NEW YORK (AP) — Saving for college is increasingly becoming an investor’s game.
As tuition continues to climb, state-sponsored college savings plans have become widely hailed as the most prudent way for families to prepare for the future. The accounts are considered advantageous because they let families invest in the market and withdraw money tax-free to pay for education costs. But like their 401(k) retirement savings counterparts, many are learning that market swings are just one of the pitfalls of opening an account.
So far this year, for example, the performance of age-based 529 plans, which are designed to grow more conservative as the child nears enrollment age, has varied widely. Their returns through the end of August ranged from a loss of 7.17 percent to a gain of 5.40 percent. Overall they’ve averaged a loss of less than 1 percent, according to Morningstar.
Because most parents only save for college for little more than a decade, any fluctuations can be nerve-wracking for investors like Anthony Abelaye, who opened an account for his daughter, Sara, when she started kindergarten seven years ago.
“I’m concerned that my investment isn’t growing quickly enough or that it could actually lose value” said Abelaye, a 41-year-old software engineer from Plano, Texas. He has considered stepping up his contributions or switching to a more aggressive investment mix to speed up growth, but fears taking on too much risk given the economic uncertainty. His daughter is already 12 and there’s just $6,400 in the account.
“I’m just hoping there’ll be something there when she turns 18,” Abelaye jokes.
That’s not to say families should shy away from 529 plans; the average published cost of tuition and fees alone at public schools is at $16,000 a year. But before opening an account, families should know that the choices they make can significantly influence how much they end up saving. Here are some key points to keep in mind when setting up a plan:
Opening an Account
From the get-go, opening a 529 plan can feel like an overwhelming task because of the sheer number of options.
Nearly all states offer their own 529 plans and families aren’t restricted to picking one from home. As a result, inexperienced investors may feel they need the guidance of an adviser to sort through the many options. The problem is that adviser-sold plans usually charge commissions of 5 percent to 6 percent of the contribution. For a $5,000 contribution, that’s $250 to $300.
But fees can be avoided by opening an account directly through an investment firm or the state plan administrator.
Since more than half of states offer tax breaks for residents, the selection process may be fairly simple for many families, notes Joe Hurley, a certified public accountant and founder of SavingforCollege.com.
“It’s the most straightforward option to stick with what’s offered in state if there are incentives,” Hurley said.
Families with a 401(k) or other retirement account may want to check with their plan’s administrator to review its menu of 529 plans. If they’re happy with service on their retirement fund, Hurley says it might be most convenient to keep all their accounts in one place. Otherwise, investors striking out on their own can check the performance and details of various plans on sites such as SavingforCollege.com and Morningstar.com.
After settling on a plan, it’s also worth considering whether to set up automatic contributions to avoid neglecting the account.
Setting the Investment Mix
Families often feel more comfortable opting for an age-based 529 plan, which relieves them of having to tinker with the mix of investments as the child gets older. A little more than half of 529 accounts are age-based plans, according to the Financial Research Corp.
Age-based plans also usually offer conservative, moderate and aggressive options to reflect the investor’s tolerance for risk. But don’t sign off on an option without reviewing the specifics; the mix of assets in plans can vary significantly and you might find that you’re more conservative than you thought.
For example, the aggressive option for Vanguard’s age-based plan for 11- to 15-year-olds invests half the money in the stock market. But families with children on the older end of that spectrum might feel more comfortable with the “moderate” option, which allocates just 25 percent to stocks.
The decision on how aggressive you want to be may be affected by current market conditions as well.
Many families with younger children are moving more heavily into stocks to take advantage of recent market declines, said Joan Marshall, executive director of the College Savings Plans of Maryland.
On the other hand, those who got a late start in saving and have children closer to freshman year might want to consider options that protect contributions. These plans may be called “principal protection,” ”stable value” or “guaranteed option” funds.
Another source of confusion is exactly how families can use the savings in their 529 plans.
The rule of thumb is that any costs required by the college qualify, including tuition, fees, room and board, books and any other supplies. Living expenses — such as clothes, food and transportation to and from school — do not qualify.
“The magic word is ‘required’,” said Mel Schwartz, who specializes in tax policy at the accounting firm Grant Thornton. Computers and software are somewhat of a gray area, but would qualify if the school clearly required students to have them, Schwarz said.
However, obsessing over what smaller expenses qualify may turn out to be unnecessary. The average account balance is about $17,000, according to the College Savings Plan Network. That suggests that most families will easily use up the entirety of their savings on tuition
If for some reason all of the money isn’t used for college costs, accountholders will have to pay income taxes and a 10 percent penalty.
But the penalty can be avoided under certain circumstances. For example, distributions would only be taxed at the normal income tax rate if the child won scholarships and all the money wasn’t needed.
Even if the child decides to take a different path than college, the beneficiary named on the plan can always be changed to any immediate family member. That includes a sibling, grandchild or even a parent.