Do you have a 529 plan? Do you work with a financial advisor? Do you have a 529 plan that’s managed directly through your financial advisor?
If you answered yes to the first question, then that’s perfectly fine. If you answered yes to the second question, that’s great as well. However, if you answered yes to the third question, well, that’s where I tend to differ from a lot of financial advisors… and yes, that’s coming from a financial advisor.
Why you ask? Great question and certainly the meat and potatoes of this article.
But, let’s begin with the basics – what exactly is a 529 education savings account and why it might make sense for you to fund one for a family member’s college or K-12 educations costs.
According to Savingforcollege.com,
“A 529 plan is a versatile savings account offering federal, and sometimes state, tax benefits, while minimizing the impact on financial aid. These plans are operated by a state or educational institution and are designed to help families set aside funds for future college and K-12 education costs.
“A 529 plan is an investment account that offers tax-free earnings growth and tax-free withdrawals when the funds are used to pay for qualified education expenses. For college, university, and other eligible post-secondary educational institutions, this includes tuition and fees, books and supplies, computers and sometimes room and board. The IRS also allows tax-free withdrawals of up to $10,000 per year, per beneficiary to pay for tuition expenses at private, public, and religious K-12 schools.”
While most people think of 529 plans as a savings account for education, there are actually two types of 529 plans.
The first is the 529 Savings Plan, which is what most people think of when it comes to this type of account. As stated above, it’s basically a savings account with various investment choices that can be used to pay for college and K-12 education costs.
But, there’s also a second type of 529 called a Prepaid 529 Plan. This much lesser known plan allows you to prepay all or part of the costs of an in-state public college education. These are much less popular.
With that said, our focus will be on the 529 Savings Plan.
529 plans are set up by each state and just about all of them offer one. However, you can pay for college in any state, regardless of the state's 529 plan you’re contributing to.
Many states also allow contributions to be state tax deductible. And, some states allow you to still deduct state taxes even if you participate in another state's 529 plan – and, Missouri is one of them. This applies to state taxes only, not federal.
If you want more details including rankings of the best 529 plans, then definitely check out Savingforcollege.com. They will go as deep as you want.
So, now that you know the basics of a 529 plan, let’s go over why you would want to fund one in the first place. I know, I know this is probably obvious to many of you reading this, but be patient with me.
You’d want to contribute to a 529 plan to help a close family member pay for college. Most commonly, it’s for a child or grandchild.
While the money does need to be used for qualifying college and/or K-12 expenses, you can still withdraw the money for any reason, but you will have to pay taxes and a 10% penalty on any of the earnings (your contributions come back tax and penalty free).
However, if you still have money left over in a 529 plan after the beneficiary graduates, you can always change beneficiaries to another child or family member for future use to avoid taxes and penalty.
I typically recommend only funding around 50% of the cost of college with a 529 plan, simply because you don’t want to have your hands completely tied. The remainder can be funded through other savings and/or regular monthly income.
Let’s face it; you’re not going to know that your child isn’t a great fit for college when you first begin funding a 529.
Another common question I get is what if they get a scholarship. Well, the great thing about this is you can withdraw dollar-for-dollar the same amount of the scholarship from the 529 plan penalty-free each year the scholarship is awarded. So, there’s no need to discourage your child from getting a scholarship because you need to use up the money in their 529 plan – that was a joke.
So, I think we know what a 529 plan is and why we’d want to fund one. Let’s now go into why you’d never want to go through a financial advisor to open one.
I’m sure you’re probably thinking it’s strange that a financial advisor is telling you to never go through a financial advisor to open a 529 plan but let me explain why.
It’s expensive, and it’s extremely easy to open one yourself directly through the various states' 529 plan websites – yes, anyone can do it, and picking out the right investments is equally easy. Let’s look at each of these in more detail.
An advisor-managed 529 plan – one that your financial advisor opens for you – can easily cost 2-3 times or more as much as if you did it yourself.
I’ve seen many cases where a client is paying 1.50%+ in expenses, and we were able to lower it to 0.25% by going direct instead of through the advisor. That’s six times more expensive for something that will only take you about 10 minutes to open and transfer over your existing account.
I’m sure you love your financial advisor, but in my opinion, they’re doing you a disservice if they don’t at least give you the option of opening it yourself since you’ll most likely be able to save thousands – if not tens of thousands – of dollars over the years.
Put bluntly, the fees that are charged don’t equate to the convenience of having someone else manage it for you because there’s truly little management the advisor is doing anyway.
States have made opening 529’s an absolute breeze on their websites, and most will take less than 10 minutes to open, choose the right investments, transfer your current 529, and start funding on a monthly basis.
10 minutes of my time to save thousands – or potentially tens of thousands – is a no-brainer to me, and why I always recommend my clients go direct. Plus, I’m more than happy to walk them right through the process.
Now, you might be asking yourself how in the world you’re supposed to choose the right funds. Well, let me tell you, it’s quite easy.
Sure, you can choose from the various funds they offer and create your own portfolio, but there’s a much easier way.
All 529 plans have what are called aged based portfolios. All you have to do is pick the portfolio that corresponds to the current age of your child and, voila, you’re all done.
The portfolio will be 100% managed and will automatically get more conservative the closer your child gets to attending college. You don’t have to do a thing.
The only other option you may have when it comes to picking an aged based portfolio is some states offer aggressive, moderate, or conservative portfolios. I personally prefer my clients go with the aggressive or moderate based options, but it’s completely up to you to go with the one you’re most comfortable with. The point is, you can do it yourself.
If you have an advisor-managed 529 plan, then check out savingforcollege.com to find out exactly what you’re paying in fees and what you could be paying if you switched to the states direct plan.
If you have $25,000 in an account and you’re currently paying 1.50% through an advisor, then you’re paying ~$375 a year. And, as long as you keep putting more money into it and it keeps growing, you’re going to be paying more and more every year.
Now, if you go direct with your state's 529 plan and it drops your expenses to ~0.25% annually, then you would only be paying ~$62.50 annually. That’s a difference of over $300… every single year! And, that’s not even figuring the growth from additional savings and earnings.
If you feel like the value is there, then, by all means, keep paying your financial advisor to manage your 529 plan. But, if you’d like to have a few extra thousand dollars to use for expenses when Timmy goes off to college, consider going directly to your state's plan. As Geico says, “it’s so easy, even a caveman can do it.”
Again, this is coming from a financial advisor who would get paid for managing these types of accounts i.e. I would make money if you opened a 529 through me. However, I just can’t justify someone paying me for such a small amount of work when I can walk them right through the process of doing it themselves…just as I’ve done for you today.
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NextGen Wealth, LLC is a registered Investment Advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities product, service, or investment strategy. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor, tax professional, or attorney before implementing any strategy or recommendation discussed herein.
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