529 plan, saving for college, best 529 plan

The higher your tax bracket, the more you can appreciate 529 college savings plans—state-sponsored programs that allow you to invest money that grows tax-deferred and that can be used tax-free for qualified higher education costs. The 529 plans also have estate-planning advantages, allowing parents or grandparents to move substantial chunks of money out of their taxable estates while still maintaining control of the funds.

The tax breaks, though, shouldn't blind you to the fact that not all 529 plans are created equal. Some suffer from poor investment choices and what research firm Morningstar calls "egregious" fees. If your state's plan or the one you're currently using falls short, you can switch to a better offering. Not only can the money from 529 accounts be spent at any accredited U.S. school—regardless of the state—but virtually every plan allows out-of-state investors to contribute. There may, however, be tax implications.  It is recommended that you consult your tax professional for specifics and advantages for 529 plans. 

Morningstar provides research with regard to the different state plans and ranks about five dozen plans annually. This information is typically made available by Morningstar every fall. A free Morningstar membership gives you access to the rankings, while a premium membership ($199 per year) allows you to read detailed analyses of the 529 plans.

Although sponsored by the states, the plans themselves are run by investment firms and differ tremendously in their investment options, management strategies and costs.

Investors typically can create their own investment mix among stock and bond options, or opt for age-weighted funds that grow more conservative as the child nears college age. In general, 529 plans that are sold through advisors tend to have more actively-managed investment options with higher annual expenses, while those that are sold directly to the public favor passively-managed index funds with a lower cost structure.

Minimum contributions are typically as little as $25, while the maximum aggregate limits range from $235,000 to $400,000. Many of these 529 plans also allow contributors to make five years' worth of annual excludable gifts at once.  With the current annual gift exclusion of $14,000 per contributor, a child’s parents and grandparents can gift up to a total of $70,000 per beneficiary to a 529 plan without triggering gift tax rules. However these givers must refrain from making additional gifts to the beneficiary for five years. The account owner retains control of the funds and can change beneficiaries or even withdraw the money at any time. Withdrawals for anything other than qualified college expenses will trigger a 10 percent federal penalty on any earnings.

For some, sticking with such a plan might be a reasonable choice if your state gives you a tax benefit for doing so. Most states with an income tax offer some kind of tax break for contributions. However, as of 2014, California, Delaware, Hawaii, Kentucky, Massachusetts, Minnesota, New Jersey and Tennessee are the exceptions If you're not sure what the tax benefits and consequences of your state's plan are, it is recommended that you call your state directly to obtain a full understanding of the tax benefits and consequences for the 529 plan.   

If you don't get a tax break, however, you might consider using Morningstar as a resource to pick one of the top-rated 529 plans.

The best plans in Morningstar's view are the ones its analysts say are likely to outperform their benchmarks and that have "reasonable fees, strong investment options and capable oversight." It’s difficult to find 529 plans with great performance and a large asset base. Of the nation's 10 biggest plans, only two—Nevada's Vanguard 529 College Savings Plan and Utah Education Savings Plan—landed in Morningstar's top category in 2014.

After opening an account, make a note to review your 529 plan annually and compare it to the current offerings. Plan advisors, investment options and costs change frequently, and you'll want to make sure you're still getting the best 529 plan for your money.

City National Bank, as a matter of policy, does not give tax, accounting, regulatory or legal advice. The effectiveness of the strategies presented in this document will depend on the unique characteristics of your situation and on a number of complex factors. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations. The strategies presented in this document were not intended to be used, and cannot be used for the purpose of avoiding any tax penalties that may be imposed. The strategies were not written to support the promotion or marketing to another person of any transaction or matter addressed. Before implementation, you should consult with your other advisors on the tax, accounting and legal implications of the proposed strategies based on your particular circumstances.

Non-deposit investment products are not FDIC insured, are not deposits or other obligations of City National Bank, its subsidiaries and affiliates, and are not guaranteed by City National Bank and involve investment risks, including the possible loss of principal.