Whether you’ve just had your first child or it’s been a few years, at some point, saving for your child’s college education has likely crossed your mind. Choosing where to set up an account can be a major barrier to getting started, and for that reason, many people default to their own state’s 529 plan, but that might not always be the best option. Follow these steps to pick the best 529 plan for your family:
Find out if your state offers a tax benefit for 529 contributions
All 529 plans are eligible for the same federal tax benefits (tax-free withdrawals for qualified educational expenses), but state tax benefits vary widely. There are two types of tax benefits states offer:
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Tax deduction: This reduces your overall taxable income, indirectly reducing your taxes.
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Tax credit: This directly reduces your taxes, and is generally more valuable.
The total amount you’d save on taxes depends on your state’s policy and is often impacted by your income, how much you contribute to the 529 annually, and your state’s income tax rate. Most states require you to contribute to an in-state 529 plan to be eligible for the tax benefit but that in and of itself is not always worth it. To calculate your estimated tax savings, you can use a calculator like this one from Scholars Edge 529.
Decide on which type of 529 plan you’ll contribute to
There are two different types of 529 plans and the distinctions are important:
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Education savings plan: This type of 529 plan is an investment account. You make contributions to the account and invest the funds. Over time, your investments are likely to grow. That growth, along with the tax-free withdrawals, gives you more money to pay for your child’s education than you would have if you just put the same amount into a savings account.
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Prepaid tuition plan: A prepaid tuition plan allows you to buy tuition credits at today’s prices for future use at participating institutions (typically public in-state colleges and universities). Unlike most education savings plans, prepaid tuition plans are usually limited to residents.
Because of their flexibility, education savings plans are more popular than prepaid tuition plans. With prepaid tuition plans, contributors typically still get to use some of the money they contributed if their child does not attend a participating college, but the plan determines the amount.
Research the top 529 plans with your needs in mind
Not all 529 plans are created equal. Here are a few of the things you’ll want to consider:
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Investment Options: With a 529, you’ll choose from a preset list of investments. Most plans have an age-based portfolio: choose the year you expect your child to graduate from high school and invest away. Other plans allow more customization among their investments. Keep in mind that you are limited to changing your investment option no more than twice per year or when changing the beneficiary.
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Investment Fees: No matter what you choose to invest in, you’ll pay some fees associated with the investment itself. A passively managed index fund generally has a fee of about 0.15% while some actively managed funds may charge fees of up to 1%.
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Plan Management Fees: Some plans may charge a management fee for the investment company providing the services.
You don’t need to research every state’s 529 plan from scratch. Instead, look up the top 529 plans recommended online by reputable sources like Morningstar. Cross-reference a few lists and do a more detailed dive into a few of the top options while paying special attention to any preferences you have on investment options and fees.
Open an account and start funding it
Once you’ve decided on a 529 plan, you can open an account online through that plan’s website. You will need your own personal information (name, address, date of birth, Social Security number) as well as that of the child or person you will name as the beneficiary. You can change the beneficiary at any time or even name yourself as the beneficiary. You’ll also want your bank information if you plan to contribute to the account electronically, either through a one-time transfer or recurring contributions.
