Morningstar recently released its annual list of the five best and five worst 529 college savings plans. Past favorites Utah Educational Savings and Nebraska College Savings dropped out of the top five - not because they got worse, but because other plans got better.

Named after a section of the Internal Revenue Code, 529 plans are state-sponsored programs that provide federal tax benefits for college savings. You can set them up for your kids, grandkids, other loved ones or yourself. There are no income limits, and most plans let you contribute large six-figure sums.

You get no federal tax deduction for money put into the plan, but the money grows tax-free and remains tax-free when you take it out, as long as it’s used for qualified higher education expenses at almost any college in the country. States also exempt earnings and qualified withdrawals from state income taxes.

No matter where you live, you can invest in any state’s plan. Some states offer a state tax deduction for contributions or other perks when their own residents invest in the home-state plan.

Most states hire investment firms to run their programs. Many states offer two plans: one sold by brokers and one that is sold directly to investors without a middleman or sales fee.

Most offer a variety of investment options, such as money market, bond and stock funds, as well as age-based funds that gradually become more conservative as a child gets older.

Morningstar’s top-rated plans this year are direct-sold plans from Illinois, Maryland and Virginia and broker-sold plans from Virginia and Colorado.

Morningstar likes plans that provide a wide variety of asset classes for diversification, low costs, solid underlying funds and the flexibility to easily make changes.

Costs are a particular concern because they come directly out of returns.

In many plans, "there are layer upon layer of fees," Morningstar analyst Marta Norton says. In addition to the fund fees, many charge program or account-maintenance fees, plus - in the case of broker-sold funds - sales commissions.

The Illinois Bright Start plan joined the top five list this year after it switched managers and cut fees.

Also new to the best list is the Virginia Education Savings Trust, a direct-sold fund that offers a wide array of options (including real estate, international and inflation-protected funds) at a very low cost (asset-based fees range from 0.31 to 0.57 percent per year).

These funds replaced Utah’s and Nebraska’s direct-sold plans on the list. "Both of those are still very good plans," Norton says. "They haven’t raised their price. In fact, Utah lowered the annual maintenance fee for nonresidents."

It’s just that "in both cases, there was a cheaper competitor that undercut them," she said.

Advertisement

Moms. Grads & Dads A 13 week gift subscription for less than $2/Week