Weighing the 529 Plan Options: In-State Tax Deductions vs. Lower Fees
- Erik James Roberts, Founder & Chief Investment Officer | Infinitus Wealth Management
- Sep 9, 2023
- 3 min read
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.
At Infinitus Wealth Management, we offer a complimentary, no-obligation portfolio review for investors who want an independent fiduciary second opinion on how their capital is actually being managed.This is a conversation, not a sales process. If your portfolio is already well constructed, we will say so directly. If we identify avoidable costs, unnecessary concentration, tax inefficiencies, or portfolio structure that may be working against you, we will show you specifically where those issues exist. From there, you decide what to do with the information.
Important Disclosures
Infinitus Wealth Management is a registered investment advisory firm. This article is provided for educational and informational purposes only and does not constitute investment, tax, legal, or accounting advice. It is not an offer or solicitation to buy or sell any security or to enter into any advisory relationship. Any references to specific strategies, withdrawal rates, tax provisions, or historical figures are general in nature and may not be appropriate for any individual investor.
Past performance is not indicative of future results. All investing involves risk, including the possible loss of principal. Tax laws are complex, change frequently, and have unique application to individual circumstances; please consult a qualified tax professional regarding your specific situation. Social Security rules, Medicare rules, and retirement account regulations are subject to legislative and regulatory change.
The information in this article was believed to be accurate at the time of writing but is not guaranteed. Readers should consult with their own qualified advisors before making any financial decisions specific to their situation.
