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time to start saving for their education with a goal to take advantage of a plan that allows my money to grow and be withdrawn free from federal income tax.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.