How to Maximize Your College Saving Program

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With so many benefits, you would rightly suspect that 529 plans must have some flaws. Indeed, there are at least two to be considered. First is that 529 savers 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. The second major downside of 529 plans is an ominous cloud lurking on the horizon named "sunset." If Congress doesn't specifically extend the tax-free nature of 529 plan earnings beyond 2010, distributions will revert to being taxable to the student when received. This could mean that the tax-free earnings savers thought they were signing up for don't turn out to be tax-free at all. While this doesn't seem likely, it would be naive to not consider the possibility that it could occur. However, even under this worst-case scenario, the years of tax-deferred savings combined with a typically low student tax rate would still make saving in a 529 plan a very solid choice.

With over fifty 529 plans to choose from, it's crucial to know what factors are important when comparing plans. One key component is the rate of return you can expect. Unfortunately, many plans have short track records, and there's no easy way to compare returns of multiple plans at a glance. However, understanding how 529 plans invest can give you some idea of what to expect from each type of plan.

Section 529 plans invest your money in a diversified portfolio of stocks and fixed income securities. While many plans allow you to pick an investment track - conservative, moderate, and aggressive for example - beyond that, until recently there used to be no way to change the investment allocation of your account. You see, it's the nature of these plans that, even though it's your money going into the plan, you forfeit the right to make investment decisions. That's the tradeoff that gives these plans their tax-advantages. Most 529 plans offer age-based mutual fund portfolios that invest your account mostly in stock funds when the child is young, and increasingly shift to bond 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, New York recently made their age-based portfolios more heavily stock-weighted, but even in the aggressive track, an 11-year old is still only 50% in stocks.

Thankfully, many plans are adding features that allow some fine-tuning. In addition to age-based portfolios, static portfolio options are being added. It's not unusual anymore to find states offering multiple static choices, like the following options Nebraska now offers in addition to their four age-based options:

While you forfeit the right to pick and choose the exact investments you want in a 529 plan, by utilizing the ever-expanding array of choices within these plans, in reality you can still exercise a significant amount of control over how the assets are invested. For example, the New York plan offers five different Vanguard stock index funds, plus a bond index fund, among its twelve individual portfolio choices. Account holders can own up to five of these options in one account and can specify what percentage they want allocated to each fund. That's a pretty high degree of control. When you consider that you can change investment options as often as once every twelve months within most plans, and can redirect new contributions at any time, you find there's quite a bit of flexibility allowed. You also have the ability to roll your account from one state's plan to a different one with better investment choices. This can only be done once in any 12-month period, but aside from that it's a simple process.