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It’s “529 Day”: What’s your plan?

May 29, 2009 | | Comments Comments Off

cspnTo encourage participation in state-run 529 plans, the College Savings Plans Network  has declared today to be “529 College Savings Day.” They’ve got an uphill battle to promote their cause.

529 college savings plans have been under fire lately, some for good reason. Those run by Oppenheimer Funds, for example, had a too-aggressive asset allocation for students approaching college, leading to big losses. Oppenheimer also had big investments in bond funds that blew up.

That doesn’t mean you should give up on this tax-advantaged way to save for college–far from it. But you also shouldn’t invest in a 529 blindly. Here’s what parents need to know about saving for college:

Retirement has to come first. You’ve heard it before: your kids can get loans for school; nobody’s going to lend you money for retirement. However:

If you can save for college, you probably should. The more money you make, the more of your income and assets a college is going to expect you to contribute toward your child’s education. Saving early and often will help soften the shock of your “expected family contribution” and reduce the amount of debt your child may need to take on.

Don’t save in your child’s name. Custodial accounts (UGMA, UTMAs) get killed in financial aid formulas. 529s get much better treatment. Another option is to use retirement accounts, which typically don’t get factored into aid formulas, but only consider this is you’re already saving way more for retirement than you’ll actually need. Tapping your home equity should be thought of as a last resort, not your primary college funding plan. Savings is always better than debt.

529 college savings plans are a good option for many families. Withdrawals are tax-free when used for qualified education expenses, a big benefit for those in the 25% federal tax bracket. If your kids are within 5 years of college, though, the tax benefit starts to diminish: your expected returns aren’t likely to be big enough for the tax break to matter that much, and you have to put up with some restrictions on how you use the money. So if your kids are already in high school when you start saving, consider doing so in a regular taxable brokerage or bank account.

When in doubt, go with Vanguard. Vanguard’s famous for its low fees and its index-based approach to investing that aims to match, rather than beat, the markets. The Utah Educational Savings Plan Trust is a Vanguard-run option that’s Morningstar consistently names as one of the five best in the country.

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