How And When To Switch Your 529 Plan

By Katie Adams AAA

According to a 2007 College Board study, having a bachelor's degree means earning 60% more than those with a high school diploma. But even if getting a degree seems like a no-brainer, paying for it is anything but. One investment vehicle designed to help out is the 529 college savings plan, a savings tool used to invest savings for a child's college education. There are no federal tax deductions for contributions to 529 plans, but some states do allow deductions and earnings grow on a tax-deferred basis.

Between 1996, when these plans were introduced, to 2006, the number of accounts had grown to nearly 10 million. Unfortunately, not all 529 plans are the same, and being stuck in a substandard one could leave you with less college savings than you need. Read on to find out how to evaluate your 529 plan. If it isn't making the grade, we'll show you how to find and switch to a better one. (For background reading, see Choosing The Right Type Of 529 Plan.)

Why You May Want to Switch Plans
Just as with any investment, you should periodically review your 529 plan's performance and your satisfaction with the investments. You have the option of switching 529 plans and, depending on your plan's cost and earnings record, you may want to consider doing so. Before making a decision, make sure you take the time to understand your current plan and carefully weigh its expenses, tax benefits and performance record. Also be aware of any costs or consequences of switching plans before doing so.

There are a number of reasons to consider switching 529 plans. Let's look at some of the most commonly-cited reasons:

  • Lower costs. Every state offers its own 529 college savings plan, and each charges different fees and expenses. Check to see what your current plan expenses are. For example, are you paying an annual fee? A management fee? A maintenance fee? Transaction fees? In addition to standard fees you may be paying more money if you are participating in an out-of-state plan. Plan sponsors are required to disclose fees to investors, so be sure to carefully research your plan's fee structure.

    If you invested in a 529 plan through an investment advisor, broker or bank (a "broker-sold college savings plan") you are likely also paying additional fees including a broker commission, annual distribution fee and, depending on the share classes that your broker offers, perhaps deferred sales charged when you withdraw money from the plan. By switching and investing in a plan directly through the plan's sponsor (a "direct-sold college savings plan"), and not through a broker, you can save on sales fees and commissions.

    Fees and expenses vary by plan and can add up to a significant amount of money out of your 529 plan each year. Find out what you're paying and how your plan fees compare with other plans as you evaluate your choices. Consider using FINRA's 529 College Savings Plan Fee and Expense Analyzer to compare costs between plans.

  • Poor plan performance. Investing involves risk; 529 plans are subject to normal market gains and losses like any other investment. However, if your plan is consistently reporting losses or meager increases compared to the overall market or to other state plans, you may want to dig deeper and evaluate the reason behind the losses. It may be that your investment goals are not aligned with the plan option you chose for the funds and you may want to switch your investment option within the plan. However, you may want to pull your savings from the plan completely and invest in a different state's plan that has a better demonstrated return on investments. (For more insight, see Gauge Portfolio Performance By Measuring Returns.)
  • Plan management is changing. 529 plans are managed by professional investment advisors and financial services firms. From time to time, states may elect to change the team or firm overseeing their plans. They are required to update investors about any changes to the plan including a change in plan management. Take the time to learn what a new management team may mean for how your plan's funds are invested. You can research investment advisors through the SEC's Investment Advisor website. If you are unconvinced that either the new team or the investment option proposed changes are in line with your investment goals, you may want to consider switching plans. (For more insight, see Assess Your Investment Manager.)
  • In-state tax deduction. If you have been participating in an out-of-state plan, you may want to consider switching to your in-state plan if your state provides income tax deduction or tax credit for contributions. Check to make sure that your state's plan fees don't outweigh the tax benefit and that your rollover contribution would be treated the same as a regular contribution by ensuring that it will be eligible for the deduction.
  • Increased flexibility and options. Plans typically offer at least two or three choices for investing your savings, such as stock mutual funds, bond mutual funds and money market funds. Those investing options usually reflect different levels of risk. Your risk tolerance will be determined, in part, by when you are going to need to use your plan funds. You may want a plan that provides more options than you currently have, or you may not like some of your current plan's restrictions, such as your ability to change beneficiaries or transfer plan ownership to a different account holder.

How to Go About Switching Plans
Once you have decided to pull out of your current plan, you will need to evaluate and choose another plan to roll your savings into. You can compare 529 college savings plans through the College Savings Plan Network website. Once you have selected a new plan, there are two ways that you can switch:

  1. Complete a rollover contribution form for the new 529 plan and the administrator of the new plan will coordinate a transfer of your funds from your current plan.
  2. Request a distribution of the entire account holdings from your current plan and deposit the same amount in the new 529 plan as a rollover.

What to Look Out For Before Switching Plans
Before you rush to switch plans, you should be aware of - and avoid - possible costly penalties and fees:

  • 60-Day Window. There is a 60-day window for all plan rollovers, meaning that you must deposit all funds withdrawn from one plan into another plan within 60 days of receipt.
  • 12-Month Limit. You can only change plans once every 12 months; change any more frequently than that and you'll risk a 10% penalty and federal tax bill on your plan earnings.
  • State Fees. Some states charge a fee for a direct-to-plan rollover request.
  • Possible Recapture Tax. Check to see how your plan treats the tax deduction for funds you have already deposited. Some states will "recapture" (bill you for) the tax deduction you received for deposits made into your plan if you choose to switch to another state's 529 college savings plan.

Conclusion
Review your current 529 college savings plan to ensure that your earnings aren't being outstripped by fees, expenses, possible lost tax benefits and poor earnings. If you are not satisfied with your plan, weigh your options carefully and then select a plan that is more suited to your investment goals and preferences. By following simple plan rollover instructions, you can move into a plan that helps you keep on track to save for your child's college education.

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