You can choose a 529 plan in just three steps that will take you less than five minutes. After you pick your plan, enrolling might take a half hour or so.
First, check out the 529 plan in your state.
More than half of states offer a state income-tax deduction or income-tax credit on residents’ contributions to their state’s own plans. This is the chief benefit of having so many plans to choose from – your state might offer an incentive to keep your money at home. The directory at Savingforcollege.com is the best place to look up the specifics of your state’s plan and any incentives it may offer. If your state offers a tax break, it’s usually worth saving in your state’s plan in order to max out the tax deal. You remain free, however, to invest in any state plan. If your state doesn’t offer a tax break, there’s little benefit in choosing to stick with your own state’s plan.
Once you’ve chosen a state, you’ll have to pick between an investment plan and a prepaid plan.
- Prepaid Plans: These plans you pay for a year (or a portion of a year) of tuition ahead of time, effectively locking in the price.
The prepaid plan may sound enticing, but we think an investment plan is the better choice – especially for parents with younger children. One big problem with prepaid plans is that they generally only work for in-state, public universities.
If your kid ends up going someplace else, you can still get the money out. The problem is that the money you invested in the prepaid plan won’t have grown at anywhere near the rate it likely would have, had you put it in stock mutual funds in the investment plan. A prepaid plan grows at maybe a couple of percentage points a year – less than half of what a good collection of mutual funds would get over the same period. And really, how can you possibly know where your kid is going to want to go to school 10 or 20 years from now?
There is a way to prepay for private colleges, but it isn’t exactly the best of both worlds. It’s called the Independent 529 plan and it allows you to buy discounted chunks of private school tuition, years or decades ahead of when the account beneficiary will go to school. The problem is that not every private school in the country participates.
Prepaid plans make sense in one scenario: Let’s say your kids are in their teens, and all they’ve ever wanted to do is go to one of the great state universities nearby (or to a private school that participates in an Independent 529). Once you know that that’s what they want, then that’s the time to buy in, at today’s discounted rates. Then, you don’t have to worry about investment returns for, say, the next five or seven or nine years.
- Investment Plans: You’re in charge of your own investing fate with these funds. Start early, and get your asset allocation right, and your savings will grow into a healthy college fund.
If you decide to go this route, look for a state where the total program fees and fees for the mutual funds are lower than 0.75%. Fees can really eat into your returns and, if you start investing early, fees can really pile up. Again, you can search by state onSavingforcollege.com to look up the fees. As you choose, you should factor in any state tax breaks (which we described above) as a positive consideration for your state’s plans.
Can’t be bothered to shop? Just use the Utah plan. We’re big fans of it, since fees are less than one half of one percentage point and Vanguard, a company that is generally very consumer-friendly, runs many of the mutual funds.
Once you’re in an investment account, you have to decide how to divide your money between stocks and bonds.
One easy way: Invest in an age-based fund, which an increasing number of states offer. These funds may also be referred to as target-matriculation date funds. These funds create an investment mix of stocks, bonds, and other assets based on the date when your child will start college. The manager of the fund changes the mix so it gets more conservative as your kid gets close to college age. The advantage here is that you never have to tweak the mix yourself.
Here are three easy (and free) ways to save some more:
- Enlist the help of grandparents and other relatives. In some states, they can contribute to the account you set up. In other states, they have to set up their own and name a child as a beneficiary (two siblings can’t share the same account.)
- Enroll in Upromise. Upromise is a loyalty program: if you agree to shop online through its site (it redirects you to hundreds of other name-brand sites like Target andiTunes), you get a percentage of your purchase refunded. Then, you can move those refunds to a 529 plan (any plan you want, though it can be a bit easier if you’re in a 529 affiliated with Upromise.) You can also earn refunds based on where you eat out and what you buy at the grocery store. This costs nothing, and it makes sense for every single person in the U.S. who has a child or grandchild to enroll. However, even the biggest shoppers won’t receive high cash-returns and Upromise does track your shopping habits. Read Upromise’s terms and conditions for more informtion.
- Divert credit-card rewards into the 529 plan. Citibank has a card with Upromise, and American Express offers an especially lucrative card that puts 1.5% of every purchase into a Fidelity 529 (you have your choice of a few state plans, since Fidelity manages a handful of them on behalf of various states). True, frequent-flier miles offer more immediate gratification for credit-card shoppers. But those miles don’t earn returns the way money in a 529 fund would.
Honestly, just getting some money in a decent index fund or target-date fund before your kids start nursery school is our definition of success. Get started, get it mostly right, and focus in on the smaller details as your kids get older and the balances get bigger.