If you are like most people saving for college is a daunting task and financially it seems overwhelming to even get started. However, the good news, time is on your side if you start early enough. As we say in the investment business, it is not timing the market that makes you a successful investor but time in the market that does. The same can be said about investing in a 529 plan.
According to the SEC’s Office of Investor Education and Advocacy, a 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. Legally known as “qualified tuition plans” 529 plans are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.
Why Invest in A Plan Instead of Saving on Your Own?
Quite frankly, most people do not have the time, skill or ability to save on their own. If you can set up a monthly deposit into a 529 plan that is best, because you are automatically saving a certain amount every single month and depending on what you invest in, you are effectively dollar cost averaging into the stock market and buying when prices could be down.
Pre-Paid Plans vs. Traditional 529 Plans
If you know for certain you want your child to attend a specific state school or your alma mater then you can use a 529 Plan to pay the tuition up front. The reason for this is to lock in a set price and eliminate all the tuition increases until your child attends this specific school. In the past this would have saved thousands of dollars because of annual tuition increases every year. The downside is flexibility. What if your child wants to go out of state or decides they do not like your alma mater and decides to attend another college, but they do not offer the pre-paid option?
State Plan vs. Out of State Plan
One of the best things about investing in a state-sponsored 529 plan is the tax advantage that goes with it. In Colorado, for example, you get the 4.63% state tax exemption for the amount you invest in Colorado’s CollegeInvest 529 Plan. If you have good investment choices in your state plan there is absolutely no reason not to. Typically, you will have age-based plans or index funds as investment choices, which means most states will have similar options and investment returns.
Child’s Age and Risk Profile
The younger your child is when you enroll in a plan the more aggressive you should be in your investment selections. This is when a few bear markets can work to your advantage. If you are starting to invest when your child is born you will have 18 years until they go to college. If you are investing every single month, then bear markets will allow you to accumulate even more than during up or bull markets. However, when your child reaches age 17 it makes sense to get more cautious and move your investments in the plan to the most conservative investment option like a fixed annuity or a short-term bond vehicle. No reason to take on stock market risk at that stage in the game since you will need the money in just a year.
529 Plan Alternatives
Another option for college savings is to open a custodial account that your child has access to at 21 years of age. The problem with this is taxes and control. You will owe taxes on any capital gains or income generated by the custodial account and most likely have to file a separate tax return. With a 529 plan, all capital gains and income generated by the investments grow tax free. The other issue is control at age 21. Your child gets the money/investments at age 21 whether you want them to or not. What is to stop them from spending the money or selling all the investments and buying a new car or taking an expensive vacation? The account is in their name and can do whatever they please the funds.
College may seem like a long way off when your child is born but with the cost of college rising consistently over the rate of inflation every year you can never start soon enough. Fortunately, we live in Colorado where I think we have one of the best 529 plans in the country, with great investment choices, low fees, and excellent service.
Fred Taylor serves as Vice Chair of CollegeInvest, the nonprofit board of Colorado’s 529 plan. Disclosures: Above material is for information and education purposes only. Past performance is no guarantee of future returns. All investing involves the risk of permanent losses, and there are no assurances that any level of distributions can be supported by a portfolio. Consult your individual advisor for guidance specific to your circumstances.