Choosing a 529 6


This is a followup to this post – What is a 529?

Please read that one first before continuing on to this one, if you haven’t already.

I hope by now I have convinced everyone that a 529 is a great option for saving for college.

For simplicity’s sake, think of it like this:

You put away money for college and although the contribution itself is not deductible, it can grow federal tax-free AND is not taxed when taken out.

There is no better way to save for college.


Before I move on, I just want to clarify that I am talking about a College Savings Plan. The other type of 529 is a Prepaid Tuition Plan.

A prepaid tuition plan is kind of exactly what it sounds like. You prepay for tuition at the current rate at a predetermined institution or from a list of predetermined institutions. This sounds great because you can pay for the current rate, which almost certainly go up by the time Junior needs to go right? Correct. However,  if Junior decides to go an institution that is NOT ON THE LIST, then the value of the payments may not be sufficient to cover costs and may need to pay out of pocket. I think it is near impossible to predict which college Junior would want to go to, and you are going to need to be in the same state indefinitely to make a Prepaid Tuition Plan worthwhile. Like I said, I am all about being flexible. For this reason, I think the College Savings Plan is the “safer” option.

*Ok then, which 529 should I use and how do I set it up?

The single most important thing to remember when it comes to state-based 529s is that just because you put money into a particular state’s 529, you are NOT locked in to having your child go to a college in that state. In this sense, all state-based 529s are equal. However, each state has its own set of tax breaks/credits if you are a resident of their state. An extensive list can be found here.

For example:

Indiana is: “20% tax credit on contributions up to $5,000 ($1,000 maximum credit)” Wow, that’s great. That’s basically free money. So you can put in $5000 a year and get $1000 back. Now, anything after $5000 doesn’t really have any benefit, but hey free money is free money. In this situation, you should definitely put in at least $5000 a year if you go with their plan.

Hawaii (where I live) is: “– “which means I don’t get any benefit at all.


Ok, so now some more commentary:

Each state has different funds that are available. Just because a state has a good tax advantage (like Indiana), that doesn’t mean it has great fund options. Let’s just take a look at them:

CASE STUDY ONE:

Interestingly, Indiana actually has 3 separate plans to choose from:  CollegeChoice 529 Direct Savings Plan, CollegeChoice CD 529 Savings Plan and the CollegeChoice Advisor 529 Savings Plan.

Their fund options can be found here (in general). The long and short of their plan is it’s pretty good. The ones that I think are important to note are:

Vanguard U.S. Equity Index Portfolio

Vanguard Bond Index Portfolio

You would need to check their expense ratios and such, but the building blocks are there for a good 529. Index Stock Fund and Index Bond Fund. You will also need an FDIC-Insured account as well.

Verdict: If I lived in Indiana, I would almost certainly use their state based 529 because it is unlikely I could offset a free $1000 a year, unless the fees are significantly worse than the other states.

CASE STUDY TWO:

I live in Hawaii, which doesn’t have any tax benefits at all. This allows me to use whatever state 529 fund I want. Based on my research, I think the top state 529 funds (assuming no tax benefits) are:

Utah Educational Savings Plan (UT)
New York 529 College Savings Program: Direct Plan (NY)
T. Rowe Price College Savings Plan (AK)
Maryland College Investment Plan (MD)
The Vanguard 529 College Savings Plan (NV)

This is almost completely based on their management fees (low), funds and the expense ratios associated with those funds. Honestly, these are all probably in the same tier. Remember that I am partial to Vanguard funds which puts Utah, New York, and Nevada higher on my list. (T. Rowe Price is the other two) I wrestled between using Utah or New York, and for some reason I just opted for Utah, and I can’t even remember why. However, this decision was like choosing between an Ultimate Red Velvet Cheesecake or Craig’s Crazy Carrot Cake Cheesecake, they’re both good, and in the end, they’re both cheesecake. In case you were wondering, the former is my go-to cheesecake and the latter is my wife’s go-to cheesecake. Cheesecake Factory, if you’re listening, I could really use a lifetime pass, if one exists.

Ok… let’s get back on topic… the Utah Educational Savings Plan (UT), what does it have:

Utah puts them all right here, in plain sight. Nothing to hide at all.

VG Institutional Total Stock Market Index Fund — Ticker Symbol: VITPX  — Expense Ratio: 0.020%  (more info here – note 3257 stocks – 6/9/2016)
VG Total Bond Market Index Fund — Ticker Symbol: VBMPX  — Expense Ratio: 0.050% (more info here – note 8006 bonds – 6/9/2016)

Those are really good expense ratios for very large stock and bond index funds.

You will also need some kind of FDIC-insured account (like a CD) for when Junior is actually *in* college. (*note that Money Market Accounts are -not- FDIC insured)


*Ok, I get it. It’s the same philosophy as before, index funds, low expense ratios, etc, right?

Yup. However, the time period is significantly smaller, and the withdrawal rate is very different. Unlike retirement, you are not looking 30+ years in the future, you are looking at a maximum of 18 years, maybe only 15, or maybe less than 10 depending on your situation. This changes your allocation of stocks/bonds significantly because of your accelerated time frame. Also, you need to put the money into something which can be assessed easily when it comes time to pay for tuition. Additionally, you are withdrawing all the money is 4 year or less, not 20+ like in retirement.

Utah’s investment options are here. It can be daunting to look at them, but basically, it’s an accelerated schedule compared to retirement. You can’t use the “age in bonds” thing here. There are other approximations to consider, but overall, I think their Age-Based Aggressive Global is a good start. You can see the details here.

Basically, you lean heavily toward stocks from 0-7 years of age, then beginning at the 7-9 year old range, you slowly move some more money into bonds. At the age of 10-12, you’re looking at roughly a 50/50 split between stocks and bonds. Then, starting at age 13, you begin tilting your money into more bonds, and FDIC-insured accounts (like a CD). At age 16, you are at around a 20/55/25 split of stocks/bonds/FDIC. Then Junior starts college at 18, and your money is 0/25/75 (as it should be). The Age-Based Aggressive Domestic just cuts out International Stock Index Funds completely. The Moderate and Conservative Age-Based options just shift money into Bonds/FDIC sooner.

*Ok, so what do YOU do then?

Honestly, I should just do the Age-Based Aggressive Global… but I like to tinker a bit. So I am doing a variation of that utilizing their Customized Age-Based option. Note, that this increases my fee slightly from 0.18% to 0.20%, but I preferred to customize my own. Will it make a difference? Probably not.

If anyone is interested, I will list my -exact- plan here.

TL;DR

Choose a state based 529 college savings plan with low expense ratios, but weigh that against any tax benefits your state gives you.

My top picks, without consideration for any state tax benefits are:

Utah Educational Savings Plan (UT)
New York 529 College Savings Program: Direct Plan (NY)
T. Rowe Price College Savings Plan (AK)
Maryland College Investment Plan (MD)
The Vanguard 529 College Savings Plan (NV)

A 529 plan has different asset allocations and rebalancing than a normal retirement plan. The shift to more bonds/FDIC occurs earlier depending on your level of comfort (aggressive, moderate, conservative).

I do a variation of an Age-Based Aggressive Global plan.


What do you do? or What do you want to do?

 

-Sensei

Agree? Disagree? Questions, Comments and Suggestions are welcome.

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About Sensei

A young attending physician trying to navigate the mine field that is life after medical school…


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