Fixing 529 College Savings Plans

Changes may be coming to  529 college savings plans.

I think most parents will like the proposed college savings changes, which could lead to lower costs and more plentiful tax benefits.

As a financial journalist, I’ve been writing about 529 plans since states began rolling them out in the late 1990s. During that time I’ve seen too many mediocre 529 plans.

A big reason for the mediocrity are unnecessary high costs. When you invest in a 529 college savings plan, the state and the underlying mutual funds automatically withdraw money from your account to cover costs. Parents never even know about this huge money drain because the 529 providers don’t send out bills that would prompt moms and dads to ask questions.

So what’s reasonable? I’d argue that you should stay away from 529 plans that charge more than .8% of your investment each year. As an example, if you have $10,000 in a 529 savings plan that charges .8%, $80 would disappear from the account to cover expenses. Some 529 plans charge 1.5% to 2% or higher, which is crazy.

So here is the good news:  the U.S. Treasury Department recently released a report that is urging states to use more index mutual funds in their 529 programs.  Index funds are superior to other mutual funds because of their significantly lower costs. For both of my children, I have only invested in 529 plans that use index funds. The two that I have used are Nevada’s 529 plan and Utah’s 529 plan.

The other good news is that the federal government is pushing states to extend their state tax breaks to residents who invest in 529 plans outside their own borders. Anyone is free to invest in any state’s plan, which is why I could turn to Nevada and Utah, which relies on Vanguard index funds. The majority of states, however, won’t give a tax break to their residents for contributions made to outside 529 plans. That’s led some parents to invest in crummy state plans to capture a tax break rather than selecting the best 529 available.

I’m keeping my fingers crossed that these changes become a reality.

Lynn O’Shaughnessy is the author of The College Solution.

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