529 College Savings Plans: Fact vs. Fiction and How to Better Manage Them
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|First, the Critical Bottom Lines of 529 College Plans:
• The one big advantage of 529 plans is the "awesome tax deferral," which basically operates similarly to a Roth IRA (but you may also get a state tax deduction if you play the game right).
• We're not picking on the pre-paid tuition plans, because that would require a detailed analysis of each colleges' deal. So this page is not about those. You'll need to do your own homework there to see if it's really worth it or not.
Next, Why 529 Plans are Not as Cool as Advertised
• Performance: Take a dozen random Vanguard Index Funds. Then add cash to make 13 asset classes. Then equally weight them all (~7.5% each) and put one name each on a piece of paper. Tape all 13 onto a dartboard that spins. Spin the dartboard, and then have a monkey throw darts at it until all 13 darts are on the papers.
Then just allocate a non-529 do-it-yourself discount brokerage account that way, by putting that much money into each index fund.
Chances are better than 50 / 50 that you'll get 1% to 2% better investment return than by using any state's 529 plan.
That's how pathetic the vast majority of their investment options are. And this is not even accounting for their fees, charges, and expenses.
• As you can read below, the investment options, if any, are usually even more terrible with 529 plans than with most 401k plans. Add to that, you'll have much less control than with even the worst 401(k) plan with most 529 plans.
• Next, you can only spend 529 money on "qualified expenses," like tuition, to get these wonderful tax breaks. Rent, food, travel, beer, and most all living expenses of an actual student are just "not 529 qualified."
As you know, these are usually much more than qualified expenses. You can't even buy the computer needed to do homework as a qualified expense anymore. Most things in this regard are only getting worse, not better.
• As far as the "Age-Based Plans" (AKA ABIO or Years to Enrollment Plans) that automatically allocate more into bonds and less into stocks when college nears, you'll probably do much better than any of those by using our Conservative High-Income Model (CHIM).
Just move into that six months before the student goes to college, and you'll have done something much more intelligent than most any Age-Based Plan would have done on their lame autopilot. Just do your homework on yields alone and you'll see (call and ask what their current yields are for students currently in college, and then compare to the current CHIM yields).
• Last, but never least, 529 college plans are not at all free! They charge you stiff fees to invest in them.
• Then there's the usual parade of front-end loads, commissions, usury 12b-1 fees on B- and C-shares, this that and the other.
As you can read below, 529 Plans are a creature of "Wall Street innovation," so you will not get away unfleeced with any of them, period.
The only way to not waste 0.5% to 2.5%+ annually on all of their usual shenanigans is to invest DIY using something like our no-load mutual fund models, our index fund models, or something similar, and then keep trading to a minimum.
As you can see on this free college planner demo's Input sheet (cell A44), the DIY plan used the same 3% initial mutual fund front-end load / commission as the 529 plan.
If you invested in no-load mutual funds, then you would not pay this, and this reduces the amount of average annual return needed to be at par with the 529 by 0.5%.
So when you add this all up, there is usually no real benefit in using 529 savings plans, compared to the lower fees, total control, total liquidity, no restrictions, unlimited investment options, and "it doesn't matter from a tax-standpoint what the student spends the money on - tuition or beer," because it's all taxed the same.
Every 529 plan costs money to use, so you'll know what the bottom line really is accounting for all "hidden fees and expenses" - like usury 12b-1 fees on mutual fund B- and C-shares, and the poorly performing investment options.
The bottom line is most of the time, when you add the Offset Factor to the Expenses Factor, it's a no-brainer that you will probably be much better off "doing-it-yourself" in a non-529 discount brokerage account - and yes this is even after all of the "awesome tax breaks" of 529 savings plans.
This Finra link calculates 529 fees and expenses for free, but you'll have to know them in advance of using it, which is the problem.
Another Wall Street innovation is keeping ALL of this information as hidden as possible to make it as easy as possible for them to keep the fleecing of the sheeple going.
Just the fact that all of this About fees, expenses, funding options (the actual mutual funds you can buy), and investment performance is being kept well locked up and hidden until after you pay, should be enough to make your robot wave his arms and go, "Warning! Extreme Danger Will Robinson!!!"
Things are bad when Waddell & Reed even has a pre-packaged 529 plan.
The Critical Bottom Lines on 529 College Plans:
The math bottom line is all you have to do is get between 1% and 2% more average annual investment return in a non-529 do-it-yourself discount brokerage account, and you'll probably end up having more spendable money (which is the point of all of this), even after these awesome tax breaks. Download the demo (showing poor market returns) and see for yourself.
The lower market returns are in general, the lower this difference is. If the stock markets only average under 5% annually, then this difference (between 529 & DIY) is less than 1%.
As you can see on this demo download, our $20k minimum no-load mutual fund models consistently perform better than this 1% to 2% difference over the average 529 plan.
Our college saving calculator is a unique money tool that calculates this difficult math.
• The college calculators' account for all three factors needed to evaluate the difference between not using a 529 plan, and using one. They have all of the usual manual override functions needed to allow you to model and account for any and all Real World situations. These three factors are:
1) The difference in investment growth rates you'll probably get between DIY and 529. Just input the difference in forecasted returns from the Offset Factor, and everything is automatically calculated.
2) The true benefits of the 529 tax shelter in great detail, so you can see they may not be significant enough to warrant their expenses, paperwork, tax / legal annoyances, lack of liquidity, and lack of control limitations (e.g., extreme lack of decent investment choices).
3) All 529 plan fees (which reduce your investment growth rates).
More on what the Deal is with 529 College Savings Plans
With 529 plans, you are called the "account holder" and the student is called the "beneficiary."
Savings are called "contributions," which is the same as in 401(k) plans.
Yes, you can fire your old 529 Plan and buy into a new one.
Some plans have fees for this (and for just canceling their whole deal, big surprise), but some of the better ones don't.
So if you already have a 529 college savings plan, and want to use a different plan, then it's just some paperwork and maybe a few bucks to roll it over (just like an IRA rollover).
Age-based automatic investment plans are where someone else is making the investment and asset allocation decisions for you.
So you're basically trusting them to become more conservative with the money as college approaches.
You basically don't care about getting the highest rate of return when the money is needed to pay bills. What you care about is getting the highest yield so you can minimize the selling of shares as much as possible, while repositioning investments to be much safer than in the accumulation phase.
This is similar to what investors do when they retire. There's more explanation of how this works on the Conservative High Income Model (CHIM) text here) text here) text here.
The actual 529 plan doesn't do much to make the money needed in the future to send someone to college. The plan is just a tax-shelter wrapper that costs you money to use.
The IRS set up Section 529 guidelines and then most all of the usual financial services corporations are then used to set them up and administer everything. So in order to get a plan, you first have to choose one that works in your state, and then you're just stuck with however they're managing it going forward.
We were going to make a fuss about making optimized investing models for all 529 plans in all 50 states. But then the big roadblock immediately appeared: One can only self-allocate in a few of the states' plans. With all of the rest of the plans, you're stuck eating only with what they feed you (and they're not good).
This is an example of, "Fool me once shame on you, fool me twice, shame on me." But this time, it's not investors that were fooled and had to learn lessons from the school of hard knocks. It was the financial services industry this time.
Late in the 20th century (~'97) when these 529 tax-qualified plan laws were being created and passed, the usual financial marketers saw an opportunity to fix the huge mistakes they made back when similar laws were being made regarding 401)k)s / 403(b)s / 457s and similar tax-qualified retirement plans in the late 70's.
With 401(k)s, there are usually always ways to DIY (do it yourself) when it comes to picking the investments you want, and then divvying the money up between them (AKA using asset allocation).
Giving investors this kind of control means there's less for Wall Street to feed off of, so that just couldn't happen again this time when passing 529 plan laws.
When investors are allowed to think for themselves, this "cuts out the middleman." While this is great for the investor, not so much for the middle men (Wall Street). So they lost out big time in these retirement plan markets.
But when the new 529 plan market opened up, they all were not about to be fooled again. So they put an almost total lock-out on all of this DIY investing stuff.
What they did is make things so most all 529 plans have to be invested in a pre-made investment portfolio - created, implemented, and maintained by the same marketing groups that do just about everything else in the industry.
This way, they can make much more money, while ensuring investors only get the same risky volatile unbalanced low-yield mediocre returns. In other words, you can rarely control or self-direct the investments inside most 529 savings plans.
What you're stuck with in 529 college savings plans are pre-packaged deals where the only winners are Wall Street.
The enticing names of most of these deals are: Age-based portfolios, age-based strategy, years to enrollment options, multi-fund portfolios, enrollment-based portfolios, lifestyle portfolios, year-of-enrollment portfolios, individual-fund portfolios, managed allocation option, static portfolios, active portfolios, equity option, balanced option, asset-allocation options, fund-of-funds asset allocation option, years-to-college option, automatic allocation choice, etc.
All of these names mean the same thing - they're just the same mediocre mutual funds packaged up in a tax wrapper, and then given an impressive-sounding name to further entice you into signing up today.
What 529 savings plans really are, is just a better way for Wall Street to maximize profits in this market, while giving investors no control over anything.
So you're losing on all fronts with these deals:
• You gave up investment control to the marketers,
• You're stuck paying them stiff fees for the privilege of doing this mediocre work for you, and,
• As these college calculators show - when properly analyzed, the tax advantages of 529 plans in general are not worth doing any of this type of 529 investing in the first place.
• Then the tax breaks you get are not free, a huge cost is that you're stuck like a sheeple in the jaws of the wolves. You're stuck because of the tax wrapper - you can't just close your account and take your business elsewhere by filling out a few forms. There's costs in time, work, annoyance, money, state rules to follow, taxes to pay, etc.
These marketers wish they had the same lock on 401(k) plans, but they were not invited to that sausage-making party. They learned those lessons well, and didn't repeat the same mistakes with 529 college saving plans.
We looked for lists of investment options online, and they'll all hidden. This is because they don't want people like us doing any real intelligent work comparing and optimizing plan performance. All you have to do is hide the data and facts, and then the analysis can't be done and the conclusions can't be published.
The biggest fallacy is thinking that if you're in a 35% tax bracket, all taxable events will be taxed at 35%. This is incorrect. The percentage of money being taxed is usually less than half of this rate.
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