The 529 College Savings Plan has been revamped and the new changes are very good and very exciting. All of the sudden, there might be many people who will start to look at these accounts not just for college, but for retirement! As usual, the devil is in the details so let's take a good hard look at how these accounts work and how you can use them to create a better future for you or someone you love.
First, the basics. The 529 plan was created in 1996 to help families save money for their children as they prepared for college. In no time at all, state after state adopted their own unique plans, filled them up with low fee and not so low fee investments, added their own set of rules to include tax deductions, and then boom, they offered them to the public (not just their state residents). That was the start.
Here are more basics. Some states provide a tax benefit and some do not. Some have low fees to the investments and some do not. Learn more about your state 529 Plan here. Learn more about the Iowa 529 Plan here. These plans could apply to a lot of people all over the country based on all kinds of variables. It could apply to a parent, a grandparent, a child, a friend, it could apply to YOU!
You could open up a 529 plan for just about anyone if you wanted to do that. For many, a state tax deduction applies. If you don't have a state tax deduction in your state, then consider looking elsewhere. Why would you look elsewhere? Your state's 529 Plan has high fees. What is high? Anything over .2% of your money on a yearly basis paid out to the financial industry is high. If it is over that amount, look elsewhere.
One of the best 529 Plans in America is the Vanguard 529 Plan. There is no tax deduction, but the fees go as low as .12% for the Total Stock Market Index Fund. Many states charge 3 or 4 times that amount. Fees matter! You will need $3,000 to open the account so that could be a stumbling block for some. The New York 529 Plan is almost as good and there is no minimum to get started.
What do you invest in? You could select an aged-based-track that gradually reduces volatility as the account becomes more bond heavy nearing the college years. See an example of these types of investments here. The aggressive growth track would be a fine choice. You could also just select one broad based stock index fund and be done with it. See an example here. The choice is yours.
Here is where it gets so much better. New legislation states you can move up to $35,000 of 529 money into a Roth IRA in the beneficiaries name once the account has been open for 15 years. It will have to be transferred out over time based on that year's max contribution rate for Roth IRAs. That is one sweet deal! It could be a college account and/or a retirement account. Learn more here.
When should a person open up a 529? As soon as a child has a social security number is one answer. Starting young and feeding that account over time can make a HUGE difference in the size of the account over time as that small child becomes a young adult and heads out into the world. The key is to get started and keep feeding the account with any extra money month after month over time.
What should a young person do with their income earned as a teenager? A custodial Roth IRA trumps the 529 Plan in my estimation. With earned income this account can grow tax free over time and then be converted into their name when they hit adulthood, which is 18 or 21 based on the state. Vanguard would be a good option and VTSAX or VSIAX would be very good funds to consider. Learn more here.
Let's wrap this up. The new rules make the 529 Plan a great option for college and/or building up money to be transferred into a Roth IRA later in life. Focus on getting started young. Keep the fees very low. Go heavy on stocks for most of the period. Keep funding it with extra dollars. Get your child involved as they age with investing in themselves with that custodial Roth IRA. Financial freedom awaits!
Stuff the lawyer wants me to say: Investing outside a bank or a credit union is not FDIC insured. You may lose the value in the investments you select. All information provided here is for informational purposes only. It is not an offer to buy or sell any of the securities, insurance products, or other products named. Translated: I am not selling anything! Educate yourself, research the information that you learned and finally make the right decisions that will benefit you and your family going forward.