If you have children or plan to take college courses in the future, you should take full advantage of 529 college savings plans. They offer one of the best tax breaks available. The plans are available to everyone. However, Congress has made these plans very complex and inflexible. Here are key issues to be aware of.
The following are the key advantages of 529 plans:
As long as the money is used for higher education-related expenses, there are no taxes on withdrawals or investment returns.
All states' 529 plans are available, regardless of residency, and for each child, multiple accounts can be opened in different states.
Although each 529 account must have a designated beneficiary, the money can easily be transferred to other related beneficiaries.
Be aware of the following disadvantages and complexities of 529 plans:
Each state decides who manages the investments, your investment options, your fees and other costs, etc. The options are not always good, and the plans are generally inflexible.
Many plans offer the equivalents of load funds and high-expense ratio funds, which can be a drain on your savings. If you're not careful, your broker or financial advisor will most likely steer you toward one of these.
Use Some Tips
So what's a busy physician-investor to do? Unless you are knowledgeable about investing, seek competent, unbiased professional help. Because of the various inflexibilities, managing a 529 account is more complex than managing other investment accounts. Find a fee-based advisor who won't steer you into plans they are compensated for.
â€¢ Investigate the plan's fees. Never invest in a plan or investment option that charges front- or back-end loads. As with mutual funds, if the investment options have A, B, or C tacked to the end of their names, turn and run. These are traps you will live to regret. At what rate do you need to save for each child, which state's plan should you use, and which investment options should you choose? Your financial advisor can help with all these decisions and explain their recommendations clearly and convincingly.
â€¢ View and manage investments in 529 plans as part of your overall portfolio. This is very important and should be reflected in the investment choices you make. Start saving early, and save steadily. Let me cite one number to motivate you to start saving right away. If you just had a baby and want to save enough money to send them to a private college, you would probably have to save $10,000 per year, increasing savings at the rate of inflation (ie, maybe $10,300 next year) until they are ready to attend college. Admittedly, this is a somewhat conservative estimate. But if your investments do well over the years, you will be able to stop saving earlier, which is something to look forward to.
Chandan Sengupta, author of The Only Proven Road to Investment Success (John Wiley; 2002), currently teaches finance at the Fordham University Graduate School of Business and consults with individuals on financial planning and investment management. He welcomes questions or comments at email@example.com.