Nickel and Diming Your Kids to College

Small rebates from retailers are just another way parents can fund ever expanding 529 plans.

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When it comes to your 529 college savings plan, it's the little things that count. Just ask Randy McCready. The Milwaukee father is saving money in his daughter's tax-deferred 529 a penny at a time—literally.

McCready signed up with Upromise, one of a handful of rebate programs that let parents save for college every time they shop. He earns 1 cent per gallon when he fills up his gas tank at Mobil or Exxon stations. What's more, because McCready uses his Citibank Upromise MasterCard, he gets an additional 1 percent rebate.

In August, the gas rebates netted his 6-year-old daughter, Molly, $2.77 for her 529 account. "I know, it doesn't sound like much," says McCready, financial aid director at the University of Wisconsin-Parkside. "But it's surprising how quickly it all adds up." In five years through Upromise, McCready has saved more than $1,600 in Molly's 529. In the grand scheme of things, $1,600 is probably a drop in the bucket of what's needed to pay for many colleges. But parents who use 529 plans—and the states that sponsor these tax-deferred savings and investing accounts—are coming to realize that it's the little things that matter.

In the decade since 529 plans were launched, these accounts, which are offered by virtually every state, have soared in popularity. About $105 billion is invested in the 80 or so 529 plans that parents can choose from (you aren't limited to just your in-state plan), about double the 2004 level. And 529 assets are expected to double again by 2010, according to a Financial Research Corp. estimate.

The growth follows major improvements to 529s, named for the section of the tax code that gave birth to the 401(k)-like accounts in 1997. Withdrawals from 529s used to be taxed at the child's rate. No longer. First, the federal government temporarily made withdrawals for qualified educational expenses completely tax free. Last year, Congress made tax-free withdrawals permanent.

Stacking Up the College-Savings Rebates

Three major college rebate programs help shoppers save for school, a few pennies at a time.

PROGRAMS RETAIL PARTNERS PROS CONS
Upromise 637* Offers the biggest network of bricks-and-mortar partners, including grocery stores and gas stations. Also offers a rewards credit card to add to savings. You must request a rebate check by letter. While you can have money deposited automatically into a Upromise-administered 529 plan, similar arrangements can't be made with other 529s.
BabyMint 540 Can save through online and bricks-and-mortar retailers. Members can also earn tuition reward credits at nearly 200 independent colleges. Has the fewest partners, and you must go through the BabyMint website to enjoy rebates at retail sites.
Little Grad 2,000 Will automatically deposit rebates into any 529 or financial account. Allows you to save at any retail partner, without going through Little Grad's website. No bricks-and-mortar retail partners to save through.

*Does not include rebates at more than 7,000 restaurants.
Source: USN&WR

What's more, assets held in 529s and most college savings vehicles aren't considered the child's, even if the student beneficiary technically owns the account. That's a major help when it's time to apply for college financial aid, since the federal aid formula considers up to 20 percent of a child's assets as fair game for paying for college (versus 5.6 percent for a parent).

"The big battles have been won," says John Heywood, a principal with the Vanguard Group who heads up the mutual fund company's education savings plans. Now, states and parents must focus their attention on smaller issues:

Fees. Competition among financial services firms is driving down 529 plan fees and expenses, often as state plans are put up for rebid to firms that manage them. Take Fidelity. Last year, the mutual fund giant won the contract for California's direct-sold 529, which used to be managed by TIAA-CREF (a separate California 529 plan is sold through brokers). Fidelity agreed to expand the plan's investment options and to include a low-cost index-fund option that charges just 0.5 percent in annual management fees, less than previously offered funds.

While a difference in annual fees of 0.5 percent and, say, 1 percent may sound slight, it can mount up. Say you invest $20,000 in similar investments in two different 529 plans. And let's say both earn 8 percent a year gross. But Plan A charges 1 percent in total annual management fees, leaving you with a net return of 7 percent a year. And Plan B charges just 0.5 percent, for a net gain of 7.5 percent. Over an 18-year stretch, you would earn $5,900 more in Plan B.

Investment choices. More plans are now offering families a choice of investing in actively managed funds or low-cost index funds, which simply invest in all the stocks or bonds in a market index. And banking products like certificates of deposit have moved into 529s. Plans in Arizona, Hawaii, Montana, and Ohio all offer parents the choice of investing college savings dollars in CDs, which will appeal to parents looking to protect savings from market losses as their kids near college age.

Tax deductions. While more than 30 states offer their residents a state tax break for investing in a 529, most make these breaks available only to parents who choose the in-state plan. But now a few states, including Kansas, Maine, and Pennsylvania, are offering state tax deductions to residents who put money in any 529 plan. It's too soon to tell if this is the start of a real trend, but similar tax parity legislation has been introduced in nearly a dozen other states.

Rebates. Whatever the states do, parents can help themselves by using rebate programs tied to 529s. They include Upromise, BabyMint, and Little Grad. Each site offers rebates every time you shop at a partner merchant, and those savings can eventually be deposited into a college savings account.

Of course, families may save more by shopping for lower-priced merchandise instead of hunting for a rebate tied to name-brand goods. And some basic credit cards offer customers a 2 percent rebate on many purchases.

But Lisa Roll, a Upromise member who works as a financial adviser, wonders what the odds are that you'll take every last penny of savings through a basic rebate credit card and deposit it into a 529 for your child. "This way, at least, you can kind of put everything on autopilot," Roll says. And getting college finances on autopilot is certainly a small way that parents can achieve surprisingly big savings in their 529s.