State-sponsored 529 savings plans are tax-advantaged estate planning tools that can also be used to save for “higher education” expenses, a category which was recently expanded to include private and religious K-12 tuition.
I’ve had an account with the Utah Educational Savings Plan, which was recently rebranded as My529, for years and have been very satisfied with their selection of very low-cost Vanguard investment funds and low account maintenance fee of 0.2%.
My brother recently asked me about the Vanguard 529 Plan, and after doing a little bit of research, I thought I’d share what I found.
How to select a 529 plan
There are three factors that should go into your decision of which 529 plan or plans to choose:
- Tax benefits. Check every state where you earn taxable income and find out whether there are deductions or credits available for contributions to 529 plans. Some states, like Pennsylvania, allow residents to take the deduction for contributions to any state’s 529 plan, while others, like Arkansas, only allow deductions for contributions made to in-state plans. Credits and deductions may only be available to residents; check with your tax professional.
- Investment options. While I would look for low-cost Vanguard index funds, it’s not the end of the world if you have to choose low-cost index funds from another provider, but stay away from plans that only offer high-cost, actively-managed, or more complex investment vehicles. Washington State, for example, has a prepaid tuition savings plan that, as far as I can tell, is a way to make a tax-advantaged bet on public higher education tuition outpacing the stock market (and Washington State not going bankrupt).
- Fees. In addition to the underlying expense ratio of the mutual funds you invest in, 529 plans also charge account maintenance fees, which you should also attempt to minimize.
The key thing to realize is that since you can open multiple 529 plans, you can optimize these factors in multiple ways. For example, an Arkansan can contribute $5,000 per year ($10,000 for married couples) to Arkansas’s relatively expensive 529 plan in order to secure the maximum state income tax deduction, then direct additional contributions to lower-cost, out-of-state plans.
How does Vanguard compare to My529?
When it comes to state tax benefits, the plans are identical except for residents of Utah, who can claim an annual 5% state income tax credit on up to $1,920 ($3,840 for married couples) in contributions per beneficiary to My529 plans. That $192 per year, per beneficiary, may not seem like much, but it swamps the differences in fees between the two plans.
What are those differences? Unlike My529, Vanguard somewhat annoyingly rolls the asset-based account maintenance fee into the expense ratio for each investment option. So while My529 offers the “Vanguard Total Stock Market Index” with a 0.02% expense ratio and 0.2% “Administrative Asset Fee” for a total of 0.22%, Vanguard offers the “Total Stock Market Portfolio” which charges 0.18%, including both the underlying expense ratio and the account maintenance fee.
The spread isn’t a constant 0.04%, unfortunately, so the actual difference in fees will depend on your weighted asset allocation. For international stocks, My529 charges a total (including Administrative Asset Fee) of 0.27% while Vanguard charges 0.25%.
So basically, for non-Utah residents, Vanguard is the clear, if slight, favorite. For Utahns, the question is how much hassle you’re willing to go through managing two 529 accounts. If that exceeds your hassle threshold, then using My529 exclusively is a perfectly reasonable, low-cost choice. If your hassle threshold is higher, stick $1,920 per beneficiary, per year, into My529 and use Vanguard for the remainder of your contributions.
Vanguard 529 balances count towards Voyager status
Unrelated to the tax and cost advantages of 529 savings plans, Vanguard has one additional slight advantage: your 529 balances count towards your qualification for Voyager, Voyager Select, and Flagship services. Vanguard “elite status” doesn’t have very many advantages, but if you have any account types, like a solo 401(k), that charge annual account maintenance fees, those fees are waived once your total Vanguard balance across all account types reaches $50,000. That can take a long time if you’re just saving $5,500 per year in an IRA, so the ability to goose your overall Vanguard balance with 529 contributions may help you save money on fees in addition to the lower cost of the investments themselves.
You have not discussed the negative side of 529s. I don’t have them, but know there are some related to future financial aid. I would think a person with one should look seriously at use for K-12 if going private route?
From what I have read on the topic:
1) A lot of colleges are only need-blind in their first round of admissions – so if you don’t have the academics but the money a 529 might help you to get into that prestigious college. I sincerely hope this practice gets abolished…
2) Colleges tend to offer the most aid in the first few years to get you hooked.
3) You can play games with beneficiaries, e.g. switch the kid in college to become a beneficiary in a later year or take it away if that helps.
In any case there is also a very select and short list of schools abroad which can be paid with a 529. So that might be an additional consideration (it has been for me).
One big thing to add is that Vanguard 529 has a minimum investment of $3000 for non-Nevada-residents. There is no minimum on the Utah plan.
Fidelity’s 529 is cheaper and they have helpfully provided a side by side comparison with your state’s plan and any other plan you wish- http://www.archimedes.com/fmr/comp529.phtml?res_state=&planid2=NH2&nonfid_state=1
I am tempted to invest in a plan despite like the author, not having any children. The proration when you take the money out between contributions and earnings is a concern, but if I put it in fixed income funds which are not eligible for preferential treatment on capital gains and dividends, then in 20 years when I take it out either I’ll have a child to apply the 529 gains to, or I’ll happily pay the 10% penalty tax since I had not paid taxes on the 20 years of compounded interest.