Tips from Donna (December 2013)
by Donna Gordon on December 5th, 2013

529 Plan, Lighten the Load, Staying Invested

Dispelling Myths about 529 Plans

Myth 1: You have to contribute to a 529 in your home state. That statement is false with regard to 529 college-savings plans, in which money is invested in a portfolio of securities on behalf of a beneficiary. Any U.S. resident can contribute to a 529 college-savings plan in any state. Contributing to a plan offered by your home state might offer an added bonus in the form of a state income tax deduction, but that shouldn't be your sole consideration. If your state's plan is poor (with high fees and poor investment options, for example) looking at plans outside your state might be worth forgoing the tax break.

Myth 2: You have to send your child to a school in the state where his 529 plan is offered. Also false. A 529 college-savings plan is fully portable, meaning that assets can be used for college expenses in any state and at some institutions abroad regardless of which state's plan holds the account.

Myth 3: You can only get a tax deduction if you contribute to your state's plan. Usually true, but not always. In fact, residents of Arizona, Kansas, Maine, Missouri, and Pennsylvania get a state income tax break on 529 contributions made to any state's plan. Elsewhere the benefit is restricted to contributions to in-state plans, with deduction limits varying from state to state and some states offering tax credits.

Myth 4: If you save in a 529 account for your child, it will hurt his financial aid prospects. Possibly, but not as much as you might think. Yes, financial aid calculations generally do take into consideration 529 assets, but money in a 529 account owned by the parents or a dependent student counts far less than assets owned by the student outside a 529. In fact, non-529 student-owned assets carry more than 3 times more weight in financial aid calculations than do assets held in the parents' names. So no, 529 accounts aren't completely impact-free when it comes to financial aid, but the impact is relatively minor.

Myth 5: If your child doesn't go to college, you'll lose the money. Unused 529 money does not have to go to waste, or to the tax collector. It can be used to help pay another family member's college costs simply by changing beneficiaries or transferring funds to the family member's existing 529 account. And the list of potential recipients is rather long, including siblings, first cousins, parents, grandchildren, aunts and uncles, and even in-laws. If you do decide to cash out the plan, you'll have to pay federal and state income taxes on earnings, plus a 10% penalty (waived if the beneficiary dies, becomes disabled, or gets a scholarship).

Myth 6: All 529 plans are the same. This is a potentially costly mistake some investors make. Like many investment products, 529 plans may look similar from the outside, but once you get under the hood you'll find major differences that determine how effective they can be at helping you meet your college-savings goals. Fees, fund offerings, glide path (the rate at which the asset allocation switches from equities to fixed-income in age-based portfolios), and even ease of use vary from plan to plan. Fees, in particular, can have a corrosive effect on 529 assets, and can vary not only from state to state but also within the same plan.

529 plans are tax-deferred college savings vehicles. Any unqualified distribution of earnings will be subject to ordinary income tax and subject to a 10% federal penalty tax. Tax law is ever-changing and can be quite complex. It is highly recommended that you consult with a financial or tax professional with any tax-related questions or concerns. An investor should consider the investment objectives, risks, and charges and expenses associated with municipal fund securities before investing. More information about municipal fund securities is available in the issuer's official statement, and the official statement should be read carefully before investing.
Lighten the Load

Do mutual fund investors prefer to invest in funds offering low expense ratios? The answer is yes. Expense ratios are an important factor in choosing a mutual fund, because they affect returns. It seems that the market is taking matters into its own hands and putting more assets in low-expense funds. As of October 2013, the average expense ratio for domestic funds was 1.14%. Investors pooled about 86% of net assets in funds with expenses lower than the average, leaving only a small portion to higher expense funds.

You would think that a majority of funds available to investors would have fairly low expenses, but 54% of funds have below-average expenses and 46% have expenses equal to or above the average expense. With more funds available and a variety of added investment choices, investors have clearly chosen the low-cost alternative.
The Importance of Staying InvestedInvestors who attempt to time the market run the risk of missing periods of positive returns. For example, the value of a $100,000 investment in the stock market from Jan. 2007 to Oct. 2013, which included the global financial crisis and the recovery that followed. The value of the investment dropped to $54,381 by Feb. 2009 (the trough date). If an investor remained invested in the stock market, the ending value would be $143,550. If the same investor exited the market at the bottom to invest in cash for a year and then reinvest in the market, the ending value would be $93,527. An all-cash investment would have yielded only $54,558. The continuous stock-market investment recovered its initial value over the next three years, and provided a higher ending value than the other two strategies. Investors are well advised to stick with a long-term approach to investing.


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