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529 Plans: the Best Way to Save for College

Barbara Friedberg

What is the top 529 plan? Although Jessica is only 5 years old and Jason is 8 years old, mom and dad are starting to wonder how they can pay for their little darlings' college expenses. If they're lucky, maybe grandma and grandpa will ask to chip in to the college savings pot.

Though there's always a chance the adorable children will grow up to be star athletes or exceptional and brilliant students, you're wise to consider the possibility they may not garner those juicy scholarships. With college costs skyrocketing, along with the accompanying debt, a 529 plan is a great college saving device.

We contributed to a 529 for our daughter when she was an infant, and along with her scholarship (who knew?), a small loan and summer job income, she graduated from college financially intact. And since we started contributing while our daughter was young, and invested in a diversified portfolio of stocks and some cash, our money contributions to her 529 plan grew quite well during the 15-year compounding time.

529 plan overview. According to the Securities and Exchange Commission, "A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as 'qualified tuition plans,' are sponsored by states, state agencies or educational institutions and are authorized by Section 529 of the Internal Revenue Code."

There are two types of 529 plans: pre-paid tuition plans and college savings plans. All 50 states and the District of Columbia sponsor at least one type of 529 plan. In addition, a group of private colleges and universities sponsor a prepaid tuition plan."

My opinion is that prepaid tuition plans are risky. These plans sell units to cover the education costs at specified state (and some private) universities. But what if Junior didn't want to go to a state university? What if Junior is set on attending the Parson's School of Design in New York City, and you paid into the (prepaid) College Savings Plan of Nebraska? Then you paid into a plan to control tuition costs at a school Junior didn't want to attend.

My preference is the 529 college savings plan. These programs offer more options with greater flexibility.

Why 529 plans are great:

-- Federal tax breaks: Your investment in the 529 plan grows tax-free (contributions are made with after tax dollars). As long as you use the proceeds to pay for education related expenses, the withdrawals are tax-free as well.

-- State tax breaks: Some states offer tax breaks on top of the federal tax treatment. If your state doesn't have any tax benefits, check out other states' programs. You're welcome to invest in the 529 plan of any state.

-- Control: You control the account, not Junior.

-- Flexibility: The plans are flexible and you can change your investment choices at will. You can even set one up for yourself, if you're planning on going back to school or graduate school.

-- No income limits: In most cases, anyone can contribute, regardless of income.

The best 529 college savings plan. It seems logical that you would contribute to your own state plan. However, your states plan may or may not be right for you. Start out by investigating the tax benefits of your state plan. If your state offers compelling tax benefits, then it will usually be a top contender. If not, definitely investigate other states' plans.

Without tax benefits, your state's plan may not be the best one for you.

Utah: the grand prize winner. Utah Educational Savings Plan Trust gets my vote for the top 529 plan.

-- Low fees: The most expensive option in the menu of nine Vanguard Index-fund portfolios is 0.38 percent. That average annual fee percent is rock bottom.

-- Index fund choices: The Utah Vanguard choices include 12 index funds. As a quick reminder, index funds have low costs and match a variety of market indexes. It is very difficult for fund managers to beat index funds over the long haul.

-- Sensible age-based options: Many states offer predetermined age-based portfolios. Utah excels in this realm as the underlying funds are low cost index funds. And, their percentage allocations are reasonable.

If Junior is between 4 to 6 years old, the Utah plan allocates 80 percent to U.S. and International stock index funds and 20 percent to bond funds. This is a reasonable allocation for a 14-year time horizon.

Barbara Friedberg, MBA, MS , is a portfolio manager, consultant, website CEO and author of "How to Get Rich; Wealth Building Guide for the Financially Illiterate." Learn more about money and pick up her newest free investing book at Barbara Friedberg Personal Finance.com .

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