With tuition costs on the rise, employees looking for ways to pay for their children's college education can save with 529 plans.

A 529 plan is a tax-advantaged savings plan that encourages parents or guardians to save for a child's college education. Phil Chandler, a financial adviser for Edward Jones, says the tax-free gains feature is the primary driving force behind the popularity of 529s. Previous products did not allow this aspect to be used for higher education.

Many plan sponsors are offering this through the workplace so participants can build up their 529 plan through payroll deduction or direct deposit via the investment adviser of their choice. There are two types of 529 plans: prepaid tuition and college savings. In the U.S., all 50 states offer at least one type of 529 plan, according to the Securities and Exchange Commission.


The minimum amount varies

Participation is higher when offered in the workplace, since there is more information and a single source, Chandler says. There are many pertinent questions advisers ask when helping clients meet their goals: "Is their son or daughter going to attend a private or public school? Will the student be attending a college in-state or out-of-state? Will you pay for part of the tuition and will [the student] have student loans against it?" Chandler says.

John D. Kenney, head of Baltimore-based Legg Mason Global Asset Allocation, and his team believe that minimum contribution rates must be greater. "If [plan participants] start with $250 a month, invest $370 a month, assume a 6% return on the investment with a 5% inflation rate on the cost of college you'll cover it over the next 18 years," he says.

Kenney shares the following numbers about 529 plans:

* More people are saving for college expenses, with new accounts increasing to 11.9%

* The average new account size has dropped down 7.8%, but that might reflect the current economic environment

*New account opening sum on average is $4,500

*Average monthly contribution has gone up from $159 a month at the end of the first quarter to $166 today


Key trends

More recently Chandler says plans are moving toward open architecture with multiple fund managers, which he says is nice because it offers advisers more flexibility.

Clients can also go online to view changing portfolios. This also allows them to gauge how much money is available when the time is getting closer for the child to start their college career, says Chandler.

It is easy for plan participants to withdraw the funds. As long as the money goes toward high education it can be taken out in portions to coincide with tuition payments.


Keeping options open

The 529 plans are client specific, Chandler says. Mostly participants ask what if their child doesn't go to college or receives a scholarship? Assets can still be used by another child and can be switched easily from one to another depending on the needs of the family. "The parent could even use the assets if they need some sort of training for a different job or different career, maybe even a retirement career," Chandler says with a laugh. If the 529 plan is not used for higher education and the parents want to liquidate the policy there is a 10% penalty, he cautions, on withdrawing the funds through Edward Jones.


State and federal income taxes

Investing in a 529 plan may offer special tax benefits, but this varies by state. Earnings in 529 plans are not subject to federal tax, and in most cases state tax, as long as participants use withdrawals for eligible college expenses, i.e. room and board. Chandler urges clients to check with their tax preparers.


Fees to share with participants

Before investing in mutual funds, Chandler says it's important that plan participants understand charges, expenses and fees, as well as the breakpoint discounts to which they may be entitled. Brokers assisting participants in understanding the charges and breakpoint discounts will assist them in identifying the best investment for their particular need. "[Clients] that have been diligent and been putting the money away can certainly see that value for them. They're using tax-free gains to pay for college whereas [a student loan] passed on to the child would be at a certain percentage over potentially the next 15 to 20 years of their life," Chandler says.

Starting early is most important, both Kenney and Chandler conclude. Not considering a 529 "is really kicking a can down the road," Chandler adds.

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