Unlike Coverdell accounts and Roth IRAs, there are no annual income limitations for 529 plan contributors, making 529s the natural choice for high-income college savers. In addition, while Coverdell ESAs limit contributions to $2,000 and Roth IRAs to $4,000 per beneficiary per year, with a 529 plan an individual can contribute up to $12,000 per year to a single beneficiary (that limit being the maximum annual gift tax exclusion). There's even a way to boost this already high limit: a contribution of up to $60,000 can be made up front, then treated as five consecutive annual contributions for gift tax purposes. Given that these limits are per contributor, a couple could effectively give double these amounts to a single beneficiary. For most people, this means 529 plans offer them the ability to save as much as they can without worrying about any restrictions.
Don't be dissuaded if you don't happen to have $12,000 laying around to fund a 529 plan with. Even small amounts invested regularly over an extended period of time can grow surprisingly large. For example, if you can save $100 per month for 18 years and the plan averages returns of 10% per year, you'll end up with $60,557. That may not cover all of Junior's college expenses, but it'll sure put a big dent in them.
A final advantage of 529 plans is that the contributor retains control and ownership of the account. This is important on several levels. For starters, it means that the contributor can pull money out of the account at any time and for any purpose, although taxes and a 10% penalty will result from unqualified distributions. It also allows for a great deal of flexibility in changing the beneficiary from one child (or grandchild) to another. And perhaps most importantly, it ensures that a child who decides not to go to college doesn't wind up with an unintended financial windfall. A 529 plan may not only be a valuable vehicle to help you provide for the costs of a college education, but also to protect your children from receiving a large sum of money that they aren't spiritually and socially equipped to handle yet.
While there are many benefits of 529 plans, there are also some flaws. Savers using 529 plans are limited to a relatively small range of investment options selected by the state—a significant downside for those who want to manage their own portfolios. Also, many 529 plans are broker-sold which results in paying a sales load that greatly reduces the 529 plan advantages. While overall expenses continue to fall, there are still some plans with outrageously high expenses (1.5% and up). High expenses in a 529 plan—where you don't have the advantage of being able to upgrade between funds —are the kiss of death.
Choosing the Right Section 529 Plan
With over eighty 529 plans to choose from, it's crucial to know what factors are important when comparing plans. Obviously, one key component is the rate of return you can expect. Understanding how 529 plans invest can give you some idea of what to expect from each type of plan.
Most 529 plans are managed by mutual fund companies and offer a range of investment options. Usually, one or more age-based portfolios are available that invest mostly in stock funds when the child is young, and automatically shift to safer, interest-earning investments like bonds and money market funds as the child gets closer to college age. In that respect, they're an easy auto-pilot way to save for many investors. But there's a huge variation in how aggressive various states are in their allocations. For example, even in the aggressive track, an 11-year old in New York's plan is still only 50% in stocks. Many would argue that isn't enough.
Thankfully, many plans are adding features that allow some fine-tuning. In addition to age-based portfolios, "static" portfolio options are now quite common. These allow the investor to select a certain mutual fund or mix of mutual funds that will remain constant unless the investor initiates a change. It's not unusual to find states offering multiple static choices, such as Nebraska's 529 plan, which offers six static portfolios in addition to their four age-based options. These static portfolios range from 100% in stocks to a very conservative 50% bond/50% money market split.
