College Savings Plans Pros, Cons for Financial Newbies

Before their son had even turned a year old, Rachel and Stan Revelle began making plans to save for his college education.

"Both my husband and I went to Notre Dame and Notre Dame is pretty expensive," said Rachel Revelle, who lives in Ashburn, Virginia. "When you calculate how much you need to save per month to get to that tuition rate, it's pretty staggering."

The Revelles chose one of Virginia's 529 college savings plans, Virginia529 inVEST, because it allowed them to invest up to $4,000 per account per year tax-free.

529 plans have the big advantage of allowing families to invest money for college without paying taxes on the earnings, but the fees tend to be higher than a comparable mutual fund, according to the financial analysis company Morningstar. The plans also require the beneficiary to use the money for college-related expenses, which could make some families feel like they don't have enough flexibility.

Find out the [steps to take before opening a 529 plan.]

That wasn't a concern for Revelle, and since having a second child, she and her husband have opened two more 529 accounts so they can invest up to $12,000 a year without paying taxes on the income.

But for those who are just starting on their college savings journey, here are several things to consider when deciding whether to invest in a 529 plan or some other vehicle.

Pro: Plans offer tax breaks. The dollar benefit from tax deductions can help overcome a so-so investment lineup or relatively high fees, according to Morningstar, which compares and analyzes plans in every state. A family of four who earns a hypothetical $50,000 per year and contributes a total of $2,400 per year would get a tax dollar benefit of anywhere from $38 in Rhode Island to $480 in Indiana.

Account holders will not only get a tax break in many states on the contribution or a portion of contributions, they don't pay capital gains on the appreciation of your 529 account when the money is withdrawn, said Laura Lutton, research director at Morningstar who has overseen the firm's 529 research. "You're getting a huge leg up if you're thinking about it in performance terms in the 529 plan that you wouldn't get in a traditional mutual fund."

Understand [who benefits most from saving in a 529 plan.]

Con: Plans can have higher fees. Costs across the industry have come down in recent years, according to a 2014 Morningstar report, but "In general, it's more expensive to invest in a 529 plan than it is in a mutual fund," Lutton said. A 2013 study out of Cornell University even suggested that the higher fees may outweigh tax benefits, although that study only looked at data through 2006.

Still, smaller asset bases, state-level administration and marketing cause 529 plans to carry more expensive price tags than comparable traditional open-end mutual funds, according to the Morningstar report.

The typical 529 investment costs 0.21 percentage points more per year in fees than a similar mutual fund, so for every $100 invested, 529 investors pay 20 cents more per year in fees on average. Four years ago, the gap was nearly twice as high.

The study also found that about half of all 529 plans charge a maintenance fee -- which averaged about $20 -- for administrative costs. " Account owners with low balances are particularly punished by these recurring charges, " the report said.

Don't fall for [these common misconceptions about 529 plans.]

Pro: Plans promote disciplined saving. The money in a 529 account is specifically earmarked for college expenses and there are penalties for taking it out for other needs. That could be seen as a negative, but Betty Lochner, chairwoman of the College Savings Plans Network, a coalition of state-administered college savings programs, said it forces families to be disciplined in saving money explicitly for college.

"It's easy for families to say, ' Gosh, we've got $10,000 in this bank account, but we really need a new car, or something came up, '" she said. " It's really easy to take it out for another purpose. These plans give families some discipline. You put it in there; you expect to use it for college, and it has the tax benefits. "

Con: Plans have penalties if the money isn't used for education. There are stiff penalties if you don't use 529 plans for qualified higher education purposes, which include tuition, mandatory fees, books, equipment, and, for students enrolled half time or more, room and board.

For instance, in Washington, families who withdraw the money for so-called " non-qualified " purposes would be subject to a state administrative charge on top of a federal penalty of 10 percent, said Lochner, who is also director of the state's pre paid 529 plan Guaranteed Education Tuition. However, the plans do allow families to change the name of a beneficiary and savings can also be deferred.

Pro: Plans have low minimum amounts for starting an account. You can start with as little as $15.

That's one of the 529 industry's arguments for why this is a great option, said Morningstar's Lutton. "You can basically get started saving with a very modest contribution, whereas you're sometimes required to commit $2,000 to invest in similar mutual fund."

Trying to save for college? Get tips and more in the U.S. News College Savings 101 center.