Saving for college
While 529 education savings plans can’t really promise quick cash for college, in recent years they’ve gained prominence as an effective way for parents to provide for the future higher education expenses of their children. A 529 education savings plan is a tax-deferred investment, similar to an Individual Retirement Arrangement (IRA), except that the qualified withdrawals are related to higher education expenses as opposed to retirement.
Section 529 of the Internal Revenue Code sanctions two types of educational plans: prepaid and savings. The prepaid plans allow participants to buy credits for future, public, in-state education at present-day prices. The savings plans, like many standard investments, are basically mutual-fund investments and are tied to market performance.
2008 stock market crash
Because they’re subject to market trends, 529 savings plans were severely eroded in the crash of 2008, with many of them losing more than ten percent of their value almost overnight. Not surprisingly, the investors who suffered these losses have been reconsidering the wisdom and value of maintaining 529 savings plans.
State offers vs. private offers
529 education savings plans are administered by individual states rather than the federal government, although they may be bought and sold – or re-sold – across state lines throughout the country. This has led to two distinct markets for 529 savings plans: those issued by the state directly and those offered privately by brokers and financial planners.
The plans sold by brokers and planners were particularly hard hit in 2008 because many of them were invested aggressively and included a number of additional fees and costs that were added on in the re-sale market. Additionally, the brokers and planners who offer re-sale plans almost always retain the incentives paid by the issuing state. Unless you intend to contribute a lot of money quickly and require a very aggressive investment strategy, these re-sale 529 plans are probably not a good idea.
Many of the state plans fared better in the 2008 crash than private plans did. In part this was because the state plans were invested more conservatively. But their better performance was also related to their overall expense and state-incentive structure. Many states offer their 529 plans at extremely low rates and also provide the additional incentive of state income-tax credits or deductions. Some state 529 savings plans are tied to offers made by state university systems as well, which provides an additional incentive.
Overall benefits of 529 savings plans
As is the case with a Roth IRA, contributions to 529 savings plans are not deducted from your federal taxes, although they may be deducted from your state income taxes. However, distributions for qualified education expenses are tax-free and earnings within the plan are tax-deferred, even if they are not ultimately applied to qualified education expenses. Coupled with the easy “hands-off” nature of the plans and the maintenance of parental control, 529 plans really can’t be beat as a way to save for your child’s future college expenses.
Should you keep your 529 education savings plan?
Even if you lost a lot of money in the 2008 crash and are now hoping for quick cash to regain your financial footing, maintaining a 529 savings plan for your child’s college education is still a good idea. If your plan was purchased through a broker or planner, you should probably have it transferred to a 529 plan offered directly by your state. Even if you live in one of the few states that do not offer tax incentives, the lower administration costs and more conservative investment strategy will make the transfer worth the effort.