By Brittany Goodwillie, CFP®
If you read our previous blog post, you'll know that 529 plans offer unique features that make them extremely valuable for college savings. Deciding to open a 529 plan is only the first step; you then have to decide which plan is best for you. There are three fundamental decisions you need to make when first enrolling in a 529 plan.
1.) Should you enroll in a prepaid tuition plan or a savings plan?
There are two main types of 529 plans - prepaid tuition plans and savings plans. You can also choose to invest in a combination of both if it makes sense for you.
Prepaid Tuition Plans work exactly how they are named - they let you prepay for college education. They will often charge a set price for tuition credit that can be used in the future. The downfall of these plans is that they lack flexibility. Prepaid plan funds can only be used for tuition, not room and board or books. Even more limiting is that the plans are meant to be used for in-state colleges. If your child has prepaid tuition plan credits and decides to go to an out-of-state school, you can rarely redeem close to their full value. Prepaid plans are becoming less common and Michigan is one of only eleven states still offering them. If you are certain your child will go to college in-state, this plan could make sense depending on how much the state is charging for a tuition credit, how early you start saving, and the expected rise of college tuition. We can help you analyze your options with a comprehensive financial plan.
Savings plans are more common and they work similar to an IRA or 401(k) plan by investing your assets over time to generate earnings. You will get to choose between investment options and the sooner you begin saving, the more time your money can grow. Because many can't predict where their child will go to college, this plan usually makes the most sense. The biggest downfall of a savings plan is that the funds are subject to market risk regardless of when you need to access them. It's important to make sure investments are more conservative as the child grows older.
In addition to these two main types of 529 plans, some states offer a special type of 529 plan called an ABLE account for students with disabilities.
2.) Which state's 529 savings plan should you enroll in?
That's right...you have a choice. You can open a 529 plan from any state and choosing your own state's plan is not always the best option. It's important to compare the plans' expenses, investment options, and the tax incentives available in your residential state. Savingforcollege.com has a good tool to compare different state plans or a financial planner can help you compare your options.
3.) Should you choose a direct-sold or broker-sold 529 plan?
You can enroll in a 529 plan one of two ways - directly from the plan manager or through a broker/advisor. As a financial advisor, you may think I would recommend an advisor-sold plan...actually, it's the exact opposite. Fee-only planners, like myself, can't even manage advisor-sold plans because of the commissions they charge. The added fees make them much more expensive than direct-sold plans and eat away at the plan's earnings.
A fee-only firm, such as Autumn Financial Advisors, LLC, has a fiduciary obligation to direct you to a plan that's best for you. That leads us to tell you that direct-sold plans avoid added fees and are often the way to go.
That being said, choosing the appropriate investments is still crucial so it's important to hire a trusted financial planner that can offer their expertise. If you don't have guidance on which investments to choose, then as expensive as it is, a broker-sold plan will at least have the benefit of professional advice.