Making plans for the next generation often involves planning for their education. And with educational costs rising, many families are using 529 education savings plans to help offset the future expense of college tuition, boarding, books, and related fees.
A 529 plan is a tax-advantaged account that encourages savings now to put toward exorbitant college costs later. What do I mean by tax-advantaged? Some states including Pennsylvania allow contributors to these plans to deduct those contributions from their taxable income in the year they are made, up to a certain amount. In addition, the contributions grow tax-deferred and the earnings on the 529 investments are not subject to federal tax or state income tax as long as they are used to pay for qualified educational expenses.
Because of these attractive tax advantages, 529 can be an excellent tool for families worried about the ever-rising cost of college. That said, not all plans are created equal, and anyone considering investing in a 529 plan should be sure to compare it with other investment alternatives before making a decision.
A recent Morningstar Inc. analysis found a sharp increase in contributions to Section 529 plans in 2012. The Morningstar analysis also noted that despite their recent surge in popularity, 529 education plans as a whole underperformed against some traditional mutual funds. Reuters reported on these findings in “Morningstar: 529 college savings plans up in 2012 despite some lags.”
One notable difference between 529 and traditional funds is that the costs and fees associated with some 529 plans are higher than those of comparable mutual funds. The higher the fees, the lower the overall return. Of course, fees vary from fund to fund, so investors should be sure review the fees of their specific plan carefully.
In some cases, the performance and tax advantages of a 529 plan will clearly favor its use over a traditional fund. However, the Morningstar analysis found that some 529 plans were simply not worth it when all factors were considered and compared against non-529 plans.
What does that mean for you, the college tuition-minded investor? It means that you must look at all of the factors that will affect your likely overall return – fees, performance record, and tax effects – and only then decide whether the 529 plan you’re considering is the right vehicle for you. As always, it is a good idea to discuss any investment questions with your financial advisors and attorney, who can help you assemble a plan that best fits your goals and specific financial circumstances.
Reference: Reuters (April 22, 2013) “Morningstar: 529 college savings plans up in 2012 despite some lags”