With college tuition growing faster than holiday waistlines, there's one year-end deadline you don't want to miss. Sign up and contribute to a 529 college savings plan in 2007 before you pop the New Year's Eve bubbly.
Even though opening a 529 plan won't net you an immediate federal tax deduction, it belongs on the list with other year-end maneuvers for claiming potential tax goodies. 529s have plenty of other perks going for them. Consider that your savings grow tax-deferred and can be used tax-free as long as you're using the money to pay for college (not that tropical vacation you're fantasizing about right now). And as our Motley Fool Green Light newsletter has noted in past issues, if you need a more immediate reward, your home state may offer a tax deduction on your state income tax.
Plus, you don't have to clear any pesky income limits, and you can contribute a lot, even by the standards of today's sky-high college tuition. It makes a great savings vehicle for parents, and a good tool for grandparents looking for ways to contribute.
Virtually every state offers at least one 529 savings plan, and you can select any plan you want -- even one in a state where you don't live -- making the choice a little daunting. Winnow down the field by following these steps:
Step 1: Investigate your state. Find out whether your state offers a tax deduction for 529 contributions. Typically, a state will offer this perk only if you sign up for your state's plan. States may cap the deduction, but they may also let you carry forward unused deductions for excess contributions. You can get more details about the plans and tax benefits at Bankrate's Savingforcollege.com.
Step 2: Ferret out fees. Don't assume that a state tax deduction makes your state's plan the best choice. Like any Foolish investment, a good college savings plan lets you invest without a lot of expensive fees that divert your money into someone else's pocket. In general, you'll find lower fees at plans that bypass an expensive broker. Some of the worst 529 plans use pricey fund managers, including Legg Mason, JPMorgan Chase, and Hartford. You can find your state's fees disclosed in these Morningstar ratings. Your state's website, or the fund manager, can give you additional details.
Step 3: Browse the menu. Like your workplace retirement account, you'll have to pick from a limited menu of investment choices, typically mutual funds. See whether the options meet Foolish criteria for low fees and solid management. You'll also want to weigh whether there are investment options that meet your requirements for balancing risk and returns.
Step 4:Pick and choose. If your state offers a tax deduction for investing in a low-cost state savings plan with investment options that you like, you probably need go no further. Sign up and deposit your contribution before ringing in the new year. If you don't get a state tax deduction, your plan carries high fees, or you don't like its investment mix, you need to do a little more homework.
You can use this College Savings Plan Network comparison tool to narrow down the plans. A Kiplinger service offers ideas for the best 529 plans, and will even issue state-by-state recommendations. Many personal finance magazines offer their own lists of the best and worst. Take them all in stride and do your own research.