The Ultimate Guide to Choosing a 529

You know you need to save for your child's college education. You have had a general savings account established since her birth, but now you're hearing you need to look into investment options too. Where, or when or how do you start?

Saving for college doesn't have to be harder than her calculus class. But before we go into more detail, let's clear up some confusion.

A few college savings misconceptions are:

-- Your child's entire education will be funded through scholarships and financial aid. Although you may be optimistic your daughter will get a soccer scholarship, it's probably a good idea to save as if she won't. A little extra in the bank could end up being a bonus in the event she does.

-- You will either qualify for financial aid or be able to cover the full cost of college. You may actually be in the middle. For folks in this segment, saving becomes imperative, and provides a way to avoid student loan payments after the diplomas are given out.

-- Saving without a plan is as good as saving with a plan. In a study released in April 14 by Sallie Mae, titled, "How America Saves for College," it was found that, "Planning parents have saved 83 percent more dollars in their college savings fund ($18,518) than savers who don't have a plan ($10,105)."

The point is this: Although intentions are great, you may not see as good of a result in your saving unless you put your goals down on paper and form a plan.

So, how do we form a plan based around solving these issues? First, ask yourself some of these questions.

What exactly is a 529 plan? A 529 plan is an education-specific investment vehicle that can enable you to take advantage of tax benefits for college savings. You can choose a prestructured plan, or customize one based on your how you want your portfolio built.

This type of plan can give investors flexibility in how much risk they want to take on, while taking advantage of tax benefits due to the educational nature of the savings account.

Not all 529 plans are the same, so it's important to know what you're getting. Setting aside some time to discuss these options and your goals with a financial advisor can help set you up for success.
What are the tax advantages? You will not be federally taxed when you withdraw funds for qualified education expenses. Additionally, many states allow deductions for contributions, and may offer distributions to be tax-free. Keep in mind that annual contributions over $14,000 in 2014 count towards the lifetime gift tax exclusion limit.

But be careful, since these plans can sometimes have fees attached you may not be aware of. If these funds are used for non-qualified expenses, that is, outside of paying for education, there can be additional taxes and even penalties.

Since each situation is different and usually complex, it's always a good idea to consult a personal tax advisor to answer your specific questions.

How are 529 plans different? Although knowing what a 529 plan is is a great start, the interest in one generally leads to more questions. And with the variety of 529s available, there are a lot of options to sort through.

Each plan will have differences in risk levels, which is both a good thing and a bad thing. It's good because you can customize it based on your personal preference. It's bad because it's something else you have to understand, and make a decision on.

In terms of growth and risk, the Sallie Mae report went on to say "Total accumulated college savings increased by 30 percent to an average of $15,346 from $11,781. Most savings vehicles saw an increase in total value, with the exception of rewards programs, trusts and UGMA/UTMA savings."

What does this mean? It means the savings vehicles increased in value because the market was doing well and those plans bringing up the average had some equity allocation. It doesn't mean, however, that this is right for everyone. Each family needs to understand gains one year can be losses the next, and should plan their risk exposure accordingly.

Some questions to ask may be, "How much risk am I willing to take on during each stage of my child's growth?" Other questions may be, "Am I comfortable taking a 20 percent or 30 percent loss, if that means I can potentially generate an equal percentage gain?"

One person's idea of how much risk they can take on may not be right for you. It's especially important to consult a financial advisor if you're unsure of how to proceed.

What is the difference between traditional versus age-based portfolios? Figuring out which risk profile you'd like to take on is the first step to addressing which option makes the most sense for you.

Since everyone is different in this area, it's really up to personal preference, and your level of comfort with potential loss. Two of the options we can look at are traditional and age-based 529 plans.

-- Traditional portfolio: Most 529 plans have traditional investment options that can be chosen from and made into a portfolio (not unlike a 401(k) plan). These are fairly straightforward.

-- Age-based portfolio: With an age-based approach, the current age of your child and her time frame for entering college is taken into account. You're able to pick a prebuilt portfolio that will adjust automatically to be more conservative as your child gets closer to college.

If you're not comfortable with an equity loss in your child's later years, choose a portfolio that's more conservative or allocate more toward cash or bonds.

Don't set it and forget it. Age-based plans offer a type of "set it and forget it" approach, as reallocations happen automatically. Though this may have worked for Ron Popeil, it doesn't always work with investing. You need to be careful that you know when your reallocations will happen, and what the market looks like at that time.

For example, some age-based year of enrollment plans may move assets quarterly, but other portfolios have larger ranges of anywhere from three to even five years.

Additionally, not all similar portfolios are the same. An example may be that you find two providers, both offering an age-based portfolio for a 3-year-old, are actually very different, after careful examination.

What to do next. Ideally, if you have planned your goals ahead of time and know how the plan in which you enrolled should react to various market conditions, you can check back on those markers to make sure you're hitting targets.

If you don't have a plan yet and you'd like to explore your, or you have one and are unsure of the level of risk you're currently taking on, be sure to talk to your financial advisor.

Greg Ostrowski is a certified financial planner practitioner at Scarborough Capital Management , who helps clients with financial planning and investment management strategies. He says that helping investors stick to their plan and making adjustments based on long-term goals rather than reacting to the market, will result in stronger portfolios. Ostrowski lives in Annapolis, Maryland.