Weighing the 529 Plan Options: In-State Tax Deductions vs. Lower Fees

When saving for college, it's crucial to consider all options, including in-state and out-of-state 529 plans. While your state's 529 college savings plan might offer a tax break, an out-of-state plan might lure you with lower fees. So, how do you choose?

Scope of Choices Most families can opt for nearly any state's 529 plan. Over 30 states give a tax break on contributions to their 529 plans, emphasizing the need to shop wisely.

The Dilemma: Tax Deduction or Lower Fees? Determining the superior choice between a state's tax deduction and a plan with reduced fees can be tricky. Generally, when your child is younger, lower fees hold more value. But as they inch closer to college, state tax breaks gain prominence, especially during their high school years.

An Easy-to-Use Guideline Here's a handy heuristic to guide your Decision:

• Let T represent the marginal state income tax rate of an in-state plan that offers a deduction.

• Let ∆F be the difference in fees between this in-state plan and an out-of-state option.

• If the product of ∆F and the number of years until college (N) is greater than twice T, the out-of-state option's lower fees lead to a better net return. Otherwise, opt for the in-state plan with its tax benefits.

Practical Application: While young kids benefit more from plans with reduced fees, the scales tip in favor of tax breaks as they approach high school. For instance, if your in-state plan offers tax deductions or credits, it's advantageous to keep investing in it, as the tax relief can effectively discount college expenses. However, specifics like the fee difference, tax rate, and contribution caps can influence this balance. It's also worth noting that the monthly contribution size doesn't alter this general rule, but annual contribution limits might.

Visualizing the Decision Consider this chart plotting years against fee differences, assuming a 6% annual return on investment. The chart will indicate when to pivot to in-state plans based on remaining years and fee differences. For instance, if the fee difference is just 0.10%, the state tax benefit almost always outweighs the lower fees.

In essence, strategize based on your child's age, fee differences, and potential tax breaks to get the most out of your 529 plan investments.

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