How to Evaluate a 529 Plan

Posted by Wayne on September 7, 2008 – 8:40 am

I know most of the people who come to TickerHound are here looking for advice on specific trades or investments, but there’s definitely been a growing “personal finance” theme on the site lately.

A number of the TickerHound’s out there have been hounding for answers on topics ranging from retirement planning to the best savings accounts.

Coincidentally one of my close friends called me the other day and asked me to help him set up a 529 plan for his daughter.  He knew what they were and why they were a great way to plan and save for her college education but he just didn’t quite know how to find and evaluate different plans.

And to be quite honest, I’ve never set up a 529 plan in my life (no children for me…yet) so I wasn’t quite sure what the process was either.  But being that this was a dear friend, I decided to spend my Friday night on the web, hunting down information on 529 plans.

So if you have children, grandchildren or even close friends with children, then I highly encourage you to read this article carefully.  It will definitely come in handy as you start to get the “next generation” ready for college, no matter how far away that may be.

Step 1 – Go Solo or Use a Financial Advisor?

The first thing you need to decide when setting up a 529 plan is if you’re going to use a financial advisor or do it on your own via a direct-sold 529 plan administrator.

If you use a financial advisor you’ll either pay money in the form of a sales commission or a flat fee when you setup your 529 plan.  If you go with a direct-sold plan, you’ll avoid the commission.

But be forewarned, some of the larger 529 plans cannot be purchased directly, they can only be bought through a broker.

Ultimately, you could be successful going in either direction but here are some of the potential pitfalls you should watch out for:

• If you decide to not use a broker, you’ll be left to do all of the homework on your own.  It could be quite daunting to sift through paper work and prospectuses on several different funds.
• If you end up using a broker be forewarned that you won’t be getting access to the entire universe of 529 plans.  Brokers typically have existing relationships with a few select 529 plan administrators and while they might give you “options”, your options are pretty limited.
• No matter what you do, make sure you read the rest of this article so that even if you go for it on your own or with a broker, you at least ask the right questions.

Step 2 – States Make a Difference

Before you pick any 529 plan, first check to see if the State you reside in offers any type of tax deductions for 529 plan contributions.

If you’re contributing on a regular basis this could mean some extra tax savings come April each year.

Also, some 529 plans offer other “home state” benefits.  Some include matching contributions, state financial aid assistance, etc.  Here’s a great resource provided by Bankrate.com for evaluating 529 plans on a state-by-state basis:

http://www.bankrate.com/brm/saving4college/brm_sfcsearch.asp

Step 3 – Look Below the Surface

Not all 529 plans are created equal.  Reason being, a 529 plan administrator doesn’t just take your money and drop it into government bonds, they invest your money into a basket of mutual funds.

And as we all know, mutual funds have wildly different track records, expense ratios and fees associated with them.

So look before you leap!

Here are a few steps you can take to dig into the 529 plans you’re evaluating:

1. Get a list of all the mutual funds they invest in
2. Go to Morningstar.com and look up each mutual fund
3. See if the mutual funds match your own investing style
4. Then check their long term track records – and ALWAYS look at that track record relative to the S&P 500.
5. Finally, you’ll want to check out the mutual fund’s expense ratio relative to comparable funds.  Is this fund charging exorbitant fees?  Are they load or no load funds?  You get the idea

Basically, you’ll want to find the 529 plan with the best mutual funds (low expenses, solid long term returns, etc.).

Some Tools to Help You With Your Research

Again, if you’re going to use a financial advisor, I hope this article has at least given you enough information so you can ask your advisor the right questions.  And if you do decide to go it alone, here are some sites and tools that can definitely help you on your journey:

Bankrate’s 529 Plan Directory 
Bankrate.com’s 529 Plan Checklist
Morningstar.com’s Mutual Fund Research Page

Good luck and remember, if you have any questions go to TickerHound.com to get the answers!