Best- and Worst-Rated College Savings Plans

A 529 college savings plan is designed to encourage savings for future expenses.

The plans, officially known as “qualified tuition plans,” are sponsored by states, state agencies or universities and are authorized by Section 529 of the Internal Revenue Code.

There are two basic types: college savings and pre-paid tuition. All 50 states and the District of Columbia sponsor at last one type of plan. Pre-paid tuition plans are sponsored by colleges and universities.

Earnings from a 529 Plan aren’t subject to federal taxes and in most cases are exempt from state tax as long as the withdrawals are used for eligible college expenses such as tuition, room and board. Money not used on eligible college expenses is generally taxed as income and hit with an additional 10% federal penalty on earnings. Be sure to read the fund’s prospectus before investing.

Morningstar recommends starting with home state offerings when looking for a good 529 college savings plan.

Typically, states offer state-tax deductions to in-state investors, putting more money in their pockets for future college expenses. This may be the major benefit of 529 plans.

But the incentives aren’t necessarily enough to overcome the disadvantages of a poorly performing or a costly fund.

A 529 plan offers the convenience of one-stop shopping, especially to novice investors. Be sure to keep an eye on fees that can erode your returns. Much like targeted retirement funds, many college plans offer age-based portfolios that become more conservative the closer your student gets to freshman year.

Remember: a 529 plan is a supplement to your other investments. Put money aside for retirement before funding a college savings plan.

In general, look for a 529 plan with high contribution maximums and low minimums, latitude in changing beneficiaries and the ability to make non-penalty rollovers to another state’s plan. Avoid a plan with limits on how long it can stay open.

“The terrible performance of some 529 plans in 2008 clearly illustrates that, now more than ever, investors can’t afford to invest in anything but best-of-breed college savings plans,” Morningstar says.

Morningstar’s top-rated 529 College Savings Plans are:
 

• Ohio College Advantage (Ohio Tuition Trust Authority)
• Indiana College Choice 529 Direct Savings Plans (Upromise Investments)
• Utah Educational Savings Plan Trust (UESP Trust)
• Virginia Education Savings Trust (Virginia College Savings Plan Board)
• Virginia College America 529 Savings Plan (American Funds)

Morningstar says these savings plans are among the worst:
 

• Nebraska State Farm College Savings Plan (Oppenheimer Funds)
• New Jersey Best 529 College Savings Plan (Franklin Templeton)
• Montana Pacific Life Funds 529 College Savings Plan (Pacific Life Funds)
• Ohio Putnam College Advantage (Putnam)
• Nebraska AIM College Savings Plan (Investco AIM Capital Management)

“We like to see plans that have sensible allocations among stocks, bonds, and cash that are appropriate for the age of the beneficiary,” Morningstar says. “We like to see plans that are not only well-diversified across the major asset classes, but are also exposed to such areas as foreign bonds, real estate investment trusts, and Treasury Inflation-Protected Securities for added diversification benefits.”