MainStreet Explains: 529 College Savings Plans

With stocks down 40% in the last year and key indexes threatening to fall further in 2009, many parents fear that six or seven years of college savings could be down the drain.

Then again, maybe not. Parents with longer investment horizons could make a smart financial move by taking money out of taxable investment accounts and moving them into a college 529 plan.

A college 529 plan is a tax-advantaged educational savings plan, usually sponsored by a state or educational institution, which enables families to allocate money for future college costs. While these plans were created by the federal Government, it’s up to individual states—all 50 as of 2008—to design and deploy the plan to their satisfaction.

Your College Saving Options
Currently, states are offering two primary types of 529 plans:

  • Prepaid Tuition Plans: These guarantee the money you save today will match the growth in tuition inflation at state-run colleges and universities, essentially locking in tomorrow’s prices in today’s dollars. With budgets strained these days, prepaid plans especially appeal to middle-income families who are aiming for a state college or university.
  • College Savings Plans: These plans allow you to contribute to a pool of money managed by the state treasurer or an outside investment adviser. A typical savings plan leans toward stocks when the child is young, then moves toward bonds and cash as college draws near. A few plans offer all-stock or all-bond accounts. You can use the money at any accredited school for tuition, room, board, books and supplies. If your state's plan is inferior or doesn't disclose performance and fees, you can invest in another state. It’s up to the states to decide who is going to run the plans, and in most cases it's a Wall Street brokerage or mutual fund firm.

From an investment point of view, 529 plans are a lot like 401(k) plans. They’re usually managed by a single investment advisor, but investors get to choose from stock, bond and money market funds. By and large, parents can be more aggressive when their kids are younger, and pursue small cap, large cap and even some international funds. But as the child gets closer to collegiate age, capital preservation becomes a priority, as investment options shift to more conservative fixed income funds.

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