The cost of college tuition continues its rapid ascent, regardless of the downturn in the economy, and, to some degree, as a result of it! According to a recent NY Times article, college tuition rose 6.5 percent this past year, while, during the same period, the Consumer Price Index declined 2.1 percent. In fact, budget shortfalls at state governments and spending cuts for education, are likely to continue to put upward pressure on tuition in the near-term. So, if you think college is expensive now – you may be shocked to see estimates for college costs 15 years from now! (see college cost calculator) With two young children, I decided it was time to start saving for their education with a goal to take advantage of a plan that allows my money to grow and be withdrawn free from federal income tax. As a result, I recently spoke with a number of experts, along with doing my own research on college savings alternatives.
The real answer as to the best college savings plan is – it depends! The primary considerations are where you live, your risk tolerance and the age of the child, among other things. My goal in writing this article is to provide you with some principles based on which to evaluate the many college savings plans that exist and try to keep this simple.
First, if you live in a state that enables you to take an income-tax deduction – it is hard to beat the 529 savings plan offered by your state. In almost every circumstance, the tax benefits trump lower fees compared to an out-of-state plan. Kiplinger’s offers a good state by state review of the best 529 plans, with a quick summary of the state’s tax breaks.
I live in a state that does not have a personal income-tax, so there is no tax incentive to select our state plan and therefore we can choose from a plan offered by any state, which presents an almost overwhelming number of options!
In evaluating the out-of-state options, I ultimately made my decision based on a number of investment principles and my expectations of the market. The key investment principles were:
- Performance of Index funds with low fees trump actively managed mutual funds with higher fees, particularly over the long-term (see recent NY Times article, which is one of many on the topic of indexing vs. active management)
- Broad diversification reduces investment risk
- Age-based option better aligns with goals than static allocation option (the age based option shifts the investment allocation from a growth orientation when your child is young [higher weighting toward stocks] and becomes more conservative as your child is closer to entering college [higher weighting toward bonds and ultimatly an FDIC insured savings account])
So, based on the above and a few more considerations, I selected the Utah Educational Savings Plan, specifically the Age-based Option 8: Diversified B. It was a close decision, with Illinois 529 College Savings Plan age-based Index option also offering the lowest plan fees available. In addition, both Utah and Illinois use Vanguard funds, which are recognized for their rock bottom fees. With comparable plan fees, I chose Utah because it provided an alternative that offered increased diversification with more exposure to International markets.
Utah has consistently ranked as one of the top 529 plans based on independet reviews, below is what Morningstar had to say:
The Utah Educational Savings Plan Trust
For those who want a tax-sheltered way to save for college using Vanguard index funds, this is the plan. Utah’s 529 plan has long been a favorite of ours and remains a strong choice for its low costs, flexibility, and tried-and-true Vanguard index funds. The plan’s fees are a rock-bottom 0.22% to 0.35%, making it one of the cheapest plans in the country. The plan offers plenty of flexibility with five distinct age-based choices, which gives investors a good deal of choice to match the options with a level of risk they are comfortable with. (Even the most risk-tolerant investors should steer clear of the aforementioned “S&P and Bonds” option, however, which has nearly two thirds of assets in equities for college-aged beneficiaries.) Investors also have the option of three individual funds and a few static options to augment the age-based options or build their own portfolios. We’ll admit it’s not an exciting option, but as this market has demonstrated, it’s tough to argue with the merits of a passive, low-cost approach.
I live in Washington and will make a few comments about the state’s prepaid college savings plan, Guaranteed College Tuition (“GET”). I chose to select an out-of-state plan, because GET only allows you to save up to the amount of tuition, or 500 units, – so, you are not able to save enough in this plan to cover other educational related expenses such as room & board – which is a lower threshold amount than Utah and other state educational savings plans. In addition, I felt more comfortable with the market risk/return represented by the diversified portfolio in Utah’s plan. However, GET is a fantastic option for Washington residents, particularly if you are risk averse – tuition is less likely to decline, but the stock market might! And, for a relatively low risk investment, GET has significantly outperformed stock/bond portfolios in other state college savings plans over the past five years (see GET historical unit pricing and tuition increases). Although, you should be aware, that “guaranteed” is not without risk (article - ”Prepaid Savings Might Not Cover All The Costs“).
In the GET prepaid tuition plan, you purchase units – 100 units covers the cost of one year of tuition – that are guaranteed to keep pace with Washington’s most expensive public University, which is the University of Washington. Your child does not have to attend an in state school and you can use the value of the units at almost any public or private school. From an investment perspective, if you purchased a GET unit 5 years ago at the 04-05 price of $61, your units would be valued at $101 today, which is an increase of over 60%! You can’t say the same for the stock market over the same period. However, as in any market, high returns (tuition price increases in this case) are not sustainable over the long-term and therefore you can’t expect this to continue. In addition, there have been other 5 year periods that GET has underperformed diversified college savings plan portfolios. Having said that, based on recent comments from our local government and trends in tuition increases from peer universities, the near-term trend of tuition increases is a positive for GET.
For more information on college savings plans, I would suggest the following resources:
Investor.gov – New U.S. SEC website provides a trusted perspective of investments for consumers, including a summary overview of 529 college savings plans.
SavingforCollege – Comprehensive website with information about 529 plans and overall college savings issues.
NY Times – Simple college cost calculator.
Morningstar – Provides independent analysis and ratings of college savings programs.
Kiplingers – Another good source for independent analysis and ratings of college savings programs, Kiplinger provides an annual ranking of the top 5 plans and recommendations for each state. Here is the 2009 review.
December 3, 2009 at 5:25 pm |
Recent article from Fidelity “Weary investors are running away from college savings plans. Here’s why you should to do the opposite”. See below:
529 double down
BY Chris Taylor,
Fidelity Interactive Content Services
© 2008-2009 Fidelity Interactive Content Services LLC. All rights reserved.
Fidelity Interactive Content Services — 12/03/09
Weary investors are running away from college savings plans. Here’s why you should to do the opposite.
When it comes to saving for college, many Americans are adopting a new strategy right now: Hiding under the covers.
Just look at the numbers. Investors have saved just $4.8 billion in their 529 college-savings plans this year, down more than two-thirds from the $15.5 billion saved in 2006. Translation: Parents are scared, and understandably so. It’s been, to put it mildly, a tough two years.
“Many people are abandoning their 529 plans, just like they’re abandoning their 401(k)s,” says Gary Schatsky, a Manhattan-based financial planner and founder of ObjectiveAdvice.com. “They’re totally spooked by the equity markets, and are throwing the baby out with the bathwater.”
The meltdown certainly shocked Allyson Allen, a physician assistant in Los Angeles. She and husband Harold oversee a basket of investments, including 401(k)s for themselves and 529s for their two boys, 11-year-old Avery and 5-year-old Harrison. “I saw it all shrinking and was really concerned,” says Allyson, 45. “I wanted to pull it all out and put it under a mattress.”
Even if your kid’s college is only two years away, you should still be investing, because state tax deductions act like a discount on the tuition bill.” Mark Kantrowitz, FinAid.org
Thankfully cooler heads prevailed and the Allens decided to stay the course. They divvy up $600 every month between the boys’ college-savings plans, and were even able to boost contributions recently, since their youngest is now out of pricey preschool. Says Allen: “It feels good to know they’ll have something when they graduate. The way tuition is going, you just have to save.”
Indeed, instead of going on a 529 strike, savvy investors should do exactly the opposite and double down on their college-savings bet. After all, tuition – now an average $26,273 annually for a private four-year college, according to the College Board, a nonprofit research and guidance firm – continues to ramp up. And given a compelling mix of incentives including tax breaks, increased investment choices and improving fund performance, it might actually be the ideal time to pump up your child’s college savings.
“The knee-jerk reaction when the market goes down is pure panic,” says Mark Kantrowitz, publisher of student aid resource FinAid.org. “And in any 10-year period, the market is going to go down significantly at least once. But saving for college is a 17-year project – and 529s are still the best vehicle for doing that.”
Of course, your hobbled 529 plan may require some significant repair. But with a dizzying array of mutual funds and state plans to choose from, where exactly do you begin? A few key tips from the experts:
Maximize your tax break. As long as you invest by Dec. 31, you can chop your tax bill come April 15. Thirty-four states (plus D.C.) now offer tax deductions or credits for investing in their plans, and the benefit can be significant. New York State offers deductions of up to $10,000 annually for a married couple filing jointly, Missouri up to $16,000, and Illinois up to $20,000. Says Kantrowitz: “Even if your kid’s college is only two years away, you should still be investing, because state tax deductions act like a discount on the tuition bill.”
If you panicked, retool your investments. For terrified investors who shifted all their 529 savings into cash earlier in the year, there’s a get-out-of-jail-free card. To date, most plans have allowed participants to switch their investments only once a year, leaving investors locked in until the following year. But with so many savers rocked by the markets, there’s a special one-time provision for 2009 that allows people to change their investment choices twice.
“If you put all your money in money-market funds, and now you want to get back into a rising market, you can,” says Kantrowitz. Act now, though, because experts say it’s unlikely the Internal Revenue Service will extend this provision for 2010.
Take advantage of increased fund options. If your fund pickings were pretty slim in past years, it might be time to revisit the plan literature. Most 529s are offering more fund options, partly in response to consumer lobbying. In particular, many 529s have beefed up their menu of index-oriented and conservative funds for investors that found actively managed funds too aggressive.
“Generally speaking, the fund changes have been very positive,” says Schatsky. For those seeking safe harbor, look for CDs (certificates of deposit) and TIPS (Treasury inflation-protected securities) that may have recently become a part of many investment menus.
Re-evaluate your state’s plan. You’re not forever wedded to your own state’s 529. In fact, you’re free to choose from the most attractive plans from around the country. You might lose your state tax breaks as a result, but fantastic funds and low fees might make it worth the rollover, which you’re allowed to do once a year. “Over a long period of time, those differences in investment choices and fees can be very significant,” says Schatsky. “It can add up to a sizable portion of a year’s tuition.”
Keep on top of your picks. Over the past couple of years, most savers have simply shuddered and stuck their 529 statements in a drawer. But you should monitor your investment choices every six months, and every year at the very least. Things may not be as bad as you think: According to a study by the research and information site SavingForCollege.com, over the past year more than three-quarters of 529 funds that were fully invested in equities clobbered the performance of the S&P 500. Allyson Allen, for instance, has seen her family’s investments rebound smartly from the market’s lows, and is now confident about the direction of her children’s two 529 plans.
“This isn’t about big, quick returns,” she says. “Just keep adding to it, because this is a race for the long haul – and slow and steady always wins out.”