Tuesday, May 10, 2016

Which 529 Plan should I choose?

If you have the basics down AND you filled all the prerequisite accounts already then you are ready to proceed.

Here are the top three 529 plans in MY opinion (highly-rated, low-cost and offer a good mix of age-based investment options as well as individual portfolios) when state income tax breaks are NOT taken into consideration:
1. New York's 529 College Saving Plan
2. Nevada (Vanguard) State Plan
3. Utah Educational Savings Plan

If your home state's plan does NOT offer state income tax benefits then the above 3 are probably sufficient for you to contrast and compare and find a PERFECT choice for YOU.

If however, your home state's plan DOES offer state income tax benefits then you should add it to the list of the above 3 and contrast and compare to find the PERFECT choice for YOU taking into account that there are state tax benefits to be had each year you make contributions to your state's plan.

Is a 529 Plan right for me?

Now that we have covered what a 529 Plan is let's address the natural concerns with a 529 looking out ~17 years from today:
1. Undergraduate college is free, my child got a full scholarship or my child has ZERO interest in going to college:
  • I can use the money for myself, my spouse, move it to another child, move it to a family member (very loose rules here...basically I can move it from my child to HIS/HER: sibling, mother, father, aunt, uncle, child or first cousin). I can even do one of those semester-at-sea deals or study-abroad deals for myself and spouse.
  • In the extreme worst case I pay the 10% penalty and pay federal/state taxes on the EARNINGS. And if you did your state's 529 plan and got the state income tax deduction on your contributions going in they may want that deduction back.

2. Now, is a 529 the right choice for ME? In other words, is this the best place to put my money?
  • You know what they say on airlines right? Put the mask over your face before putting it over your child's face.
  • Student loans are CHEAP. Personal loans are expensive. Better your child take out student loans than you eating welfare turkey out the can ~17 years from now.
  • If you are like most folks today who waited to have children then the age 59.5 is much closer than you would want it to be. At that age, access to your 401K, IRA, and Roth IRA comes into play. Sooo, with that said...

3. Accounts to fill BEFORE you do a 529, IN descending ORDER:
  • 401K up to employer match - FREE EFFING MONEY! Always take this first. If your employer matches your contributions up to X always contribute up to X. DUH!!!!! Pre-tax going in, tax-free growth, taxed (without penalty) coming out after you are 59.5 years old.
  • HSA - I personally think this is the best account ever made. Pre-tax (even pre-payroll taxes) going in, tax-free growth while in, tax-free coming out for medical expenses. If you have a child then medical expenses come with the territory.
  • Roth IRA - After-tax money going in, tax-free growth, and tax-free coming out after age 59.5.

What is a 529 Plan?

What is a 529 Plan?
  • A tax-advantaged account where you can put after-tax money into and it grows tax-free. The money can then be withdrawn tax-free for higher education qualified expenses.
  • Higher education is undergrad college and graduate school. It is NOT high school.
  • Examples of higher education qualified expenses are tuition, room and board ON campus, COMPARABLE off-campus housing, REQUIRED books and supplies, computer, and internet access.
  • Examples of *NON* higher education qualified expenses are clubs fees/dues, fraternity/sorority fees/dues, etc.
  • Since the money you put in (your contributions) is AFTER-TAX you can withdraw your contributions (principal) at any time without PENALTY. You will owe taxes on a pro-rata basis however. Additionally, if you took a state tax deduction on your contributions going in then naturally that state may want that deduction back.
  • If you withdraw the money for a NON higher education qualified expense you will pay a 10% penalty PLUS federal/state taxes on EARNINGS (the growth on your contributions).

The Basics of Financial Independence: Time

5. Time
  • Time...it really is that simple. Once you have done 1-4 all you have to do is rebalance to your target allocation as needed. Time is ON YOUR SIDE. Time is YOUR BEST FRIEND. So what are you waiting for? GET STARTED! The sooner you get started the sooner you can sit back and let time be your best friend.

The Basics of Financial Independence: Total portfolio

4. Invest in a low-cost, tax-efficient, diversified, balanced index portfolio.
  • You should view your portfolio in the TOTAL sense and not try to replicate your desired portfolio in each account. That is, you should pool ALL your assets (401K, IRA, Brokerage, etc) and view it as one TOTAL PORTFOLIO. This way you will best optimize for tax-eficiency, low-cost, and diversification. 
  • Start with LOW-COST. Aim for all funds in your portfolio to have an expense ratio of below .20% ($20 for every $10,000 invested per year). As we now know, since it has been beaten into our heads, costs are VERY IMPORTANT and they COMPOUND.
  • Your portfolio should be tax efficient. Ideally, you should have some tax-advantaged accounts such as a 401K (or equivalent such as 403b), a IRA (Traditional or Roth), 529, and/or an HSA. You should also have an account that is not tax-advantaged such as a brokerage account. Assets that are NOT tax-efficient such as bonds, REITs or ones that pay out unqualified dividends should be placed into your tax-advantaged accounts (401K, IRA, etc). Assets that are tax efficient such as the Total US Stock Market (S&P 500) should be held in your brokerage account.
  • Your portfolio should be broadly diversified. That is your total portfolio should contain asset classes that do NOT correlate closely. For most individuals this can be solved by owning some US assets (Total US, S&P 500, etc), some International (Total Int'l, Developed Int'l, etc) and some fixed income (Total Bond, TIPs, etc).
  • Your portfolio should be balanced based on YOUR own risk profile and YOUR own timeline. It should also be rebalanced when any asset class becomes more than 20% outside of its desired allocation. For MY personal portfolio (based on MY own risk profile AND MY own timeline) I am using 25% Total Bond, 25% Total US, 20% Total Int'l, 10% Emerging Markets, 10% Small Cap Blend, and 10% REITs. (And because I am keeping it tax-efficient the bonds and REITs are held in tax-advantaged accounts.) If any of my allocations become 20%+ more/less than its desired allocation I then take action to bring my portfolio back to my desired target allocation.