529 plans require high minimum initial investments. Some 529 plans have better online platforms than others, or allow you to create your own age-based investment portfolio.
Avoiding fees is always a good idea, and the website savingforcollege.com has a great 529 fee study that can help you compare plans. And depending on the other specific features you’re looking for, certain plans may end up being more attractive than others.
Making a Decision
If you’re eligible for a state income tax deduction and your home state’s plan offers low-cost index funds, then your decision is pretty easy. You can choose your home state’s plan.
If you’re not eligible for a state income tax deduction, you can simply look for any 529 plan that offers low-cost index funds and any other features that are important to you.
If you are eligible for a state income tax deduction BUT your home state’s plan only offers high-cost investments, you’ll have to evaluate whether you’re better off taking the deduction or finding better investment options elsewhere.
Image from: http://coulsonelderlaw.com/section-529-college-savings-plans-medicaid/