Reader Feedback: Opening A New 529 Plan

opening a new 529 plan

Hello $wanigans! I need a little help from you today. As you may be aware, Lucy and I just had our second child…born on April Fools Day…no joke! So time to give some thought to the good old 529 plan again. And what better day to talk about 529s than on 5/29?

I should be a little more regular and routine in analyzing 529 plans as I learned some new things this go around. For our first born, Cygnet #1, we opened a Utah 529 plan which at the time in 2014 had the lowest fees and best investment option for us which included static index investments (Vanguard funds) in US and International equities. This basically mirrors our retirement investment selections with 65% domestic and 35% international.

If there were good tax advantages of investing in our own state 529 plan we probably would have done so, but North Carolina adjusted the state tax code effective January 1, 2014 and the deduction for 529 plan contributions went away…what timing! So Utah’s was the next best option for us.

I chose static investments rather than age-based as I want control in how and when the investment choices change to a more stable and safe investment…if I want to ever change it at all. I’m completely comfortable holding all equities for a while though since we have such a long time until he’s ready for college.

529 Plan Review

So, like I said, I probably should do a more regular review of 529 plans as the state offerings are constantly in flux. Whether changing investment managers (e.g. active to index, etc.), investments options (e.g. static, age-based, or allocation options) or adjusting the level of fees, some states seem to be constantly jockeying back and forth to offer better and better choices.

While Utah was the best back in 2014, it appears New York now has a very competitive offering at lower fees and it may suit me better now. It has similar investments options as Utah (Vanguard US and Int’l index funds), but at a lower cost. The reason I need to monitor more closely is that switching among states is allowed. Maybe it is time I take this offer up?

Federal tax law allows the rollover of any or all of a 529 plan to another 529 plan once in any 12-month period. Most state 529 plans follow the federal tax-free treatment and fortunately both New York and Utah are among those states. Since I am not resident in either state and didn’t benefit from deducting contributions on the respective state tax return, I wouldn’t be subject to any recapture of tax savings or penalties.

Plus, I checked with both states and neither charge any processing fees for incoming or outgoing rollovers. So theoretically, I could change back and forth between the two state plans (and perhaps other states if their 529 plan offerings improve) fee- and tax-free in the future as investment fees improve at one versus the other, etc., so long as I wait 12 months in between.

opening a new 529 plan

529 Plan Considerations for Cygnet #2

In my review of 529 plans for Cygnet #2, I had the following primary criteria:

  • Low Fees: 529 plans are unique in that they need to be bought through the individual state who each have their own platform, but then export the management of the plans. As such, fees can come in many different shapes and sizes including enrollment / application fees, account maintenance fees, program management fees and underlying investment fees. This can obviously be annoying as hell, nobody likes to pay fees and be nickle and dimed, so I told Google to point me in the direction of the lowest fee plans!
  • Vanguard Funds: My inclination is to look solely for Vanguard funds based on being the traditional leader in low cost funds, but I am open to other index fund managers as well since all index funds basically operate in the same manner in how they track the underlying index.
  • Investment Selection: I prefer to directly manage the investment selections and diversity so I shy away from age-based options. Unfortunately, it is difficult finding 529 plans that offer much flexibility in this regard and allocation percentages to US vs International equities can sometimes be rigid. Why can’t this be as simple and easy as buying funds through my IRA?!

My Dilemma

Here comes the dilemma I need your help with! And it is a two-part dilemma…

1. Utah or New York?

Cygnet #1’s 529 plan is with Utah right now. I’d prefer to have both kiddos’ 529 plans in the same spot for ease in tracking and also for the ease of potential transfers between the two in the future.

While New York’s 529 plan has materially similar investment offerings at a lower cost, is it worth the hassle of a plan transfer?

The fees I pay in Utah include 20 bps for program management along with the underlying investment expense ratio which averages to 4.5 bps across the three index funds I own (large cap, small cap, and international). With roughly $80,000 in the account today, that equates to $196 per year in fees. And this $80,000 for Cygnet #1 is what I consider to be a fully funded 529 plan.

Alternatively, New York’s expense structure is much easier and better. They charge a 16 bps flat program manager fee which includes underlying fund expenses and there are no other fees. New York seems to have figured it out by avoiding nickle and dime-ing folks! On a comparable $80,000 fund, this would equate to $128 in fees per year, or $68 less than Utah each year.

opening a new 529 plan

2. 529 or Taxable Account?

The other dilemma I face is whether to save for college in a 529 plan or a standard taxable brokerage account?

There are a few primary considerations I have here. First, the 529 plan has its tax benefits. Namely, the investments grow tax free. As I mentioned before, there are no tax benefits in North Carolina in terms of deductions to income tax of contributions, but some states offer this as well.

Alternatively, if I retire in 5-7 years, my taxable income will likely drop to the 15% tax bracket or lower, and therefore I’d owe no federal capital gains tax on the brokerage account anyway, thereby growing tax free in a similar manner as the 529 plan. Sure, I’d pay some tax in the meantime on dividends from the investments during the 5-7 years before I retire, but not too much.

The benefit: by keeping it in a brokerage account, I’d maintain ultimately flexibility! Say my cygnets don’t end up going to college? Or what if they find low cost ways to “hack the cost of college” such as CLEP tests, dual enrollment during high school for college credit, taking some community college classes in the summer that are transferable to their full-time university, and/or graduate in three years?

In a way, I hacked the cost of college without even knowing it at the time as I took advantage of each and every one of those above mentioned examples…so I wouldn’t put it past my kiddos to do the same. And that would mean I would risk over-funding their 529 plans. Unless of course they went on to get an advanced degree…which I also did.

Oh what a dilemma!?

If I chose not to fund a 529 plan for Cygnet #2, the solution could be opening an account for him and then transferring half of Cygnet #1’s assets to Cygnet #2. This would keep things fair and even between the two, and ~$40,000 in each of their respective plans would help fund approximately half of their respective college costs at an in-state public university by the time their 18 per my earlier estimates.

Your Feedback

Please let me know your thoughts on my 529 plan dilemma. Is there anything I may have missed or failed to consider? Where do you have your 529 plan and why?

You can also now see my conclusion on opening a 529 plan.

Thanks for taking a look!

The Green Swan

 

Some Good 529 Plan Resources:

Saving For College 529 Plan Comparison

Vanguard 529 Plan Comparison

Nerdwallet 529 Recommendation

Reviews.com Best 529 Plans of 2017

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26 Comments

  1. I have a mix of 529’s and I Bonds for the kids college, and I do have some in CT (for the tax benefit) and some at Vanguard (Nevada) 529’s. I like your idea of transferring $40k into #2’s account and letting both compound, while investing in after-tax brokerages for flexible funds. That way if there’s a shortfall because the market doesn’t perform, you’re covered – but if the 529’s do perform well, then you can just use those funds to cover college.And the bonus is you’ll be able to use what you have in the taxable account for whatever you need at the time.

    1. Thanks for the feedback Liz! I agree, it’s good to maintain flexibility. Unless the 529 Plan is being used as a tool to pass on inheritance to the next generation I’m not sure there’s any sense in risking over-funding it.

      1. ESI money wrote a great article about the risk of overfunding-he posted it on the Rockstar forum to help me with today’s article about 529 plans. Highly recommend checking it out!

  2. We also just had a little one in NC. Mine is actually setup through Welathfront which I believe buys through Nevada. Total fees are 34 points which is about what I would have paid anywhere. I am looking to fund half of college with the 529 and the remainder through brokerage accounts or scholarships. Come on scholarships!!

    1. Congrats to you folks! Thanks for sharing your plan, Grant. Nevada is another good option.

      My wife and I are leaning toward paying for half or two thirds and then having the kiddos responsible for the remaining to have some skin in the game.

  3. Timely review, as I will have another “Curious Junior” arriving this summer, and had planned to look at these again myself!

    For #1 I have been using the Nevada plan. When I checked a few years ago, the expenses were so close among the lowest cost plans, it seemed like a crapshoot.

    The only real argument I can think of for a 529 over taxable in your case would be a behavioral finance one: the 529 is earmarked for education, no questions asked. I’m guessing that’s not an issue in your case 🙂

    I like the idea of the flexibility of a taxable account, and will be considering it myself now. Thanks!

    Take care,
    Dr. C

    1. That’s great Dr Curious, congrats!

      Yes the taxable account option is a compelling alternative for early retirees to take advantage of.

      And I agree about the behavioral finance aspect of it. I’m thinking even if I go the taxable account option that I open a new brokerage account designated for college expenses so that it remains separate in mind and physically!

      Thanks for the feedback!

  4. We live in NY and use NY’s 529 plan – but we get a tax advantage too 🙂 Make sure you check out Liz’s post (ChiefMomOfficer) about 529 day today! There is a contest in NY 529 right now and it doesn’t look like you need to be a resident.

    1. Double benefit for you folks!

      I just read her post, what a great compilation of resources and it’s great to know about those 529 plan giveaways. I’ll be sure you check out New York’s and it looks like North Carolina has one as well.

      Thanks Vicki!

  5. I’m not of much use here since I’m still trying to wrap my head around the different 529s out there, but I’m so happy to hear you’re prioritizing saving for your kiddos! That will be a great gift to them once they grow up. 🙂 I think we’ll keep our 529 with USAA, since we have pretty much everything with them anyway.

    1. Definitely a priority! My parents helped me out with about half the cost and Lucy’s parents paid for hers so it is our duty to pass that benefit on to the kiddos.

  6. I wrote a post a few weeks back on why I do not have a 529. I have some of your same fears and since money is fungible I’ve decided to treat my normal savings tax optimized collectively as my kids college funds. Some readers commented their situation was different due to local state tax exemption with no payback requirements. However in my case with no state tax breaks over funding is worse then tax exempt due to more fees.

  7. When you open a regular account, there are in general issues. When it is in your name and something happens, how to make sure the money id for education. When it is in the name of the kid, how to avoid abuse at age 18 or 21.

    That being said, I value the flexibility of regular accounts. No tax shelter and no rules to take into account. In Belgium, such an accounts do not exist. we thus have all in regular accounts, with some protective measures around it.

    1. Great point Amber Tree Leaves! I think that is a key factor in the decision, putting money in a regular account can make contingency planning a little more difficult.

      Thanks for that feedback!

  8. I always go back to that idea that if the kids get a full-ride somewhere, that 10% penalty for withdrawal for non-qualified educational expenses is impossible to get around. It’s like you are rooting for the kids not to get a scholarship! So I personally feel like funding enough to take advantage of the qualified computer expenses and one year of room and board (most people I know only lived 1-2 years on campus). I like the idea of the kiddos getting free or reduced tuition. And in many states with cheap in-state tuition, many people have more than the college costs in a 529 and that ends up being disadvantageous!

    1. In state tuition is the way to go!

      If the kids get a scholarship though I believe withdrawals can be made penalty free for up to the amount of scholarship. Are you saying that withdrawals are more difficult than people realize?

      Thanks for the comment!

      1. Whoops! I wrote that completely wrong! Meant the income tax portion you have to pay on gains. Not the 10% penalty. Shows how rusty I am on my college funding haha.

        1. Yeah gotcha! It’s a shame that you’d still have to pay back the tax benefits if a scholarship is received. The great news of receiving a scholarship is then tempered by the tax bill!

  9. How does duel enrollment work? You face off with the registrar with pistols at dawn? (Homophones are the bane of spell checkers. They give writers homophonophobia.)

  10. That’s a dilemma for sure. I dont remember which state we have ours in, but I know it wasnt one we lived in. 🙂 It was chosen for all the same reasons you chose yours though. We’ve discussed mutliple times about what we’d do if the money was available to us later on and not used for college. Take the penalty, or roll it over for one of their kids or do what with it? Either way, we decided to keep them both in a 529 and worry about it if the time comes that we have to do that.

    Good luck with your decision!

    1. I think what we’d ultimately do is hold onto it, let it continue to grow, and eventually put it in the names of grandkids. The funds will likely grow faster than the cost of college and become a large number, but if each kid has a couple kids themselves it will split up nicely.

      Thanks for the comment Mr SSC!

  11. I think you hit the nail on the head. I started a couple 529 plans for my kids but then realized later I wish I hadn’t for a couple reason. A. not getting any help for college from my parents (and I spent 50k at private school) was a big contributor to me growing up, and B. I don’t want my kids to feel obligated to go to College because of how much money I saved for them. I opened my 529s through Fidelity and fund them solely through credit card reward points. They’ll probably only have 10-15k each by the time they hit college age, but that’s more than I got and if they do really need more help I’ll use my taxable accounts.

    I think success after high school ultimately depends on your kid’s personality. You might have a child that actually appreciates the money they are spending for education and the help you are giving, or a kid like i was who doesn’t understand large amounts of money and just thinks a good life should be handed to him. Again, though my parents wanted to, not paying for my education was the best thing for me. So yeah, at the end of the day, I do not recommend 529s. Save it all in taxable accounts and when the time comes to decide whether they need your help or not (or if they even want it) you’ll have that flexibility.

    1. Great feedback, MPH. I think you make some valid points. I know paying half of my college costs helped keep me focused. I took a lot of pride in how I performed in college and knowing I was helping contribute financially was a part of that pride.

      Worst case, paying a little from the taxable account won’t hurt much.

      Thanks again! Tune in for Mondays upcoming post on my final conclusions!

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