Make Your Own Best 529 Plan Using Partial Rollovers

529 plans have become a very popular tool for saving for college for those that choose to help out their kids (or simply funding some continuing education for yourself). Most states have their own 529 plans, sometimes even multiple choices within those plans. They are very flexible – anybody can invest in any state’s 529 plan, and that money can pay for college expenses in any other state. Beneficiaries are also easily changed between relatives.

Conventional Advice
The standard advice for picking a plan is to first check if your state has a good tax deduction for using your state’s plan. Something like 32 states offer some sort of benefit. If so, then consider going with that plan. If not, then go with the “best” out of state plan since many state plans have poor investment choices and higher fees. If somehow you have a really horrendous state plan with high fees, then you might even forgo the tax deduction and go with an out-of-state plan.

But… Why not do both?
Most 529 plans allow both partial and complete rollovers into another state’s 529 plan. So, why not first take any tax breaks available to you by contributing to the in-state 529, and then see if you are able to quickly roll over those funds into a better out-of-state plan. Keep the in-state plan open if you intend to make future contributions. I checked out a sampling of various state plans and they all offered partial rollovers.

This way, you get both the upfront tax benefit, and the long-term low-fee benefit. Seems plausible, no?

Some states might have a tax-deduction recapture rule. In that case, I might consider contributing only up to the tax deduction and then opening up another better 529 for additional contributions. You can have multiple 529s.

My Experience – Oregon, New Hampshire, and California 529s
You may be wondering why I have a 529 plan listed in my net worth, even though I don’t even have any kids. In fact, I have opened 529 plans from three different states! About five years ago, the California 529 was giving away $50-$100 gift cards for opening a plan and depositing $100. I figured, why not, that’s a pretty nice return on investment. We might use it, and if not you can always withdraw principal without penalty. So I opened up an account for me and one for my wife, with us as the beneficiaries.

Then, while in Oregon, they offered a state tax deduction on $2,000 of contributions each year (now $4,000 for a married couple). So I contributed to that. Finally, there was a Fidelity College Rewards 529 credit card that paid 2% back into a Fidelity 529 plan (it now only pays 1.5% back to new applicants). 2% back on everything was great, so I opened up a 529 from New Hampshire that Fidelity ran.

Long story short, I have since rolled everything into the New Hampshire 529 plan with no fees from anyone. The paperwork was easy, although you do want to track your contributions in case you make a non-qualified withdrawal. The New Hampshire plan is not bad, with a 0.50% expense ratio for their index fund portfolios including all management fees, and no maintenance fee, and only a $50 minimum to start.

Best Out-of-State Plans To Consider
I haven’t done exhaustive research on this topic, but if you believe in low-cost index funds then one of the best plans is definitely the Ohio CollegeAdvantage 529 plan. The have Vanguard mutual funds with a 0.18-0.23% management fee on top of fund expenses. The total annual asset-based fees can be as low as 0.21%, but the age-based portfolios are about 0.30%-0.35%. No maintenance fees.

If you believe there is a performance benefit to investing in several asset classes, there is also the more-expensive West Virginia SMART529 Select plan which offers mutual funds from Dimensional Fund Advisors (DFA). Total asset-based fees are 0.65% – 0.88%, plus a possible $25 maintenance fee for non-WV residents.

Since I still have my credit card relationship and my balances are low, I don’t bother moving away myself. I don’t actively contribute anything except my credit card rebates, so saving 0.15% in fees on my $3,000 would be less than $5 a year. But for folks with larger balances and held over longer periods of time, the performance advantage of lower fees can definitely be significant.

Comments

  1. Jonathan S says:

    I was going to contribute to my NY state 529 to get a state tax break but I decided not to when I read about their rollover penalty:

    “Rollover penalty. A rollover of assets from your account in the Program to a qualified education savings program in another state is subject to New York State income tax on earnings, as well as the recapture of all previous New York State tax deductions made during the life of the account.”
    http://nysaves.uii.upromise.com/content/programInfo/taxBenefit.html

  2. Raymond says:

    The contribution portion of a distribution does not have to be included in income

    BUT!

    distributions do not have the specific ordering rules of the Roth IRA. Your distribution is proportionally allocated between earnings and contributions. I’m not clear how the earnings ratio is currently calculated. Form 1099-Q refers to notice 2001-81, which was not (at the time) final regulation. The proposed regulation was to determine the ratio from close of year, but the notice expects it to be based on date of distribution, which would seem more accurate.

    The same is true of the Roth 401(k). These don’t work as tax-penalty-free emergency-funds-of-last-resort like the Roth IRA. I suppose you are safe from a penalty if you have a net loss, but that’s not something you normally wish for.

  3. Jonathan S – Good catch on the rollover penalty. You have to even pay state tax on earnings? I guess that money has to stay in there forever. Their current Upromise plan uses Vanguard investments and is relatively cheap, let’s just hope it stays that way.

  4. The Utah plan is always rated highly in Kiplinger’s and they also have Vanguard funds.
    “Rock-bottom fees. If low investment costs are your primary concern, take a look at the Utah Educational Savings Plan Trust.”
    Kiplinger’s Personal Finance
    September 2007

  5. Utah is good and cheap with Vanguard funds too, but if you have smaller balances and are not a Utah resident there is an additional annual maintenance fee that can make it cost more than Ohio. All in all, still one of the top plans as well.

  6. A site that compares 529 plans is http://www.savingforcollege.com/

    A blurb from another site:
    1. The best direct sold 529 plans for out of state are Alaska’s T. Rowe Price College Plan, Michigan’s Education Plan and Utah’s Educational Plan. These plans have low asset based costs and have a fair to good range of investment options. The quality core of investment options in these three plans have been rated good to excellent. These three plans are managed by the T. Rowe Price College, TIAA-CREF and Vanguard respectively.

  7. Michelle says:

    I live in New Hampshire and am opening a 529 for my friend’s baby (due in 3 weeks!) . Actually, so that she can be the administrator, I am just giving her a check. Fidelity manages the funds. More information here: http://personal.fidelity.com/planning/college/content/landing_nh.shtml.cvsr

  8. wow, i was just wondering why you had a 529 in your NW! with a kid on the way, i’m gonna have to look for juicy offers, and i havent heard anything, +/-, about my state VA
    but my wife and i agree that retirement money is priority #1, kids can get student loans after all.
    when did parents paying for college become so commonplace???
    our view might (probably) change after having a kid though

  9. Thank you for someone validating my choice of three years ago! I researched exhaustively and ready all of the above mentioned articles. While Utah is highly rated, look at the investment options. You get no choice but age-based funds with no control in options. Ohio’s College Advantage offers over 10 different Vanguard funds including international, total market, aggressive growth, the vaunted Vanguard 500, and even inflation-protected bonds! The Putnam options aren’t good but you don’t have to invest in them.

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