How to Choose a 529 Plan

With 5/29 being this past weekend, my Right Financial Plan co-author Kevin Grogan thought it would be great time to discuss 529 plans.

If you're not familiar with 529 plans, they're tax-advantaged accounts for saving for college. (Basically, 529 plans are to college what IRAs are to retirement.)

529 Plan Basics Here are some general facts about 529 college savings plans:

• Individuals contribute after-tax dollars that grow tax free, such as they do in a Roth IRA.
• Anyone can act as the owner of the plan and name a child or grandchild as the beneficiary.
• A parent or grandparent can contribute to any state's plan, but some states allow residents to claim state-tax deductions for all or a portion of 529 contributions.
• Investors are restricted to the investment options within a state's plan.
• The owner (and not the beneficiary) retains control of the 529 assets.
• 529 earnings can be withdrawn free of federal taxes for qualified college expenses.
• 529 plan assets aren't treated as a child's personal assets for federal financial aid purposes.

• Investment Options -- Find the plans that allow for the most effective global diversification. I also have a preference for plans that have passively managed investment options.
• Costs -- Costs are a drag on returns, so you should look for 529 plans with low costs.
• Tax benefits -- I don't recommend choosing your own state's 529 plan without investigating the plan. However, enjoying both federal and state tax advantages should be considered when choosing a plan.

Nevada, New York and Utah offer passively managed Vanguard funds at very low expenses. New York charges 0.25 percent per year, while Nevada and Utah charge 0.28 percent per year. Utah doesn't have a value investment option among its equity fund choices, but it does have a nice feature for fixed income investments. Utah allows participants in its plan to use a mix of Vanguard funds for equity and the Utah Public Treasurers Investment Fund (PTIF) for fixed income. The PTIF is a free investment option (if you view statements online and don't receive paper statements) that invests in CDs and highly rated commercial paper.

Tax Benefits There are currently 21 states where residents can choose any 529 plan without considering the impact of a state tax deduction:

• No state income tax -- Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming
• No deduction for any 529 plan contributions -- California, Delaware, Hawaii, Kentucky, Massachusetts, Minnesota and New Jersey
• Deduction available for contributions to any 529 plan -- Arizona, Kansas, Maine, Missouri and Pennsylvania

529 plans are a great tool for funding college expenses, and selecting the right plan can be complicated. A good starting point is your home-state plan if you get a state tax benefit. If you live in one of the 21 states listed above, I recommend using the Nevada, New York, Utah or West Virginia plans, as those states offer passive investment options at a low cost.

More on MoneyWatch:
Why LinkedIn Stock Isn't a Good Bet The Smartest Things Ever Said About Beating the Market Should the Treasury Stop Issuing TIPS? 5 Differences Between Passive Management and Indexing The Benefits of Passive Management Without Indexing
Three ways I can help you become a wiser investor:

• Follow me on Twitter: http://twitter.com/larryswedroe.
• Read my latest book The Quest for Alpha.
• Listen to my radio show every Sunday at noon on 550 AM KTRS in St. Louis or streaming via the KTRS Web site. You can also download the podcast of the show via Buckingham Asset Management's iTunes page.