Opening an Educational 529 Plan
529 plans were created in 1996 and are named after section 529 of the Internal Revenue code. They are operated by state or educational institutions and provide tax advantages when the funds are used to pay for college or other post-secondary training. Earnings are not subject to federal or state tax. Up to $14,000 per year can be contributed per 529 plan.
I started researching these 529 plans initially as a means to reduce taxes.
Unfortunately, what I discovered was that a 529 plan was not going to help me for any immediate federal or state tax deductions. From a federal tax standpoint, while contributions to a 529 plan are not deductible, earnings are not subject to federal tax upon withdrawal when used for the qualified education expenses.
There are over 30 states that do allow tax deductions from contributions, but Minnesota is not one of them.
Another thing to remember when opening a 529 plan is that you need to choose a beneficiary. This typically is the name of your child who will use the money to pay for college educational expenses. I don’t have any kids yet so instead opened a 529 plan in my own name. I’ll be able to start contributing to it now and be able to change it to a child a few years down the line.
Despite not being able to get any tax deduction benefit, getting 18+ years of tax free growth will be worth it.
I compared a bunch of plans and ended up going with Nevada’s plan, which is through Vanguard. I went with them because they had one of the least expensive management fees, good selection of mutual funds to invest in, and I’m becoming eligible for my company’s 401k in July and that is through Vanguard as well. Won’t hurt to consolidate things as much as possible.
Vanguard’s 529 plan requires a minimum initial contribution of $3,000. I invested that and have chosen (for now) to contribute an additional $75 per month. I’ll increase this amount in the future.
I picked the Vanguard Aggressive Growth Portfolio with a low 0.17% expense ratio. This fund invests 60% in the Vanguard Institutional Total Stock Market Index Fund and 40% in the Vanguard Total International Stock Index Fund. It’s very easy to switch the fund that the 529 plan is invested in. Nearing when the fund will likely be used, it would make sense to transition to more conservative investments.
$3000 invested now compounding at a conservative 5% interest rate would amount to $8138 in 20 years. With the $75/month contribution, the total amount in 20 years becomes just over $39,000. Not too shabby, but still not nearly enough to pay for college even at today’s prices, let alone after 20 years of inflation! I’ll definitely be increasing the annual contributions in the future. If I were to do 20 years of $14,000 per year, then the investment would rise to nearly $490,000 ($283,000 in contributions and the rest in compounding growth).
Does anyone else contribute into an educational 529 plan? If you have kids and are hoping to help with college expenses, I think it makes a lot of sense. Plus, you may live in one of the lucky states that allows tax deductions!