My kids’ 529 college savings accounts are getting hammered. As you may know, these vehicles are a good way to save for college for a few reasons: your savings grow free of federal taxes and can be withdrawn federally tax-free for qualified education expenses; the parent retains control of the account; and the savings has a lesser impact on financial aid prospects than a UGMA/UTMA. (Open an account directly with the state rather than with a commission-based financial planner to lower your costs.)

In addition, some states offer an upfront tax break. We contribute to New York State’s plan, for example, because my husband works in the city and so we pay state taxes; the state allows married couples filing jointly to deduct up to $10,000 of their contributions from their state taxable income; $5,000 for single filers. 

Since my oldest daughter is just six years away from college, I am considering shifting future contributions to a more conservative option (and hope the current portfolio bounces back a little in the next six years). But I was a bit aggravated by what I discovered.

Vanguard has managed New York’s 529 plan since 2003, and its five-year returns  are pretty abysmal. I was considering the conservative Inflation Protected Securities Portfolio (with a 5-year return of 4.56% – the second highest of the dozen individual portfolio options.) The expense ratio is 0.55 percent. Then I looked up what I would pay for the same fund (VIPSX) as an individual retail investor; the expense ratio was just 0.20 percent! One would think the expense ratio for a collective group of millions of participants would be lower, not higher, than an individual investing in the same fund. But according to one planner I spoke to, the state is taking a 0.35% cut for offering the program.

It’s just a thought, but weigh the benefits of tax-free compounding and upfront tax breaks against the return you expect to get in your state’s 529 plan. Check out this article for advice on what to do if your 529 is getting similarly hammered. (If you’re just getting into a 529 plan, consider one of these five state plans, rated tops by Kiplinger.)

• Vanguard Responds
• Will A College Education Become A Luxury?
• Opening a 529 Plan Is Cheaper Than A Fast-Food Lunch
• When Inflation Rises, Beware of Fees
• More best-kept financial planning secrets

This entry was posted on Thursday, October 30th, 2008 at 1:23 pm and is filed under 529 college-savings plans, education, fees, higher education, saving. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.