Choosing a Beneficial 529 Plan

In Basics of a 529 College Savings Plan, we discussed the basics and qualified expenses of 529 plans. Once you’ve decided that you want to invest in a 529, it’s time to decide on a plan that will be beneficial for you.

Three Steps to Choose an Appropriate Plan

We consider the following factors most critical to the decision-making process:

  • What are the plan’s investment options? Find the plans that allow for the most effective global diversification – and preferably are passively managed.
  • What are the plan’s costs? The lower the costs, the less returns will be eroded by fees.
  • What are the plan’s tax benefits to the account owner? While we do not believe investors should automatically choose their own state’s 529 plan without thorough investigation, enjoying both federal and state tax advantages can be an important deciding factor.

Below are three steps you can take to assess the above critical factors as well as other components that contribute to your final decision.

Step 1: State of Residency

First, assess your own state’s plan (if it offers any state tax benefits) using the three factors above. An additional consideration:

  • If you were to move to a different state, is the plan flexible? Some 529 plans dictate that, if one transfers assets out of his or her state of residence plan and into another plan, 529 distributions may be taxed by the state of residence and/or past tax benefits may be subject to recapture. (Heads up on this one Illinois residents!) When tax benefits are recaptured, one pays taxes retroactively on any benefits received in the past.

As an interesting note, there are currently 21 states where residents can choose any 529 plan without considering the impact of a state tax deduction: Alaska, Arizona, California, Delaware, Florida, Hawaii, Kansas, Kentucky, Maine, Massachusetts, Minnesota, Missouri, Nevada, New Hampshire, New Jersey, Pennsylvania, South Dakota, Tennessee, Texas, Washington, and Wyoming.

Illinois residents will definitely want to consider the state tax deduction in the different Illinois plans prior to choosing. To complicate things a little more for those of you on the east side of the river, there are several different Illinois plan options that range from good to awful.

If your state option is not the best choice, it’s time to move to step 2.

Step 2: Consider state plans that offer passively managed and/or low-cost funds, such as Dimensional Fund Advisors (DFA), iShares, TIAA-CREF, or Vanguard

Tennessee, Utah, and West Virginia are states that offer a diverse mix of our preferred asset manager: DFA.  The fees on the Tennessee plan are .35% for all allocations, but they have a more limited selection of DFA funds relative to West Virginia and Utah. The fees on the West Virginia plan range from .67% to .78% per year, while the fees on the Utah plan range from .25%-.53%. For those of you who live in Missouri, we generally recommend the Utah plan due to its lower cost.

Step 3: Check that appropriate asset allocation is available in the plan

In general, 529 plan assets should be invested more aggressively for beneficiaries who are younger and less aggressively for beneficiaries who or older. We typically prefer age-based options when available because they generally become less aggressive on their own as the beneficiary nears college. These options still require monitoring. Should one have the good fortune of accumulating enough to pay for college in a 529, we would recommend shifting to an allocation that is conservative but will still keep up with tuition inflation.

Lastly, and on a different note, for those with children closer to or about to enter college, don’t forget to fill out the FAFSA. Many times, parents assume that they will not qualify and end up surprised at some of the loan options available to them.

If you have any questions about choosing a 529 plan, please contact Claris.

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