Conventional wisdom says 529 plans are the best way to save for college. These plans, based on rule No. 529 of the federal income tax code, are investment accounts that allow tax-free savings and withdrawals for qualified higher-education expenses. But as the economic climate has shifted dramatically, so have 529 options.
With a student’s education depending on a solid 529 plan, what are the latest developments in these offerings? How can you take advantage of them if you’ve saved in another type of account or aren’t happy with your current 529 plan? And has the economic crisis changed the rules of college savings?
- No more ‘set it and forget it’
- Index funds and ETFs join investment mix
- 529 plan fees are dropping
- In 2009, IRS allowing 2 changes to 529s
- Affiliated credit cards contribute to 529s
- Corporate sponsorship may be in the works
No more ‘set it and forget it’
Early on, most 529s offered age-based, asset-allocation strategies, says John Carl, president of Brainerd, Minn.-based Retirement Learning Center, which counsels financial advisers. The older your child grew, the more the plans shifted to a conservative mix of more bonds and less stocks.
Those plans still exist, but financial experts suggest you keep an eye on them nonetheless. The market has changed, and you’ll want to take advantage of an array of new options.
For instance, if your plan’s automatic rebalancing schedule says it’s time to sell stocks and buy bonds as your child reaches college age, you might want to make a change, says Larry Glazer, managing partner at Mayflower Advisors, a financial consulting firm in Boston. It’s probably not wise to sell stocks now after they’ve already fallen so far.
“The idea that you can park your money and not worry about it doesn’t work,” says Glazer. “You need to examine your funds periodically.”
Index funds and ETFs
In recent years, index funds have become a hot item among 529 plans, says Joseph Hurley, a Bankrate adviser and founder of Savingforcollege.com (a Bankrate company), a Web site that provides information about funding higher education. Index funds invest in a basket of stocks or bonds that represents a particular benchmark, such as the Standard & Poor’s 500. They are not “actively managed,” meaning there’s no trading of securities in reaction to changing market conditions. This keeps their fees lower than other funds’.
Also popular are exchange-traded funds, or ETFs, which are special securities designed to track groups of stocks or bonds, usually market benchmarks as index funds do, Hurley says. The primary difference between ETFs and index funds is that ETFs are traded like individual stocks, he says. Their price changes throughout the trading day while index funds have their value calculated only once a day.
ETFs tend to have an even lower expense ratio than index funds, except with ETFs you have to pay fees because they can only be bought and sold through brokers. “Among broker-sold (college) plans, ETFs are a fairly new development,” Hurley says.
But if recent market volatility has soured you on stock funds, a number of more conservative instruments are available, including a variety of banking products.
“More 529 programs are offering FDIC-insured banking CDs or savings accounts,” Hurley says. These certificates of deposit are insured by the Federal Deposit Insurance Corp. for up to $250,000.
An equally welcome development has been the slashing of 529 fees as competition has heated up. Yet 529s remain more expensive than other types of investments because of the extra level of management and marketing, Hurley says.
For instance, the Vanguard Total Stock Market Index Fund has an expense ratio of annual operating expenses versus the fund’s net assets of just 0.15 percent, one of the lowest around. But the corresponding 529 plan, which invests solely in the exact same mutual fund, has a total expense ratio of 0.5 percent.
“There’s still room for fees to come down,” Hurley says.
Fee structures are complex, too, he says. Before choosing a 529 plan, compare fees and understand what they include. A good place to start is at Savingforcollege.com.
Changing your asset allocation
Many 529 investors have been disappointed by their plan’s performance lately. If you think current stock prices represent a buying opportunity, you might want to shift your 529 portfolio to favor stocks. On the other hand, if recent volatility has turned you off stocks, you might prefer to move to safer, more conservative instruments such as bonds or bank CDs.
To make such changes, all you have to do is contact your broker or the plan’s sponsor — Fidelity, Vanguard and others. There’s no penalty, as long as you don’t do it too often.
“The IRS allows changes to your 529 investment mix one time per year, but for 2009 it’s allowing two changes,” says Kara L. Harmon, a financial consultant at Moneta Group in Clayton, Mo.
A rules change in 2009 and 2010 allows computer purchases as qualified expenses for higher education, says Will Hepburn, president of Hepburn Capital Management in Prescott, Ariz. That means 529 funds can be withdrawn tax-free to purchase PCs and related accessories.
Switching 529 plans
If you want to switch funds from one state’s 529 program to another state’s 529 program, known as a rollover, you can do it once every 12 months, Hurley says. “When setting up your new plan, simply write on the application that you want the funds rolled over from a different 529 plan,” he says.
Alternatively, you can withdraw funds from one 529 and deposit them into another, but you have to do it quickly to avoid paying taxes as well as a 10-percent penalty for unqualified withdrawals. You must redistribute the funds to a new plan within 60 days to avoid it, Hurley says.
You also can change your 529 plan every time you change the beneficiary, even if it’s less than 12 months since your last 529 rollover. The rule on changing beneficiaries is once every calendar year, provided the new beneficiary is a sibling, cousin, parent or child of the previous one, says Carl.
If the new beneficiary is the child of the former beneficiary, the transfer may be considered a “gift,” which would be taxable if it’s worth more than $13,000, Carl says.
Switching from another type of account
If you have savings in another type of account and want to switch to a 529, your best bet is to liquidate the old account and place your money in a new 529 or add it to an existing one, says Greg Merlino, president of Ameriway Financial Services in Voorhees, N.J.
In general, he says, 529 plans can only be funded with cash. You can’t simply reclassify a different type of account.
Still, it can become more complicated if you want to shift funds from a custodial plan, an account for a minor who takes over ownership of the account upon reaching adult age — 18 or 21 — depending on the plan. These would include accounts set up under the Uniform Gifts to Minors Act or Uniform Transfer to Minors Act.
In such cases, you have two choices:
- Move the custodial account into a 529. That is, fund the new 529 with the old account instead of cash. The new plan will gain the 529’s advantage of tax-free withdrawal for higher-education expenses, though not the option to change beneficiary, Merlino says.
- Withdraw funds from the custodial account, which becomes taxable, and promptly reinvest in a 529 in your own name but with the same beneficiary. The IRS can levy penalties if it thinks you’ve spent the custodial funds for yourself or some other noneducational purpose. You can, however, change the beneficiary later.
New contribution methods
There are some new ways to contribute to 529 plans. “Some 529 vendors offer affiliated credit cards, so a percentage of every purchase goes to the fund,” says Julie Murphy Casserly, a planner at JMC Wealth Management in Chicago and author of “The Emotion Behind Money: Building Wealth from the Inside Out.”
“It’s like collecting mileage points,” she says.
She also highlights Upromise.com, the Web program that puts a portion of qualified purchases into a designated college savings plan, using multiple credit cards and even certain store memberships to earn credits.
A greater need than ever, and greater rewards
More corporate sponsorship of college savings plans may be in the works, Hurley says. Congress is considering giving employers a tax break for contributions to employees’ 529 plans.
There’s also a bill that would give low- to moderate-income individuals a federal income-tax credit for contributions to 529s, as is now available for IRA contributions, under what’s called the Saver’s Credit, a program that allows nonrefundable donation s to qualified plans with a dollar-for-dollar reduction in tax payments, Harmon says. Both measures remain active in Congress, but it is unclear if either will reach a vote in the current session.
Glazer says that should counter one troubling aspect of the credit crunch: the increasing difficulty of securing student loans.
Is a 529 plan right for you and your child? For more information, see “When not to use 529 plan.”