Should I invest in a mutual fund or a 529 plan for my child?
July 31st, 2010
The 529 plans that I have found in NY have an average of 3-5% return since inception (2003). I feel that if I invest in a traditional mutual fund, I can get a better rate of return over the next 18 years and this will out weigh the tax advantages of the 529 plan. Is my rational correct?
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Tags: 18 years, 529 plans, inception, mutual fund, rate of return, tax advantages
Yes – if you can do better (and you should be able to do better) than 3-5% then a traditional mutual fund will be better in the long run, so long as the extra interest outweighs the tax you’ll pay on the capitol gains you earn. 529 plans also typically have higher management fees. The one advantage the 529 plan does offer though is that you can deduct your contributions from your state taxes. (Not sure about New York, but a Connecticut’s contribution to the Connecticut 529 plan reduces state tax by 5% of the total contributions).
You may want to consider opening a ROTH IRA in your name but for the specific purpose of investing for your kid’s college. The interest will grow tax free and you CAN use your contributions and interest without penalty or additional tax for higher learning expenses. If your kid doesn’t go to college you can simply use the money in the ROTH for your own retirement, which you wouldn’t be able to do with a 529 account. The money in the ROTH IRA will also not be included if you apply for FAFSA loans or other government aid. The only downside to this method of college saving is that you are limited to contributing $5000 per year. (Or $10,000 per year if you open two ROTHS – one in each parent’s name).
529 plans are essentially mutual funds that gradually get more conservative as the minor approaches college age. Look at the stock allocation for any plan you are interested in to make sure it is not too aggressive.
Investigate the 529 plan for your state. Some states offer an additional tax advantage to residents that invest in their state’s plan. If not, remember you can invest in any State’s plan. Look for states that offer Vanguard investments.
One concern about 529 plans is that the assets are in your child’s name and that may have affect eligibility for college scholarships.
You may be correct, depending on the choices you consider. I’d guess you’re a NY resident, since you’ve looked at the NY 529 plans. You can also set up a 529 account in some other states, even though you don’t live there. Many states allow nonresidents to open accounts in their 529 plans, although out-of-staters often have to pay slightly higher fees. Even with those higher fees, states like Utah and Virginia are very inexpensive even for out of state account holders. Fees are a crucial factor in rates of return–an inexpensive 529 plan may be a better bet than a taxable mutual fund account, but not necessarily. You’re thinking along the right lines. I’d suggest doing a bit more research, comparing cheap plans in Utah and Virginia against an inexpensive mutual fund, like those offered by Vanguard.
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