Saving for college? 529 plans are your best bet

If you needed a new car, you probably wouldn’t pick the first one you saw, you’d drive others and compare prices. You’d want to get the most for your money.

Yet even though a four-year college education—at about $100,000—now costs roughly three times more than the average car, parents generally do little comparison shopping for the best way to amass the money they will need for college. Many don’t make the most of their savings, arriving at college years unprepared.

Relying on a savings account, for example, typically falls far short. Savings accounts, while safe, barely grow. If parents saved $2,600 at the start of each year in a savings account, they’d have roughly $13,200 for college after five years.

Meanwhile, a 529 college savings plan can put a family closer to where it needs to be.

A “moderate allocation” investment in a 529 amasses about $16,800 on average with the same $2,600-a-year in savings.

A “moderate allocation” investment gets its name by taking judicious risks with a combination of stocks and bonds, often putting close to 70 percent of a person’s savings in mutual funds that invest in stocks. During the last five years, the “moderate” risk-taking has gained about 8.7 percent a year, according to Morningstar. But there aren’t guarantees with mutual funds, and there have been years like 2008, when investors lost more than 20 percent on “moderate” risks.

Still, given the opportunity to recover from a loss when children are young, advisers often pick a moderate allocation for children about 9 to 12 years old and become more conservative as children approach college.

It’s not the investment choices alone that generally make 529 plans a more effective way to save for college than using savings accounts.

Under tax laws, when a family saves for college in a 529, they get to use all the money they’ve accumulated for college without sharing it with Uncle Sam.

Savings accounts don’t provide that tax advantage. Nor do mutual funds that are selected outside of 529 or Coverdell College Savings Accounts.

Taxes matter. Morningstar has calculated that if a person in the 25 to 35 percent tax bracket put $2,600 a year for five years into the average mutual fund that selects large fast-growing company stocks, they would have about $17,800 to pay for college. But in a 529, because of protection from taxes, they end up with $18,440 in the same type of mutual fund.

As an extra benefit, almost half of states give people extra benefits, often additional income tax breaks, if they save money in their home state’s 529 plan, according to Morningstar. Some also provide grants or scholarships.

About 10 percent of states will give 529 savers a tax benefit even if they pick a 529 plan offered by another state. See what your state offers here.

You don’t have to pick your state’s 529, although Morningstar notes that valuable home-state benefits can make it worthwhile to use a good versus an exceptional 529 plan. Morningstar gives “bronze” ratings to good plans. Compare quality and benefits at Morningstar’s site or here.

A key to maximizing your savings is to pick a 529 plan from a state that is conscientious about offering you quality investment choices appropriate for the age of your children, plus solid fund managers and low fees. Quality varies from state to state.

The four best, according to Morningstar, are the Maryland College Investment Plan, T. Rowe Price College Savings Plan in Alaska, the Vanguard 529 College Savings Plan, and the Utah Educational Savings plan. The funds are managed by T. Rowe Price and Vanguard, which Morningstar lauds for strong management at very low prices. It also praises the American Funds, which operate Virginia’s College America and the low cost index funds of the Michigan Education Savings Program.

States have been improving and cutting fees over the last year. Consequently most are worth the state benefits, according to Morningstar. The only plans Morningstar pans with a negative rating are the CollegeAccess 529 of South Dakota, the Ivy Funds InvestEd 529 of Arizona, and the Schwab 529 College Savings Plan of Kansas.