Dear Dr. Don, For our just-born granddaughter, we want to select a 529 college savings account. There is a dizzying array of plans, so which are recommended? We live in Pennsylvania. -- Wayne Winnow
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Dear Wayne, Living in Pennsylvania gives you more options because Pennsylvania is one of the states that allow a tax deduction on contributions made into a Section 529 plan regardless of which state's plan you choose. Many states only grant a tax deduction or tax credit for contributions made to their own 529 plans.
Pennsylvania allows the deduction up to the limit of the gift tax's annual exclusion amount, which is $13,000 in 2012, or $26,000 for a couple filing jointly that elects split gifts. That's providing both spouses have at least $13,000 in income to take advantage of the state tax deduction.
The big decision is between a prepaid tuition plan and a college savings plan. Both are types of 529 plans. Contributions to prepaid tuition plans are indexed in some fashion to college cost inflation. For example, if you pay for a year's worth of tuition and the school's tuition rises, you won't have to pay more to meet the increase.
However, attending a private college or out-of-state school may reduce the value of the account, depending on the state plan you choose. States typically limit participation in prepaid tuition plans to account owners and/or beneficiaries who are residents of that state. States have mostly gotten away from providing any guarantees on the fund or fund performance.
A college savings plan is a tax-advantaged investment account. Shopping the different states' plans will present you with a wide array of investment choices and fee structures. You'd want to strike a balance between managing fees and having your preferred investment choices.
With a college savings plan, you can move the account if you decide you're not happy with that plan. There are limitations on how often you can move the account. In general, you can only roll over all or part of a Section 529 plan once in a 12-month period.
I wouldn't recommend rolling over a prepaid tuition account unless there is some sort of crisis with that plan.
The more conservative you are in investing in a college savings plan, the more likely it is that the investment returns won't beat the returns in a prepaid tuition plan. If you're comfortable investing in the stock and bond market, with an investment horizon of 16 to 18 years, you should be able to do as well or better in a low-cost college savings plan versus a prepaid tuition plan.