6 Essential Tips on Starting a College Fund for Your Kids
Every year, Morningstar Inc. rates college savings plans, which are called 529s. The rankings either ease the minds of parents and grandparents who have established dorm eggs in the top-rated plans, or cause a sense of panic in those who find their hard-won investments are languishing in a poorly rated plan. Then, of course, there are the people who have not yet established a college fund for their children who see this annual list and scramble to make the right choice.
Many parents who choose to invest do so to avoid student loan debt that they or their kids will have to pay off down the road. Currently, America has over $1 trillion in outstanding student loan debts. Last year, college kids who graduated with a bachelor's degree left school with the highest annual student debt in our nation's history.
In time for this week’s debut of the 2012 college savings plans honors list, TakePart caught up with Morningstar’s Laura Pavlenko Lutton, director of fund of funds research and supervisor of the rankings. We asked her for a few tips on how parents, grandparents, and guardians might use the Morningstar ranking list (which weighs criteria such as fees and fund performance) to avoid college debt and establish a healthy, panic-free investment for their future scholars:
What is the first thing parents should do when trying to decide which plan to choose?
The first decision is going to be deciding whether to do this by yourself or with a financial advisor. Most parents are going to do it themselves. If that’s the case, you will be interested only in the direct-sold plans [and not the advisor-sold plans]. If you’re doing it yourself, there’s [generally] only one direct-sold plan per state.
So, if you’ve decided to save yourself some fees and go with a direct-sold plan, should you only use the 529 that your state offers?
Check to see if there are tax benefits in your state associated with 529 plans. Can you take those tax benefits and apply them to any plan? They [may be] portable. Or would you have to give them up if you leave the state?
There are some states that don’t have any tax benefits. If there are no tax benefits, you can consider any state’s plan. There is no financial reason for you to stay with your home state’s plan. And if your home state doesn’t have a medal from Morningstar, the sky’s the limit—you can go anywhere.
What if your home state’s 529 has tax benefits, but does not rank very high on Morningstar’s list?
I would say if there are local tax benefits that are not portable, you’re better off just staying put. If tax benefits are looked at as lowering the cost on the 529 plan or as improving your returns on college saving, there’s a dollar value you’re giving up if you leave the state. Our research shows this makes up for things like if the [associated] fees aren’t rock bottom or if the investments are not best in class. It ends up being reasonably attractive.
Why should an investor looking to save for a child’s future education turn to a 529 instead of another investment package?
529s used to be criticized because they were expensive and had lousy investments. Those days are pretty much over. The industry is demanding the 529 asset managers put good investments in the plans. Those annual expenses have come down and everybody should benefit.
There are a lot of choices to make, and they are potentially confusing. I think they potentially turn some people off. But this is a [really] nice way to save for college. Tuition goes up on average 7 percent a year. Tuition inflation is working against you for bills when they come down the road. Let the market appreciation keep up with tuition inflation.
If you see your child’s 529 plan on your negative list, should you switch?
It’s such a pain in the butt to switch. All that tedious paperwork. The 529 industry is very responsive to criticism. If we rate a plan poorly, it tends to make changes. Two plans were on the below-average list last year because they were too expensive. They both cut fees [after that ranking].
So, don’t panic if your plan is on the negative list—it very well may improve. But there may be opportunities to make better choices.
Is it ever too late to invest in a 529 for a child in your family?
The earlier you get started, the more likely you’ll be able to offset that lumpy payment later in your life. There are age-based options in the plans, based on child. The nice thing [with these is] the asset allocation changes over time. If you have a newborn and are getting started, all your savings will be in the stock market. As the child gets older, more and more will move into bonds, which in the industry tends to be safer investments. This happens automatically. Your money will be more conservatively allocated without your having to remember to make the change. That’s a really nice feature in these plans. Rebalancing accounts is not on the top of the list when you’re trying to remember lunches and basketball practices.
Starting when your child’s young in stocks gives you the biggest chance for appreciation. That’s a reason to get started early. It will grow at a faster rate than tuition inflation. But that doesn’t mean you shouldn’t get started if your child is 10 to 14 years old. The 529 industry has done a lot of research, and if someone is saving for a child to go to college, statistically that child is more likely to go to college. That is a parent’s priority.
The hardest part is just getting started.