Is Free Money for College Worth It?

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If you have a child, you know how important it is to start saving early for your child's education. But when times are tough, it's easy to put off college saving in favor of more immediate needs -- especially if your child has a long time to go before graduating from high school.

The state governments that sponsor college savings plans, also known as 529 plans, know that many parents are in an economic bind right now. But to help parents get the savings ball rolling, some states are giving them a big incentive to get started: free money.

Where's the cash?
A handful of states have started rolling out modest programs to add to parents' college savings contributions with government money. For instance, last month, the Virginia College Savings Plan announced its SOAR Virginia scholarship pilot program, whereby about 100 students who maintain a 2.5 GPA, perform community service, and comply with their school's code of conduct will receive as much as $2,000 in 529 accounts during their high school years. Although the scholarship program is just beginning and has a limited audience at this point, success during the pilot could bring expanded opportunities in the future.

Some states have programs that anyone can use -- if they're quick enough on the uptake. In Rhode Island, parents who open a 529 plan through fund manager AllianceBernstein (NYSE: AB  ) and its CollegeBoundBaby program before the child's first birthday are eligible to receive a $100 grant. A recent SmartMoney article reported that Oregon is considering a similar provision for its 529 plans, one of which is administered by Sun Life Financial (NYSE: SLF  ) subsidiary MFS.

What's the catch?
Free money is certainly helpful for parents saving for their child's college education. But before you jump into a plan to get a small bonus, you need to look at the costs of a particular 529 plan. A small upfront bonus could turn out to be trivial if you end up paying far more in higher costs between now and when your child gets to college. This is a situation where you should definitely look the gift horse in the mouth.

For one thing, states have an incentive to get assets into their plans. States receive fees for administering 529 plans, and with government budgets stretched to their limit, it's essential that the programs earn enough revenue to cover the state's administrative costs of running them.

In addition, the financial crisis and ensuing losses in the stock market had a huge impact on public perception of 529 plans. With the average plan having lost 24% in 2008, many parents lost faith in 529s as a tool to help them reach their college savings goals. That perception only got worse as states fought with plan managers; for instance, Oregon sued the fund division of Oppenheimer Holdings (NYSE: OPY  ) in 2009 over the losses.

Moreover, the fund companies that run these programs also have financial incentives to attract assets. In Virginia, Vanguard -- the Templeton Institutional arm of Franklin Resources (NYSE: BEN  ) -- and Legg Mason's (NYSE: LM  ) Western Asset Management are among the companies managing various investment portfolios within its 529 plans. In addition, banks BB&T (NYSE: BBT  ) and Union First Market Bankshares (Nasdaq: UBSH  ) offer FDIC-insured CDs for more conservative investors. Drumming up more business is always a good move for those companies, but it won't always benefit you. Varying fee levels force you to take a closer look when choosing the right plan.

Pick the right plan
As attractive as free money sounds, it can take your eyes off what should be your top priority in choosing a 529 plan: minimizing costs. Of course, just because a plan offers you an incentive to open an account doesn't mean that it's automatically a bad one. But the best 529s don't need to offer minor rewards to get you to sign up; their features and low costs give parents reason enough in themselves.

Raising a child isn't easy, and paying the ever-rising costs of a college education is just one of many challenges parents face. But if you take the time to seek out the best 529 plans out, your effort will reap much bigger rewards than what you're likely to get from sign-up bonuses and other freebies.

Learn more about saving for college and other financial goals in our Savings Center.

Fool contributor Dan Caplinger always thinks 529 is a formula for cleaning products. He doesn't own shares of the companies mentioned in this article. The Fool owns shares of Legg Mason. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy gives you a great education.

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  • Report this Comment On March 07, 2011, at 10:01 AM, jwebbzor wrote:

    I was hoping this article was going to be centered around how college tuition prices are affected by government subsidized loans.

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