Ask Money

Money thoughts for a ‘perfectionist uncle’

Chris Farrell Jan 11, 2012

Question: I have a wonderful little 4-year old niece for whom I have been setting aside money. Currently, it is just going into a savings account as I have perhaps been letting the perfect be the enemy of the good. It seems like the 529 plans out there vary in performance and fees quite a bit. I’m having trouble finding any good resources to compare them. I want something that is not going to be overly vulnerable to the whims of the stock market while also not hitting me with high fees. Any suggestions? Jason (a.k.a. perfectionist uncle), Grand Forks, ND

P.S. There was a good post in the Marketplace archives that noted some of the concerns I mentioned.

Answer:  You’re a good uncle. A website I like that should help you research and narrow your 529 choice is Joseph Hurley’s Hurley offers a lot of free information. He charges for more comprehensive investigations. The website is updated to take into account changes in the law and in plans.

I wouldn’t worry too much about your financial paralysis. You might decide to keep the money you’ve set aside already right where it is — in a safe parking place. It could be part of a low-risk college savings portfolio. (I would make sure the money is earmarked for her in your will.)

The key to saving for college is to remember that you have to draw on the money within a relatively short period of time. You don’t want to take a lot of risk with the money. Imagine, your niece is likely to head off for college in 14 years and graduate in 18 years!

Still, there’s no question that a 529 offers a lot of advantages. To run through them quickly, the account is funded with after-tax dollars, but the money grows tax-deferred from both federal and state taxes. (A majority of states allow some or all contributions to be deducted from state taxes.) When you withdraw the accumulated savings, it’s free of federal taxes (and usually state taxes) as long as it goes toward qualified educational expenses, such as tuition, mandatory fees, books, supplies, equipment and personal computers. 

You can own an account in any state. The money can be spent at any accredited public and private college. Anyone can contribute to a 529, including parents, grandparents, uncles, aunts, cousins and friends. A 529 plan in most states can be opened with less than $100 and the maximum is typically several hundred thousand dollars. The federal financial aid formula treats 529 plans favorably. (Private colleges have the leeway to consider any asset in calculating financial aid, but most follow the federal guidelines.).

What’s not to like? Well, I highlighted the reasons in the post you liked.  The 529 has moved away from a well-intentioned program that made it easy for middle-class adults to save for their children’s college education; now, it’s a byzantine maze of choices — often with high fees, inappropriate investments and too large a slice of equities.

As I mentioned, I would tap into to do your research. To simplify your choice, it’s almost always cheaper to buy a 529 plan sold directly by a state. Most of the plans sold through broker-dealers are too expensive.  I would stick mostly to the more conservative investment choices, such as funds made up of Treasury Inflation Protected Securities (TIPS), high quality stocks and investment-grade, fixed-income securities. 

The basic, plain, vanilla, age-based investment option can work well — with these caveats. The money should be invested in low-cost index funds. I’d stick with the more conservative option that eliminates or reduces to a sliver the equity portion by the time the child is 16 or so.

Now, to be clear, I’m optimistic about the outlook for stocks. And you may be comfortable with the risks associated with equities. My concern is that your niece will go to college in about 14 years. It’s a pretty inflexible date. By the time she’s 16, I don’t think stocks should be in the college portfolio mix unless there are additional resources to tap in case of a stock market meltdown at the wrong time.

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