Best 529 Plans
These state-sponsored plans are still the best way to save for college. Learn how to pick the right one.
By Kristin W. Davis
April 14, 2003
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Just as the stock market went cold, state-sponsored college-savings plans -- 529 plans, for short -- got hot. Many parents, drawn to these plans by new tax breaks and improved investment choices, invested just in time to watch their college savings dwindle or even plunge. Over the 12 months that ended December 1, 2002, New Hampshire's popular Unique College Investing Plan (run and marketed by Fidelity and holding more than $1.2 billion in assets) lost up to 33% in its age-based portfolios, which include stocks and bonds.
We say, keep the faith. Generous tax breaks and other benefits still make 529 plans, named after a section of the tax code, the best place to invest college savings. (To understand the basics of these plans, see "529 Plan FAQs.") Many plans have done better than the overall stock market. And as plans have added investment choices, there are safer choices for the market-shy, as well as for those who believe we're finally due for a recovery.
Plus, good comparative data are finally available on how 529-plan investments performed, so you don't have to choose blindly. Until recently, track records were short, and no data service had standardized the reporting of returns. This made comparisons difficult. In this comprehensive review of 70 savings plans from 50 states and the District of Columbia, we used Morningstar's brand-new 529 Advisor-for now, marketed only to financial advisers rather than to the general public-to analyze returns of 529 plans.
In addition, we looked at investment choices (how many are available and how they're allocated), fees and expenses, state-tax benefits and other features.
Choosing -- The details
With 70 plans out there, where do you start? Look first to your home state's 529 plan, especially if your state offers a hefty tax deduction for contributions. But remember that this break is a one-time windfall, while annual expenses are ongoing. At a state-tax rate of 5%, for instance, you may save $500 on taxes by making a $10,000 contribution, but an extra percentage point in annual expenses eats up that benefit in five years.
Expenses. These include annual fees, annual management expenses, underlying mutual fund expenses, and broker sales charges. Total expenses of less than 1% are low. Anything above 1.5% should be considered expensive.
Investment choices. Look for investment selections that match your own investing style and preferences. If you're going to choose an age-based portfolio (one that automatically shifts the ratio of stocks to bonds as the beneficiary nears college age), look for one that uses a mix of stocks and bonds you might select yourself at the various age levels. If you prefer index funds to actively managed funds, look for a plan that includes several index-fund options.
Most plans have added several off-the-shelf portfolios, which can include 100% stocks, 100% bonds, a fixed combination of stocks and bonds, socially conscious stocks or index funds. You can tweak the asset mix in an age-based portfolio by mixing in one or more fixed portfolios.
In addition, many plans have begun adding individual mutual funds to the investment menu. You can change your investment selections once a year (and you can also roll your money over to another state's plan as often as once a year).
To appeal to market-shy savers, many 529 plans have also added an interest-bearing option, some with a minimum guaranteed return.
Performance. It would have been hard to imagine three years ago that the best-performing 529 plans would be those that lost the least. In the youngest slice of their age-based portfolios, only two plans (Kansas and Nebraska) have earned positive returns over the past three years. Among the fixed all-stock portfolios with three-year returns, only the top 11% are in positive territory.
Naturally, conservatively invested portfolios have fared better than aggressive ones over the past three years. That has particularly favored TIAA-CREF plans, which are seldom 100% in stocks and tend to begin pulling back on risk even as a child enters the elementary school years. In a rebound market, the opposite is likely to be true: Aggressive portfolios will likely outpace conservative ones.
When reading about returns in the state reviews, it's important to note how 529-plan investments are compared against one another. In Morningstar's 529 Advisor, returns in each age band of an age-based portfolio are measured against similar age bands in other portfolios-so the 1-year-old age band in Plan A is the peer of the 1-year-old age band for Plan B, regardless of the underlying investments. In the fixed portfolios, however, investments are compared against others with similar asset allocations-so the peer group for an all-equity portfolio is other all-equity portfolios. Where no returns are mentioned, performance data were not available to Morningstar.
Our picks
Our favorites are those plans we think you should consider if your home state's plan doesn't suit you. There's no perfect plan.
For conservative investors: TIAA-CREF plans are a good choice -- especially Michigan' and Minnesota's plans, which have very low expenses and have performed well.
For aggressive investors: Take a look at Iowa's and Utah's plans and Nevada's recently introduced Upromise plan, all of which use low-cost Vanguard index funds. (The latter has the broadest array of investment options.) Pennsylvania's plan stands out for strong across-the-board returns.
Buying through a broker: You're being served well if you're directed to Virginia's or West Virginia's plans, which have attractive investment choices. And while it's not marked a favorite, the District of Columbia's new plan is worth a look for those who like socially screened mutual funds.
For more information about these plans or to learn about your state's plan, see our state-by-state comparisons of 529 plans.