BY THE END of this year, all states are expected to offer college savings plans. But more options may only mean more confusion.
Each state's plan has quirks. Some offer residents tax breaks for investing in a home-state plan. Others have high fees and commissions that can significantly erode returns. The differences from plan to plan aren't always easy to decipher, either.
The savings plans, sometimes called "529 Plans" after the federal tax code that created them, are becoming one of the hottest ways to save. People invest in tax-deferred accounts, and, thanks to last year's tax law, the earnings will be free of federal taxes as long as the money is used for college. This tax break, though, will disappear after 2010, unless Congress renews it.
States sponsor the plans, but they are often managed by major investment managers such as TIAA-CREF, Vanguard Group, Fidelity Investments and Merrill Lynch. Assets in the plans reached $7.2 billion last year and are expected to climb to $51 billion by 2006, according to Cerulli Associates.
If you're thinking of investing in a plan or switching plans, experts suggest that you consider the following factors:
Look homeward first. Many states encourage residents to invest in home-state plans by offering them benefits, such as allowing them to deduct all or part of their contributions on state income tax returns. That might be reason enough for residents in high-tax states to invest at home, provided the plan is good.
"Brokers should mention that you may want to consider your state's program if it offers special benefits," although some won't recommend a plan if it doesn't pay them a commission, said Joseph Hurley, author of The Best Way to Save For College. Hurley's Web site (www.sav ingforcollege.com) rates states' plans and lists some of the rules governing each.
Maryland is clarifying its tax deduction so that an individual would be able to deduct no more than $2,500 in contributions each year per child or other beneficiary. The state plan is managed by T. Rowe Price Associates.
Christopher Brown, a financial planner in Gaithersburg, figures that a Baltimore resident contributing $2,500 in Maryland's plan would save about $183 in state and local taxes. "If you don't spend the money, it's like the state is adding 7 percent to your contribution. That's not bad," said Brown, who has invested in the plan for his year-old son, Jeffrey.
Investors should explore other states if their state's plan doesn't offer a tax break, the fees are high or they don't like the investment options, Brown said.
Fees and commissions. These are not always easy to spot in plan documents, although they play a huge role in your investment return, experts say.
Compare a $10,000 investment in New York's college savings plan, with total annual expense of 0.65 percent of assets, with the Wisconsin plan, with yearly costs of 2.25 percent, said Chris Cordaro, a wealth manager with RegentAtlantic Capital in Chatham, N.J. Assuming a 7 percent annual return, the New York account would be worth $30,288 at the end of 18 years, compared with $23,055 for the Wisconsin plan, Cordaro said.
"Anything above 1 percent is too high," Cordaro said of the fees.
Some states charge an enrollment fee. At $90, Maryland's fee is among the highest, but plan officials say they are considering lowering it.
The account maintenance fee can range from $25 to $50 a year, although some plans waive it for large accounts or if investors make regular automatic contributions, Hurley said.
Some fees are tied to account balances. For example, investors will pay a certain percentage of their assets for the money management of the mutual funds in their accounts.
Maryland and most other states allow direct investment in a plan without paying a commission to a broker. But many states also distribute their plans through brokers or financial consultants.
Costs will be higher with a broker because you pay for financial advice. You might pay an upfront sales charge, ranging from 1 percent to 5.75 percent, each time you contribute, Hurley said. Or you might face no upfront charge but pay higher annual costs for several years or throughout the time you invest. Some plans with higher annual costs might add a sales charge if you pull money out of the plan within a certain period.
If using a broker, ask how the broker is being compensated and what is the least expensive commission option based on how long you will be investing in the plan, experts say.
Know your plan's quirks. Sometimes when investment firms promote a college savings plan, it's not clear what state is sponsoring the plan, experts say. But investors must follow the rules of the specific plan and need to know them.
New York's plan requires that investors keep money in the plan for at least three years. But if your child is headed to college in two years and you'll need the money then, you will pay a penalty under New York's plan for early withdrawal.
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