Education: The Ins and Outs of 529 College Savings Plans

Saving for college is an important part of many families' financial picture. Families may choose to explore state-run 529 plans, which allow investors seeking tax-free growth of assets to pay for higher education.

More than 80 different 529 savings programs (distinct from prepaid tuition plans also offered by several states) are available in 49 states and the District of Columbia.

Twenty-six states offer some level of tax deduction on annual contributions, but only if you invest in that state's plan. Residents can often avoid sales charges on broker-sold plans by investing directly through the state.

Enrollment and account fees are typically waived or lowered for those who stick close to home. In other cases, low-income residents can qualify for matching contributions or scholarships to state schools.

Two drawbacks of 529 plans are the layers of fees and tricky cost comparisons. States basically act as middlemen, frequently adding administrative and account fees. Comparisons are tough, as some states charge a flat percentage-of-assets fee while others charge a la carte in both dollar and asset-based costs.

According to experts with investment research firm Morningstar Inc., investors should look to low-cost leaders like Vanguard for indexing, T. Rowe Price for active management or American Funds for broker-sold options and then see how their states stack up.

Investors should also research plans that offer a broad menu of fund asset classes that allow you to create a well-diversified portfolio, Morningstar advises. Age-based funds that follow a steady asset allocation path and grow less aggressive as a child approaches college age are also desirable. Investors should also look for plans run by reputable fund shops with a history of shareholder friendliness.

Many states and fund companies tout the performance of their plans, but investors should be wary. Few plans have records much longer than five years. And comparisons with common benchmarks like the S&P 500 Index are often inappropriate for plans that invest across the globe and the entire market-cap spectrum. Free 529 plan information is available on Morningstar.com.

Investors' focus should be less on plan performance and more on finding a low-cost portfolio of quality investment options using a moderate asset-allocation model, according to Morningstar.

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