Yahoo Finance Learn the Do's and Don'ts of Choosing an Out-of-State College Savings Plan
After socking away college savings in a Virginia-based 529 account for five years, John Seelke and his wife recently switched to Maryland's plan, Maryland College Investment Plan.
That's because the Seelkes, who live in Silver Spring, Maryland, discovered they could save more money for their twin 6-year-old daughters by taking advantage of the state tax break they would get for using an in-state plan.
Navigating the world of 529 plans, tax-advantaged education accounts, can be daunting. Investors aren't limited to choosing a plan in their home state, and nearly every state has at least one 529 plan available. The accounts allow investors to make contributions that grow tax free, and withdrawals are not taxed as long as they are used for qualified educational purposes.
[Find out the pros and cons of 529 college savings plans.]
Experts say while it's a good idea to look at plans in your own state first because of potential state tax breaks, it can be wise to compare and contrast them against other top-ranked plans. That's especially true if you live in a state with no income taxes or if your state's plan has comparatively high fees.
Seelke said he originally invested in Virginia's plan, Virginia529 inVEST, because he liked its high rate of investment return and age-based investment options. Virginia also happens to have by far the nation's largest 529 asset total at $46.8 billion, according to financial analysis company Morningstar. Although he was happy with his returns, he realized he could save more with Maryland's tax break.
"We realized if the returns are about the same and we're getting the tax benefits of using a plan in our own state, it's better to have a plan in our own state," he said.
To help would-be investors get started with comparing plans, experts offer the following do's and don'ts.
Do look at your state's plan: Learn about your own state's plan, especially if you live somewhere with state income taxes. Most states offer tax incentives for investors in the form of a deduction for contributions or a tax credit, but it's usually only available to residents investing in the home-state plan, says Joseph Hurley, founder of the website savingforcollege.com.
Only six states -- Arizona, Kansas, Maine, Missouri, Montana and Pennsylvania -- offer tax breaks for out-of-state 529 plans, he says.
"You definitely have to understand what your own state offers with its 529 plan that you might not get if you invest out of state, what you might be walking away from," Hurley says.
Seelke said using Virginia529 inVEST, he and his family owed about $200 in state taxes. Since switching to the Maryland 529 plan, he is hoping to get a refund of about $500 after investing $5,000 for his daughters.
Don't get overwhelmed by choices: There are a number of good websites that compare or evaluate plans. Morningstar ranks plans based on performance compared with peers. Savingforcollege.com assigns plans a rating for both residents and nonresidents. College Savings Plans Network, a network of state-run plans, allows users to compare and contrast features between plans.
[Get more information about plans with the U.S. News 529 Finder.]
The most important thing, Hurley says, is to just pick one.
"It's really more important to just get a 529 plan than to try to pick the absolute best 529 plan," he says. "You'll find lots of differences, but in the end, you'll do much better making sure you've invested in a 529 plan rather than waiting to figure out the right one."
Do compare fees and rate of return: Stellar investment performance and low fees with an out-of-state plan may outweigh the benefit of a tax deduction with an in-state plan.
"Naturally, over a long period of time, investment performance becomes more important than an up-front state tax deduction," Hurley says.
Mark Kantrowitz, senior vice president and publisher of Edvisors.com, says depending on the fee differential between plans, plus the state income tax rate and the number of years invested, it may be wise to choose an out-of-state plan with lower fees, especially if the beneficiary is very young.
"You need to focus on plans that charge fees of 1 percent or less," Kantrowitz says. "The lower the fee, the better."
Don't automatically go with your investment advisor's plan: Some 529 plans are offered directly through a 529 plan manager while others are sold through financial advisors.
It might be tempting to buy a plan through your investment advisor, but those plans tend to have higher fees, Kantrowitz says. Advisors may also steer you into a plan that pays the highest commission, not one with the best benefits, he says. He recommends purchasing direct-sold plans, which can often be done through the plan's website.
[Consider four questions before opening a 529 plan.]
"Any financial advisor who is honest will say, 'Don't get the plan from me,'" he says.
That doesn't mean it's a bad idea to buy a 529 plan through an investment management firm where you already have accounts, Hurley says. For instance, if you have a lot of faith in an investment firm -- whether it be Fidelity, Vanguard, TIAA-CREF or another firm -- you can look for direct-sold plans with that firm. It can be helpful to see all your investments in one place, he says.
"Presumably you can see all your investments, not just your 529, by going to one website for an investment manager," he says.
Trying to save for college? Get tips and more in the U.S. News College Savings 101 center.
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