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Choosing the State to Establish a 529 Plan

August 07, 2007

By MoneyRates Team | Money Rates Columnist

Setting up a 529 college savings plan is not always as easy as assuming your state's plan is the best for your child because of the tax benefits of investing in-state. Your state's management fees, your tax bracket and tax situation, your state's fund performance, the investment options your state's plan offer, and back-end plan fees charged by your state's fund manager should all be compared before determining if an in-state or out-of-state plan. An excellent resource for comparing the different state's and their current plans is www.finaid.org and Kiplinger.com. These sites report the following regarding rating the 529 plans of each state and the best in certain categories:

Rating the Plans

Since some states differentiate between residents and non-residents, we evaluate the plans twice, once for residents and once for non-residents. Our ratings are based on the following criteria:

State tax incentives, such as state tax deductions for contributions and tax-free withdrawals for qualified expenses.

Affordability, such as a minimum investment of no more than $500 during the first year.

Good selection of investment options. Does the plan include sufficient age-based, risk-based and principal protection options? Are indexed funds available, or just managed funds? An extra bonus is given for plans that include a guaranteed return fund.

Relative investment performance.

Flexibility. A lack of any unusual restrictions, such as severe penalties for early withdrawal.

Low costs, including both low annual costs (management fees, administrative fees, and fund loads) and low sales charges. Some funds charged sales charges or back-end loads of as much as 5.75%, which is excessive. High costs can eat into investment gains.

The Best Section 529 College Savings Plans

The best section 529 college savings plans for the state's residents are, in no particular order:

All of the TIAA-CREF plans: Kentucky, Idaho, Mississippi, Oklahoma, Tennessee, Vermont, California, Connecticut, Georgia, Michigan, Minnesota, Missouri, New York,
Pennsylvania, South Dakota, Texas, Virginia, Iowa, New Jersey, Arkansas, Florida, Hawaii, Utah, Louisiana, Ohio, Illinois, Nebraska, and Maryland.

The New York, Minnesota, Missouri and Michigan plans are particularly outstanding for state residents. Pennsylvania is noteworthy for being the first state to allow state income tax deductions for contributions to any state's college savings plan, not just Pennsylvania's.

The following state plans are worth considering because of the state income tax benefits for residents, but are not otherwise noteworthy: West Virginia, South Carolina and New Mexico.

If you live in one of the states listed above, you should first consider your state's plan because of the low costs and state income tax benefits. You should also consider the plans that are listed below as being among the best for non-residents.

If you don't live in one of the states listed above, you should compare your state's plan with one of the plans listed below, since they are likely to be better than your state's plan.

The best section 529 college savings plans for non-residents are, in no particular order:

All of the TIAA-CREF plans except Kentucky (which is not open to non-residents): Idaho, Mississippi, Oklahoma, Tennessee, Vermont, California, Connecticut, Georgia, Michigan, Minnesota, Missouri, New York, Pennsylvania, Iowa, Hawaii, Illinois, Utah, and Nebraska.

The following information formed the basis for these ratings.

Low fees: 23 states had fees of 1% per year or less for both residents and non-residents. All of the TIAA-CREF and Vanguard plans were in this group. These states included Alaska, Carlifornia, Connecticut, Georgia, Hawaii, Idaho, Illinois, Iowa, Kentucky, Louisiana, Maryland, Michigan, Minnesota, Mississippi, Missouri, New Jersey, New York, Oklahoma, Pennsylvania, Tennessee, Texas, Utah, Vermont, and Virginia. Nebraska, Massachusetts, New Hampshire, and Delaware were borderline.

High initial investment: The following states were downgraded for a high initial investment for residents or non-residents: Arkansas, Massachusetts, Nevada, New Hampshire, Rhode Island, and Wyoming. The minimum investment was seen as being high enough to act as a barrier to entry for low income families.
Guaranteed return: The following states were upgraded for offering a guaranteed portfolio. This includes several of the TIAA-CREF plans, which offered a hedge against inflation plus a minimum 3% fixed rate of return, and the College Savings Bank CollegeSure CD, which is indexed to private college tuition changes. The states included Alaska, California, Connecticut, Georgia, Michigan, Minnesota, Missouri, New York, Ohio, and Pennsylvania.

Impact on state aid: The following states specified that money in the state plan does not affect eligibility for state grants: Illinois, Indiana, Kentucky, New York, Pennsylvania, and Virginia.

The following states do not exempt qualified withdrawals from other state plans from the state's income tax: Alabama, Alaska, Arkansas, Illinois, Mississippi, Nevada, New Hampshire, North Carolina, South Dakota, Tennessee, Wisconsin, and Wyoming.

The following states do not exempt qualified withdrawals from the state's own plan from the state's income tax. These states only provide a tax deferral. Alabama.

The following state plans are closed to non-residents: Kentucky, Louisiana, New Jersey, and North Carolina.

The following state plans are open to non-residents, but only through brokers and advisers or with higher fees: Alabama, Arkansas, Maine, North Carolina, Ohio, Rhode Island, South Carolina, South Dakota, Texas, and West Virginia.

The following states provided special state benefits, such as matching contributions for low-income families: Minnesota, Louisiana, and Michigan.

State tax deduction for contributions: The following states offer a full tax deduction for contributions to the state's plan: Colorado, Illinois, New Mexico, South Carolina, and West Virginia.

The following states have no state income tax, effectively offering a full tax deduction for contributions to any state's plan: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.

The following states offer a modest tax deduction of at least $4,000 per taxpayer for contributions to the state's plan: Idaho, Michigan, Mississippi, Missouri, Pennsylvania and New York.

Restrictions: The following states included early redemption penalties or age limits in their plans: College Savings Bank, New York, Utah, Iowa, and Virginia.

The Kiplinger Top 529 Plans

Lowest Fees
If low investment costs are your primary concern, take a look at the Utah Educational Savings Plan Trust. The plan serves up a menu of nine Vanguard index-fund portfolios and charges only 0.38% per year for its most expensive option. (The plan also levies a fee of $4 per $1,000 of your account balance up to a maximum of $20 annually.)

Best Portfolios of Underlying Funds
The pre-fab portfolios offered by 529 plans are only as good as their underlying mutual funds. That's why we like Maryland College Investment Plan, which uses a great mix of funds from T. Rowe Price. Maryland cut its annual fees this year, and the plan's most expensive option costs just 0.98% annually. That makes it a better value than the Alaska 529, which has a similar line-up of T. Rowe Price funds.

Best Plan for Conservative Investors
The Michigan Educational Savings Program, run by TIAA-CREEF, is ideal for investors who shy away from putting their college savings into the stock market. The plan has a savings option that guarantees principal and a minimum annual interest rate based on a Treasury note index. That option doesn't charge an annual fee. The plan also offers portfolios of TIAA-CREF mutual funds that are tilted more toward bond funds than most other 529 plans. Those options cost a very low flat fee of 0.45% annually.

Best Mix of Investment Choices

For do-it-yourself investors who want to build their own portfolio, the College Savings Plan of Nebraska offers a selection of 20 funds from American Century, Fidelity, PIMCO and Vanguard. The wider assortment does come with higher fees. The most expensive fund option costs 1.64% annually, and there's a $25-per-year maintenance fee for all accounts.

Best Adviser-Sold Plan
If you feel more comfortable using an adviser, ask about the Virginia CollegeAmerica plan. You'll pay more in fees than if you bought a plan directly, but your adviser can craft a solid portfolio with 22 top-notch funds from American Funds.

About the listings
Most savings plans allow you to enroll at any time, while many prepaid plans limit enrollment to just a few months during the year.

Now that 529 plans are federally tax-free, most states are expected to follow suit. State tax deduction rules for contributions are included in the profiles above, but not which plans exempted earnings from state taxes prior to the tax-law changes.

All savings and prepaid plans are transferable to out-of-state and private institutions (though a few prepaid plans may make lower payouts to those schools).

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