Morningstar Top 529 College Savings Plan Rankings 2016

mstarlogoInvestment research firm Morningstar has released their annual 529 College Savings Plans Research Paper and Industry Survey. While the full survey appears restricted to paid premium members, they did release their top-rated plans for 2016. This is still useful as while there are currently 84 different 529 plan options nationwide, the majority are mediocre and can quickly be dismissed.

Remember to first consider your state-specific tax benefits that may outweigh other factors. If you don’t have anything compelling available, you can open a 529 plan from any state (although I would only pick from the ones listed below). Also, if you grab some tax benefits now but they are discontinued later, you can roll over your funds into another 529 from any state.

Here are the Gold-rated plans for 2016 (no particular order). Morningstar uses a Gold, Silver, or Bronze rating scale for the top plans and Neutral or Negative for the rest.

Newcomer Virginia529 inVEST was upgraded from Silver to Gold, helped by a recent management fee reduction. Missing from last year are the T. Rowe Price College Savings Plan of Alaska and the Maryland College Investment Plan (T. Rowe Price), which were downgraded from Gold to Silver. Reasons for this include fees staying average when the competition overall got cheaper, while at the same time some of the underlying actively-managed funds received lower Morningstar fund ratings.

Here are the consistently top-rated plans from 2010-2016. This means they were rated either Gold or Silver (or equivalent) for every year the rankings were done from 2010 through 2016.

  • T. Rowe Price College Savings Plan, Alaska
  • Maryland College Investment Plan
  • Vanguard 529 College Savings Plan, Nevada
  • CollegeAdvantage 529 Savings Plan, Ohio
  • CollegeAmerica Plan, Virginia (Advisor-sold)

The trend here is consistency. There was no change in either of the lists above as compared to last year. Utah only missed on out the consistent list because they weren’t top-ranked in 2010.

The “Five P” criteria.

  • People. Who’s behind the plans? Who are the investment consultants picking the underlying investments? Who are the mutual fund managers?
  • Process. Are the asset-allocation glide paths and funds chosen for the age-based options based on solid research? Whether active or passive, how is it implemented?
  • Parent. How is the quality of the program manager (often an asset-management company or board of trustees which has a main role in the investment choices and pricing)? Also refers to state officials and their policies.
  • Performance. Has the plan delivered strong risk-adjusted performance, both during the recent volatility and in the long-term? Is it judged likely to continue?
  • Price. Includes factors like asset-weighted expense ratios and in-state tax benefits.

A broad recommendation is to simply stick with one of the plans listed above unless your in-state plan is offering significant tax breaks. Many other state plans may have specific investments that will work just fine as well. Here are my personal favorites, and why:

  • The Nevada 529 Plan for its low costs, variety of Vanguard investment options, and long-term commitment to consistently lowering costs as their assets grow. The Vanguard co-branding is also a sign of positive stewardship.
  • The Utah 529 plan has low costs, includes a nice selection of Vanguard and DFA funds, and is highly customizable for DIY investors. Over the last few years, the Utah plan has also shown a history of passing on future cost savings to clients.

I feel that a consistent history of consumer-first practices is important as the quality of all 529 plans can change with time. Sure, you can move your funds if needed, but wouldn’t you rather watch your current plan just keep getting better every year?

Follow-up: Georgia Tech Online Master’s Degree in Computer Science for $7,000

gtomsI’m always fascinated by the potential power of cheap, accessible education. Back in 2013, I wrote about how Georgia Tech planned to offer an online master’s degree in Computer Science for only $7,000. Three years later, the NY Times has a follow-up article on the program. Here are my notes in case you’re stuck behind a paywall.

  • Georgia Tech has a Top 10 CS program, according to U.S. News & World Report. Their online version offers lectures from the same professors, the same homework assignments, and the same exams.
  • A few other top universities have online versions of their masters programs, but they charge the same tuition as in-person ($40,000+). Georgia Tech’s online masters can be completed with only $7,000.
  • Through the use of online discussion software, a CS professor claims he now interacts with online students more often than with on-campus students.
  • A study found that this program attracted students that would not otherwise study for a master’s degree. This could be due to cost, geographical limitations, current employment, or other factors. Most enrolled students were older and currently employed while taking courses.
  • The first students started in 2014, and the first class of 20 graduates got their diplomas in December 2015. The current enrollment is over 3,000 students.
  • The Georgia Tech diploma will read “Master of Science in Computer Science,” exactly the same as those of on-campus graduates. There will be no “online” designation for the degrees of OMS CS graduates.

Promotional video below:

It’s still unknown whether this online degree will have the same impact as a traditional on-campus degree. For now, Georgia Tech is still the only university to offer a prestigious, high-quality computer science degree that is both convenient and affordable. The OMSCS program states their $7,000 tuition is priced to just barely cover their costs. Will any other university attempt an “at-cost” pricing model? What if someone extended that model to undergraduate programs?

On a related note, Khan Academy is trying to combine their free online educational materials with “internationally-recognized diplomas that provide direct access to economic and educational opportunities.” I think they should pursue accreditation, which I imagine would require human graders at the very minimum even if they used video lectures and community-based teaching support. Perhaps they can form some sort of volunteer network to keep costs low. Proposal video below:

Private College Tuition Discount Rates to Sticker Price Still Rising

captuitionThe National Association of College and University Business Officers (NACUBO) recently released their 2015 Tuition Discounting Study. While the average quoted “sticker price” tuition went up again as expected, so did the “tuition discount rate”.

For academic year 2015-16, the average institutional discount rate—or the percentage of total gross tuition and fee revenue institutions give back to students as grant-based financial aid—was an estimated 48.6 percent for first-time, full-time freshmen and 42.5 percent for all undergraduates. In other words, these private colleges put about 42 cents on every dollar of tuition and fee revenue toward scholarships and grants.

NACUBO found that 88% of first-time, full-time freshmen and 78% of all undergraduates were awarded some amount of aid. The amount awarded was roughly half of the sticker price for freshmen. The tuition discount rate has been rising rather steadily over the past decade or more:

naubo2015_1

Now, I am not saying college tuition is cheap. However, I do think that knowing how these things work can make parents and students smarter consumers. Even though we often think of universities as benign non-profits, in reality many are quite aggressive marketing machines. I’ve written more about tuition discounts before, but here are my brief takeaways:

  • Don’t immediately write off private colleges with high sticker prices. The total costs may be much lower than you think. Private colleges have a lot of discretion, and your application may fit their desired characteristics.
  • Always apply for financial aid. Odds are that you’ll get something, and you could get a lot if they like you for whatever reason (academic numbers, sports, special interests and extracurriculars, other background factors).
  • Your freshmen aid package may be much more generous than in future years. Try to Always get your future aid package amounts in writing.
  • You can even negotiate your aid package with them further after getting your acceptance letter. The worst they can say is no.

529 Plan Interactive Comparison Map and Tax Deduction Calculator

The Vanguard 529 College Savings Plan (based in Nevada but open to all state residents) is one of the consistent Morningstar top-ranked 529 plans and one of my three personal finalists when choosing a plan for myself.

While poking around the site, I also came across this interactive map tool that helps you compare your in-state plan with the Vanguard/Nevada plan. Although created by Vanguard, it still offers a lot of useful information and I’m okay with then Vanguard plan being used as a benchmark.

vg529map

Below is an example screenshot for Utah. Note that it will tell you if you have an in-state tax benefits, and also if that tax benefit is restricted to contributions to your in-state plan only. Where applicable, it also links to Vanguard’s 529 tax deduction calculator. Finally, if you click on “Full Comparison” you can dig even deeper.

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As an example of why Vanguard is highly-regarded, I was recently notified that Vanguard once again lowered the expense ratios on many of their 529 investment options. This matches the same trend with their regular mutual funds and ETFs.

Effective May 3, 2016, the expense ratios for all Vanguard 529 Plan investment options went down, affirming Vanguard’s ongoing commitment to lowering costs for our clients. Now you’ll be saving even more. The cost of our age-based options decreased from 0.19% to 0.17%, which is 67% less than the industry average.* And the expense ratios of our individual portfolios dropped from a range of 0.19% to 0.49% to a range of 0.17% to 0.45%.

Here are some similar resources I’ve shared before: 50-state 529 tax benefit comparison (uses a common hypothetical family) and SavingForCollege tax benefit calculator.

Ask The Readers: Refinancing Student Loan Debt?

college_shirtSometimes I get questions about dealing with student loan debt, but I no longer feel well-qualified to answer. I graduated in 2000 with roughly $30,000 in student loan debt myself, but I never participated in any government-backed repayment plan, nor did I refinance it into a lower interest loan. Roughly 70% of students are graduating with debt today as opposed to 60% in 2000, according to this NPR chart:

eduloans1

Once I started earning income, I did the “live cheap like a student” thing (not hard, I was a grad student for most of the time) and paid off the debt in about four years. If I had a bigger balance or a tighter budget today, I might do things differently given the current options. I know there are smart readers out there with more recent experience, so I ask you:

How did/are you handling your student loan debt?

Perhaps one of these government-backed repayment plans? If so, which one did you pick and why? Some limit your payment due to 10% to 20% of “discretionary” income, and some will even forgive the remaining balance after 20 to 25 years.

  • Pay As You Earn Repayment Plan (PAYE)
  • Revised Pay As You Earn Repayment Plan (REPAYE)
  • Income-Based Repayment Plan (IBR)
  • Income-Contingent Repayment Plan (ICR)

Did you refinance your loan privately through a student loan start-up or traditional bank? Why did you pick yours over the competitors? Some examples:

  • SoFi.com
  • CommonBond
  • Earnest
  • Local community bank or credit union
  • National bank or credit union like Navy Federal

Please share your experiences, positive or negative, in the comments. It will help me focus my own research. You can also contact me directly.

SavingForCollege.com Top 529 Plan Rankings 2015

sfc5capSavingforcollege.com is a popular privately-run site for researching and comparing 529 college savings plans. They released their updated ratings this month, which represents their “opinion of the overall usefulness of a state’s 529 plan based on many considerations.” The judgement criteria include:

  • Performance. They selected similar “apples-to-apples” portfolios with 7 different asset allocations from each plan and rated them based on historical performance. Rankings are updated each quarter.
  • Costs. Total average asset-based expense ratios among plans are compared, in addition to separately considering program manager fees, administrator fees, and annual account maintenance fees.
  • Features. This includes other factors that affect participants, including the ability of the plan change their investment options quickly if called for; creditor protection under the sponsoring state’s laws; availability of FDIC-insured options; minimum and maximum contribution restrictions.
  • Reliability. The appears to measure the likelihood of a good plan staying a good plan. Do they have experienced program managers? Does the plan have a good amount of assets? What is the quality of the documentation and reporting? How restrictive are the withdrawal and rollover processes?

Here is the full list of 5-Cap Ratings for each state, on a scale of 0 to 5 Caps. Note that there are separate ratings for in-state and out-of-state residents. The following plans received a 5-Cap Rating for in-state residents (alphabetical order):

  • California: The ScholarShare College Savings Plan
  • Colorado: Direct Portfolio College Savings Plan
  • Colorado: Scholars Choice College Savings Program – Advisor Plan
  • Illinois: Bright Start College Savings Program – Direct Plan
  • Iowa: College Savings Iowa
  • Maine: NextGen College Investing Plan – Direct Plan
  • Maine: NextGen College Investing Plan – Advisor Plan
  • Michigan: Michigan Education Savings Program
  • Nebraska: Nebraska Education Savings Trust – Advisor Plan
  • Nebraska: Nebraska Education Savings Trust – Direct Plan
  • New York: New York’s College Savings Program – Direct Plan
  • Ohio: Ohio CollegeAdvantage 529 Savings Plan
  • Rhode Island: CollegeBoundfund – Direct Plan
  • South Carolina: Future Scholar 529 College Savings Plan – Advisor Plan
  • South Carolina: Future Scholar 529 College Savings Plan – Direct Plan
  • Utah: Utah Educational Savings Plan (USEP)
  • West Virginia: SMART529 WV Direct College Savings Plan
  • Wisconsin: Edvest

Out of the 100+ different plans they rated, here are the 4 programs that attained the top 5-Cap Rating for out-of-state residents (alphabetical order):

  • California: The ScholarShare College Savings Plan
  • Maine NextGen College Investing Plan – Direct Plan
  • New York’s College Savings Program – Direct Plan
  • Ohio CollegeAdvantage 529 Savings Plan

Consistently top-rated plans. The last time I noted these rankings was 2012, and the following plans were 5-Cap rated back then and also now: California, New York, and Ohio.

I should point out that the SavingForCollege Top-rated 5-Cap plans are different than the Morningstar Top-rated Gold plans. In fact, there is no overlap at all! Two of my favorite Gold-rated plans, the Vanguard 529 Savings Plan (Nevada) and Utah Educational Savings Plan received 4.5 out of 5 Caps, although I am not exactly sure why.

However, in general the top 15 or so plans are pretty much the same for both. With that in mind, I see nothing wrong with most Morningstar Silver Plans and/or the 4.5 Cap SavingForCollege plans, if their investment options meet your needs. Here were my personal finalist 529 plans and asset allocations.

Finally, here is another resource about comparing the state-specific tax benefits that may be available to you.

529 Plan Qualified Expenses Now Include Computer Hardware, Software, and Internet Access

macbook_smallThe government just passed the Protecting Americans from Tax Hikes (PATH) Act of 2015, which had a few notable provisions for 529 college savings plan participants. Some of them need to be taken advantage of quickly.

  • Laptops, computers, and related technology and services are now a qualified higher education expense. As defined by the new IRS code, this includes peripheral equipment, computer software, and internet access. They must be purchased for use primarily by the beneficiary of a 529 college savings plan during any years the beneficiary is enrolled at an eligible educational institution. Previously, certain computer purchases counted only when they were explicitly required by the school for course enrollment.
  • You are now allowed to re-contribute qualified withdrawals from a 529 plan that are later refunded by an eligible educational institution into a 529 plan without tax penalty. For example, you may receive a tuition refund after leaving school due to sickness or other reason. Except for a special case for 2015 (see below), you have 60 days from the date of the refund to redeposit the money.
  • Accounting rules were updated to eliminate distribution aggregation. This mainly eases burdensome recordkeeping requirements for plan administrators. Hopefully this will lead to lower administrative expenses for accountholders.

All of these actions are retroactive to January 1, 2015. So if you’ve already made a qualifying computer, software, or internet access expense in 2015, you can take out some more money tax-free. You must initiate this withdrawal by December 31, 2015.

Account owners who received a refund of Qualified Higher Education Expenses between January 1, 2015, and December 18, 2015, the date the law was enacted, have until February 16, 2016 — 60 days from the enactment date for the PATH Act of 2015 — to redeposit the money. Account owners who receive a refund of Qualified Higher Education Expenses on any date after December 18, 2015, have 60 days from the date of the refund to redeposit the money.

Qualified expenses for 529 plans still include tuition, fees, textbooks, supplies and equipment. Room and board also counts up to the greater of (1) the school’s official housing cost estimate or (2) the actual cost of school-operated housing. In all cases, keep good receipts and/or documentation.

The American Opportunity Tax Credit was also made permanent. This provides up to $2,500 in tax credits on the first $4,000 of qualifying educational expenses on up to 4 years of post-secondary education, and increased the phase-out limits to $80,000 (single) and $160,000 (married filing jointly) of modified adjusted gross income.

Sources: CollegeAdvantage, Kansas City Star, UESP e-mail to accountholders.

My 529 Plan Asset Allocation, Part 3: Final Decisions

college_shirtAfter probably too much thought, I have settled on an investment plan for our two 529 college savings plans (one per kid). My circumstances and preferences are unique and likely different than yours, but as usual I will share my process and final decision. Based on my conclusions from Part 1 and Part 2, here are the general requirements:

  • Each 529 portfolio will be similar but separate from my retirement portfolio. Similar means a low cost, balanced portfolio of roughly 60% stocks and 40% bonds.
  • I want the stocks to have a long holding period. I plan to front-load my contributions early on, and then not touch it for 10 years. After that, I will gradually shift the portfolio to short-term bonds and cash.
  • Low maintenance is good. Zero maintenance would be even better, where I wouldn’t even rebalance annually.
  • Since 529 plans are tax-deferred with tax-free qualified withdrawals, I have the ability to play a little bit with higher-turnover or higher capital-gains strategies. No tax paperwork until withdrawal time.
  • My state has no special tax benefits for 529 contributions, so I should pick from any nationally-available plan.

I narrowed it down to my top three combos:

1. Utah Educational Savings Plan and DFA Global Allocation 60/40 Portfolio (DGSIX)

Pros

  • The Utah Plan is a top rated plan, with many low-cost investment options and probably the best customization tools.
  • Dimensional Fund Advisors (DFA) applies academic research to try and capture a more “efficient” portfolio to focus in on size and value factors. More here.
  • The DFA Global Allocation 60/40 Portfolio is their all-in-one portfolio that includes domestic and international stocks as well as high-quality bonds.
  • This allows me to “scratch the itch” of investing in a DFA fund without having to deal with any tax drag on performance or additional paperwork.

Cons

  • DFA’s methods are more expensive than Vanguard’s cap-weighted indexes. The total expense ratio is 0.49% annually, vs. roughly 0.26% for a similar Vanguard portfolio. I may or may not experience enough extra return to offset the higher fees.

2. Ohio CollegeAdvantage Direct Plan and Vanguard Wellington Fund

Pros

  • The Ohio Plan is a top rated plan with many low-cost investment options, some of which are relatively hard to find like the Wellington Fund and TIPS.
  • The Vanguard Wellington Fund is an actively-managed fund that has a target allocation of roughly 65% stocks and 35% bonds. Run by Wellington Management, it has been around since 1928 and is run with a conservative, long-term view. There is plenty of information elsewhere on this fund. The stocks are usually dividend and value-oriented, and the bonds are actively picked for moderate income.
  • This allows me to “scratch the itch” of investing in the Wellington Fund without having to deal with the tax concerns of owning an actively-managed fund (higher turnover, capital gains distributions).

Cons

  • The Wellington Fund is very cheap for an actively-managed fund, but is still slightly more expensive than Vanguard’s cap-weighted indexes. The total expense ratio is 0.35% annually, vs. roughly 0.22% for a similar Vanguard portfolio. I may or may not experience enough extra return to offset the higher fees.

3. Nevada Vanguard Plan and Custom Mix of Vanguard Index Funds

30% US Total Stock Market Index
30% International Total Stock Market Index
20% US Total Bond Market Index
20% US Inflation-Protected Securities

Pros

  • The Vanguard 529 Plan is a top rated plan with many low-cost investment options, some of which are relatively hard to find like TIPS.
  • Simplicity. If you already have a Vanguard account, you wouldn’t have to add another monthly statement or online account login to your financial life.
  • This portfolio would most closely match my existing retirement portfolio.
  • The total cost would be 0.28%. This is a bit higher than other pre-made portfolios since I like to have a higher amount of international stocks and TIPS which are slightly more expensive than the traditional default options.

Cons

  • I don’t like any of their pre-made static portfolios, so I would have to make my own and rebalance periodically.

In the end, I went with the DFA 60/40 fund. My reasoning is that I have the potential for some higher returns using their strategies, and if I don’t, the passive structure prevents returns that lag too far behind the overall market. The most likely result is a slight win or slight loss. Obviously, I hope for the former but I can tolerate the latter. However, I think any of the options above (or something similar) will also work out just fine.

My 529 Plan Asset Allocation, Part 2: Glide Path

This is a continuation of Part 1: Extension of Retirement or Standalone Portfolio?

If you’ve chosen a standalone portfolio for your 529 plan, every provider will offer you age-based portfolio that automatically adjusts based on the age if your child. In general, it starts out with mostly stocks and over time becomes mostly bonds and cash. This preset plan is called the glide path.

My biggest gripe about the glide path of most age-based default portfolios is their short holding periods for stocks. Nearly every one starts with a ton of stocks, and then quickly shifts to a ton of bonds. You’re basically hoping for big stock returns over a short window of time, which is more gambling than investing. Allow me to explain…

Here is the glide path for Moderate Age-Based Option of the Vanguard 529 plan, Nevada (click to enlarge):

vg529aa_2

You start at 75% stocks, and then at 6 years old you are down to 50% stocks, and then at age 11 you are down to 25% stocks. So 25% of your portfolio only holds stocks for at most for 6 years. (Imagine if you contributed money at age 5.) Another 25% is only held at most for 11 years.

If you contributed equal amounts of money every year to this Nevada 529 moderate age-based plan, your average hold time for half your portfolio (2/3rds of the stock portion) is around 4-5 years in stocks. If you did a lump-sum in the beginning, the average hold time for half your portfolio would be 8.5 years.

Here is the glide path for Moderate Age-Based Option of the UESP 529 plan (Utah):

utah529aa_1b

You start at 80% stocks, and then at 7 years old you are down to 60% stocks, and then after another 3 years (age 10) you are down to 40% stocks. At age 13, you are at 20% stocks. That means 20% of your portfolio only holds stocks for at most 7 years. Another 20% only holds stocks at most for 10 years. Another 20% holds stocks at most for 13 years.

If you contributed equal amounts of money every year to this Utah 529 moderate age-based plan, your average hold time for 60% your portfolio (75% of all your stock holdings) is around 5 years in stocks. If you did a 100% lump-sum in the beginning, your average hold time for 40% of your portfolio would be 8.5 years.

Hold time vs. Investment returns

Here is a customized chart from PortfolioCharts.com that shows how past returns varied by holding period for the US stock market. (More info on these charts here).

Note that within 5-year and 10-year periods, there are lots of white and red squares which indicate periods of zero or negative inflation-adjusted returns. The longest drawdown was 10 years. Wouldn’t you like to have ridden that out with a longer holding time?

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Side note: Some people have criticized the sharp step-downs in the glide path. Vanguard addressed this concern in their 529 whitepaper [pdf]. They ran back-tested simulations and found little difference between a smoothed and stepped glide path (click to enlarge).

vg529_stepped

They concluded asset allocation was more important, which I agree with, but I wasn’t satisfied with the amount of evidence supporting their short stock holding periods. Sure, on average things look good, but in any given 5-year period things could be quite bad.

My alternative plan is more slow-and-steady, just like my overall retirement portfolio. I will start out with a balanced allocation at roughly 60% stocks and 40% bonds, as opposed to 75%, 80% or 100% stocks. I will then stay that way as long as I can so the stock portion will have a long holding period. Probably 6 years out from college, I will convert 10% from stocks to bonds/cash. So 60/40 > 50/50 > 40/60 > 30/70, and so on until I am at 100% cash at age 18.

I will also front-load my contributions so that they are within the first few years. I know not everyone can do that. This means I will hold all of my stocks for a minimum period of 10 years, with the average holding time closer to 15 years. Look again at the green/red chart above with a 15-year holding period.

I haven’t quite decided on the exact fund mix, but I have settled on using the Utah 529 plan, as it allows full customization and scheduling of your own glide path with a pretty solid menu of low-cost and passive investment options. Last part of this series will have the full implementation.

My 529 Plan Asset Allocation, Part 1: Extension of Retirement or Standalone Portfolio?

529I’m finally getting around to setting up 529 college savings plans for my kids. It remains my opinion that you should make sure your retirement savings are on track before worrying about college savings. The government let me borrow over $50,000 in student loans for college, but they won’t let me do that again for retirement.

(Related: Top-ranked nationally-available 529 plans and state-specific tax benefits.)

Other than deciding how much money you’ll contribute, the big question is what do you invest it in? The most common default investment choice is an all-in-one fund that adjusts automatically based on the age of the beneficiary. Essentially, a tweaked target-date retirement fund. Under this model, each child of different age would then have their own standalone asset allocation.

However, I ran across an interesting discussion on the Bogleheads forum where some people used their 529 plans as an extension of their primary retirement portfolios. As the 529 offers tax-deferred growth and tax-free withdrawals for qualified educational purposes, you could treat it like an IRA and put some tax-inefficient assets inside. For example, I could squeeze in some riskier stuff like real estate (REITs), small value stocks, and/or emerging markets stocks for a couple of decades. Or safe stuff like TIPS. You wouldn’t have to adjust for beneficiary age, just rebalance things whenever you spend it down.

This gets a little tricky because even if you start early, you’re typically going to save up a bunch of money over 15-20 years and then spend it all within 4 years. Contrast this with retirement, where you typically save up over 30-45 years and spend it over another 20-35 years. Also, if you don’t spend the funds in a qualified manner, your withdrawals may be subject to both income tax and an additional 10% penalty.

In my opinion, an important factor to consider is your personal tuition assistance philosophy.

Are you going to cover a certain percentage of your child’s tuition, no matter what? Some parents will promise to cover 50%, 75%, or 100% of college expenses, regardless of actual 529 balance. In that case, the 529 plan is less of a savings bucket as it is just another way to gain some extra return via tax sheltering. Perhaps then it makes sense to consider your 529 as a piece of the bigger picture.

Let’s say you invest solely in 100% risky stocks for the entire 15 years, and there is a last-minute crash where you lose 50% of your value. If your final 529 balance is much less than expected, the rest of your portfolio probably did better and you can fulfill your commitment with other assets. (The same thing could happen if you invested solely in 100% safe bonds. The return might be so low that your final balance is quite disappointing.)

Are you treating the 529 plan as a piggy bank? “Here, I saved this much money for you. You handle the rest.” In this case, you are setting aside a fixed amount, labeling it “college funds”, and you’re done. It is separate in your mind. So why not invest it separately? You probably do want to make your investments diversified initially and also more conservative as your child gets close to college. Having the value drop in half at the very end could force your child to take on a significantly larger amount of debt.

After some thought, I am taking a hybrid approach. I am committed to covering at least a “good chunk” of my kids’ college expenses, without limiting it to a fixed amount. (I won’t guarantee 100% as I am wary as to how colleges use their huge sticker prices.) First, we have the financial means, even if it means working a little longer. Second, we feel an obligation to pay it forward because my parents covered a big portion of my own tuition and my wife’s parents covered all of her tuition. My goal is to have my kids feel free to take some career risk in their 20s, although I am not opposed to them having a little debt (“skin in the game”).

My plan is to make my 529 a miniature copy of my retirement portfolio. If my retirement portfolio asset allocation is 60% stocks and 40% bonds, then the 529 portfolio will also be 60% stocks and 40% bonds. So the 529 will be a standalone portfolio, but it will grow at the same rate as my retirement portfolio. Once the time comes, I will spend the 529 money and also withdraw from my retirement portfolio if needed (hopefully not). However, in the meantime, I won’t have to constantly rebalance across two additional smaller accounts.

My kids are 1 and 3 right now. I plan on keeping my cloned asset allocation setup for at least the next 10-12 years, and then taper down over the last 5 years so that it is 100% cash or short-term bonds by age 18. This differs from most age-based default options offered, as they taper steadily over the entire 18-year period. More details on why I like my way better in Part 2 tomorrow.

529 College Savings Plans: State-by-State Tax Benefit Comparison 2015

Updated for 2015. When choosing a 529 college savings plan, you’ll often have to weigh any in-state benefits with the superior investment options from an out-of-state plan. Every state seems to have their own unique combination of tax deductions and/or matching grants. Morningstar has a new PDF whitepaper called How to Choose a 529 Investment by Janet Yang, CFA. Inside, it goes into detail regarding state-specific tax benefits and provides a rough guideline as to whether you should stick with your in-state 529 plan. Here’s a handy map that break things down visually, state-by-state:

mstar_529state

  • If your potential in-state tax benefit is greater than 5% of your contribution, then you should stick with your in-state plan. For example, if you contribution $100 a month ($1,200 annually), the tax benefit should be at least $60 to offset the chance that another state has a plan with slightly lower annual costs.
  • If your potential in-state tax benefit is less than 5% of your contribution, then it is a close call. You should weigh various factors like relative fee amounts and quality of investment options.
  • If your state does “tax parity” – meaning it offers the same tax benefits for any 529 plan – then you should (obviously) just choose the best nationwide plan.

There is also a detailed chart provided that quantifies tax benefits for a hypothetical family saving for college (two adults, two children, $100 per month savings per child) at both the $60,000 and $200,000 household income levels. Here’s just the top 10 states ranked by biggest tax break, updated for 2015. Download the PDF for the full list.

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For reference, here’s an older chart from 2014:

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Keep in mind that many of the factors considered here are subject to change. State-specific tax breaks may come and go. 529 plan costs and investment options also change from year to year, with the overall trend being that the worst plans tend to get better due to competitive pressure. (No state wants to be the “worst” plan, and an expensive plan can switch administrators and transform into a cheap plan within a year.) Meanwhile, the top plans tend to stay that way.

Therefore, I would perhaps lean towards grabbing any significant tax break that is available now and hope that the plan gets better in the future. Some states even let you grab the tax deduction and then immediately roll over the assets to any outside plan; other states “recapture” the tax deduction if do you that. Sometimes you can wait out the recapture period and then roll funds over to a better state 529 plan.

Morningstar Top 529 College Savings Plan Rankings 2015

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Investment research firm Morningstar has released their annual 529 College Savings Plans Research Paper and Industry Survey. While the full survey appears restricted to paid premium members, they did release their top-rated plans for 2015. Remember to first consider your state-specific tax benefits that may outweigh other factors. If you don’t have anything compelling available, you can open a 529 plan from any state.

Here are the Gold-rated plans for 2015 (no particular order). Morningstar uses a Gold, Silver, or Bronze rating scale for the top plans and Neutral or Negative for the rest.

Here are the consistently top-rated plans from 2010-2015. This means they were rated either Gold or Silver (or equivalent) for every year the rankings were done from 2010 through 2015.

  • T. Rowe Price College Savings Plan, Alaska
  • Maryland College Investment Plan
  • Vanguard 529 College Savings Plan, Nevada
  • CollegeAdvantage 529 Savings Plan, Ohio
  • CollegeAmerica Plan, Virginia (Advisor-sold)

The trend here is consistency. There was no change in either of the lists above as compared to last year. Utah only missed on out the consistent list because they weren’t top-ranked in 2010.

The “Five P” criteria.

  • People. Who’s behind the plans? Who are the investment consultants picking the underlying investments? Who are the mutual fund managers?
  • Process. Are the asset-allocation glide paths and funds chosen for the age-based options based on solid research? Whether active or passive, how is it implemented?
  • Parent. How is the quality of the program manager (often an asset-management company or board of trustees which has a main role in the investment choices and pricing)? Also refers to state officials and their policies.
  • Performance. Has the plan delivered strong risk-adjusted performance, both during the recent volatility and in the long-term? Is it judged likely to continue?
  • Price. Includes factors like asset-weighted expense ratios and in-state tax benefits.

A broad recommendation is to simply stick with one of the plans listed above unless your in-state plan is offering significant tax breaks. Many other state plans may have specific investments that will work just fine as well. Here are my personal favorites, and why:

  • The Nevada 529 Plan for its low costs, variety of Vanguard investment options, and long-term commitment to consistently lowering costs as their assets grow. The Vanguard co-branding is also a sign of positive stewardship.
  • The Utah 529 plan has low costs, includes a nice selection of Vanguard and DFA funds, and is highly customizable for DIY investors. Over the last few years, the Utah plan has also shown a history of passing on future cost savings to clients.

I feel that a trend of consumer-first practices is important as the quality of all 529 plans can change with time. Sure, you can roll over your funds elsewhere, but wouldn’t you rather have your current plan just keep getting better and better?