Why 529 College Savings Plans Still Make SenseWhen the economy went sour and took the stock market with it, lots of pundits came out swinging against 529 college savings plans.
"You see, you saved all this money for college and now it's gone," they exclaimed. They claim that investing for college in stocks is risky and, therefore, shouldn't be done at all.
Like anything, using black and white criteria is a mistake. In fact, it's a mistake not to take advantage of the tax benefits of 529 plans. You just need to do it smartly.
Stock investing is long term investing. How long is long term? At least 10 years. If you open a 529 plan for your child or grandchild when they're born, that gives you about a 20 year horizon. That's long enough to invest in stocks.
But that doesn't mean you should sock all of it into a risky stock mutual fund and let it ride until your child enrolls in college. Instead, you need to gradually move your investments into less risky asset classes.
Many 529 plans will do this for you. These target-date funds put most of your money in stocks to begin with and then move it into treasuries, bonds, and other asset classes as you get closer to needing to withdraw it.
One fair criticism of target date funds is that they might not be conservative enough with investments as you get closer to your target date. That's fair, which is why you need to research how your fund works. Don't just put everything on autopilot.
I personally manage the target dates myself. I'm still investing in my daughter's 529 account each month, one hundred percent in stocks. When she gets a little bit older I'll move some of this into less risky investment options. Then when she gets to within a few years of college, I may move it all into FDIC-insured assets. Whether or not I do this depends on how much I'll rely on that money to pay for college. If I have significant savings elsewhere, I'll keep the 529 in slightly more risky assets.
It's important to not overlook why 529 plans are such a great investment vehicle for saving for college. The tax benefits are extraordinary, especially if you live in a state that levies income tax and also offers 529 plan tax benefits.
First, you get federal income tax benefits when you withdraw your money to pay for qualified education expenses, such as tuition. You don't pay any tax on the capital gains and investment income. This applies to everyone with no income limits.
Second, some states will give you a tax deduction or credit when you contribute money into your plan, in addition to not paying tax when you pull the money out. That means you get a financial benefit today...not just 20 years from now.
You shouldn't necessarily invest in your states' 529 plan, even if they offer these tax benefits. It's important to search for the state that offers the ideal mix of investment options and fees for you.
But don't ignore saving for college with 529 plans just because of an alarmist news headline warning you to stay away. It's simply not sound advice. You just need to be smart about how you invest.