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The Best Ways to Save for College

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A jumpy stock market has made some parents wonder if they'll ever be able to save enough to send their kids to college. But by taking advantage of tax-favored accounts that let you save tax-free for college expenses, you can put yourself back into the driver's seat and get your kids the education they'll need to succeed in the dog-eat-dog job market of the future.

When you look at the choices you have for saving for college, 529 college savings plans give you a lot of advantages over the competition. But to make the most of the opportunity that 529s give you, you need to pick the best plan you can find. The right choice can put thousands more into your pocket over the years. Below, we'll take a look at the 529 plans that Morningstar chose as industry leaders, but first, here's some background on why these accounts are worth looking at.

Why 529 is a number you should remember
529 plans look a lot like retirement accounts. As long as the money you contribute stays inside the plan, you enjoy tax-deferred growth on your investments. Moreover, just as Roth IRAs let you reap the gains on your money tax-free if you wait long enough before taking it out, 529 plans give you tax-free treatment of your investment income if you use the money to pay college-related expenses including tuition, books, and even room and board.

The complicated thing about 529 plans is that there are a huge number of them. Each of the 50 states has at least one 529 plan, and each offers different menus of investment choices -- as well as associated investing costs and other fees. Because you're not required to use the 529 plan that your own state offers, deciding which plans give you the best deal can take a lot of research.

Boiling down the choices
That's where Morningstar's annual look at 529 plans can save you some legwork. In this year's edition, Morningstar noted several favorable trends among college savings plans. Not only have expenses started to come down, but plans are also working to expand and improve their investment offerings, giving parents better choices for how to invest their college savings.

But Morningstar's broad look at the industry still reveals some plans that stand out from the crowd. In particular, 529 plans from Ohio, Nevada, Utah, Virginia, and Maryland topped the list. You can see the full details here.

Less important than the plan specifics, though, are the overall trends that those top plans share. For instance, four of the five plans offer low-cost, high-quality mutual fund choices from providers including Vanguard and T. Rowe Price (Nasdaq: TROW  ) . Moreover, even Virginia's CollegeAmerica plan offers American Funds mutual funds through financial advisors at relatively low cost, though the fees aren't quite as low.

But plans don't always make it easy for parents to separate the good choices from the bad. Many 529 plans offer greater varieties of higher-cost options that aren't necessarily your best bet. For instance, the Ohio plan offers not only Vanguard funds but also fund options managed by OppenheimerFunds, General Electric (NYSE: GE  ) , and Pimco. Moreover, even plans that offer similar investments often have vastly disparate fee schedules that make their net costs much different.

More broadly, plans have started giving savers ways to invest outside traditional mutual funds. A separate Virginia plan lets savers put money into FDIC-insured accounts at BB&T (NYSE: BBT  ) or Union First Market Bank, while the Ohio plan offers CDs from Fifth Third (Nasdaq: FITB  ) .

Watch out
Not all plans are so beneficial, though. Morningstar cites Maine's NextGen College Investing Plan as below average, in part because program manager Merrill Lynch, now a subsidiary of Bank of America (NYSE: BAC  ) , was fined for not having good procedures to determine suitability for its savers. Plans from TD AMERITRADE (Nasdaq: AMTD  ) and Schwab (NYSE: SCHW  ) also got below-average ratings, with Morningstar citing high fees.

In general, though, 529 plans can give you a lot of help in saving for college. By paying attention to which plans get top ratings, you'll be better positioned to make the most of your 529 opportunity.

For many parents, though, 529 plans should only be one part of a larger investing picture. At the Fool, we've identified 11 rock-solid stocks that can help you secure your future. Check them out here in this free special report.

Fool contributor Dan Caplinger is eternally grateful to his parents for helping with his college expenses. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Bank of America, Fifth Third Bancorp, and T. Rowe Price. Motley Fool newsletter services have recommended buying shares of Charles Schwab. 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.

Read/Post Comments (2) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 28, 2011, at 11:27 AM, Cfuddy wrote:

    I would put the first $2,000 in an ESA at the discount brokerge firm than look to a 529. An ESA is more flexible with investment choices and ditributions.

  • Report this Comment On October 28, 2011, at 6:08 PM, YIF wrote:

    My experience is that the only advantage of a 529 plan is tax-deferred growth. These plan have many hidden charges and the investment choices can be confusing. My first choice is a custodial account where the savings can be used for anything..(.not all kids go to college). The first $850 of earnings are tax free and the next $850 taxed at the child's rate of 15%.Assuming an 8% investment return the acount value would have to exceed $10,000 to be subject to any tax. Your investment choices are not restricted in a custodial account and therefore should be a parents first choice in savings for college.

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