Ask DWM- What's the latest on 529 Plans?

Q: What's the latest on 529 Plans?

Thanks for the question. As another school year starts, clients and friends are asking about 529 plans and other college funding programs. Here are some things to consider:

Is it any wonder that 90% of parents are worried about the cost of their kids' college education? Tuition and fees are rising even as the economy sputters and the average 529 plan, many invested in "age-based funds," lost 22% in 2008. As a result, the tax benefit of 529s (tax-free appreciation of principal), has lost much of its luster.

Almost every state is pushing its own state 529 plan. In addition to the federal exclusion on appreciation on principal earnings, most states allow residents a tax break, usually a deduction from state income, for new contributions to the plan sponsored by the resident's state. No deductions are typically given to investments to other state's plans. It's big business. There is roughly $85 billion in state sponsored 529 plans. Virginia and New Hampshire have been particularly successful in attracting assets, with $19 billion and $6 billion under management, respectively. Illinois has $2 billion and South Carolina $810 million as of March 31, 2009.

Most states offer two types of 529s; college savings and prepaid tuition plans. The prepaid plans are receiving much interest lately. For example, College Illinois! benefits may be used at any non-profit, accredited institution eligible to receive federal financial aid. This includes Illinois public universities and community colleges and many other colleges throughout the country. College Illinois! will pay the undergraduate in-state or in-district tuition and mandatory fees for the number of credit hours covered by the prepaid tuition plan. College Illinois! does not cover the full tuition and fees at private colleges and at schools outside of Illinois.

Much like the College Illinois! plan, but geared toward private schools all across the country, thre is also the Independent 529 Plan. This prepaid plan is sponsored by the Tuition Plan Consortium mde up of 270 Privates, including Duke, Pepperdine, Notre Dame and Xavier. The members guarantee your tuition benefit at the pre-purchased discount rate.

By prepaying, parents lock in the cost. So, if college education costs continue to grow at 5 to 8%, you in effect are earning that much of a return on your money. You've eliminated the investment risk and the risk of college costs exceeding your investment returns.

529 college saving plans do provide more flexibility, since they can be used for qualified higher education costs in the United States and some foreign universities as well. However, the plans can be expensive. Many of the state investment choices include funds with underlying fund expenses in excess of 2% annually plus sales charges of 3-4% upfront.

Lastly, if you do select a 529 plan, be very careful about your porfolio selection. The age-based program, which was very popular, typically allocates almost 100% of the funds for the youngest children to equities and reduces the percentage of equity to all or almost all fixed by the time the student is ready for college. In the 90s, this worked well. Now, it may result in lack of appreciation of even loss of principal for many students. Since you can only change allocations once a year, consider a more conservative approach for all portfolios, particularly for those students approaching college years.

Of course, give us a call if you have questions about college educating funding options and choices. It's a topic very close to our hearts.

For more information on the College of Illinois! plan click here