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Should we stick with our in-state 529 plan?

May 11, 2012: 2:24 PM ET

We'd like to start a college savings program for our three young children. Can you tell us what the highest performing and most cost-effective state 529 programs are right now? We live in Texas, but I've heard that the Texas 529 plan is poor performing. And is there a savings vehicle we should consider instead of the 529? –Cathy M., Dallas

In many states, you get a break on your state income taxes when you contribute to your local 529 college savings plan, but that's not the case in Texas, which has no state income tax at all. And although Texas offers a 529 plan that you can buy directly—meaning you won't pay an adviser or broker a commission to invest in it—the ongoing fees are steeper than other options out there.

"I don't recommend the Texas 529 plan because it has higher fund expenses," says Gary Busch, a financial planner in Houston. "My favorites this year are Nevada's Vanguard 529 Direct Savings, Utah's Educational Savings, and Ohio's College Advantage Direct plans. They have no sales commissions and invest in low-cost index funds." (For more on these plans, including links and contact information, go to Savingforcollege.com.)

Aim to save no more than half of your children's anticipated college expenses in a 529 plan. That way, if your child receives merit-based financial aid—or goes to a significantly cheaper school than planned—you won't have money stuck in a 529. (Making withdrawals for anything other than qualified education expenses will trigger a penalty, and you'll pay taxes on the earnings.) "The best vehicle for any additional savings would be a taxable brokerage account at a discount broker, invested in low-cost index funds and becoming more conservative as the child approaches college age," says Busch.

You can also use a Roth IRA as an alternative to a 529 plan. However, a child can't contribute to a Roth unless he has sufficient earned income. "I don't recommend that parents use their own Roth IRAs for college," says Busch, "since saving for retirement should take precedence over saving for their children's college."

--Kate Ashford

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