What should we do with funds that were previously allocated funds for a 529 plan?
We live in New Jersey where there is no tax benefit for using a 529 plan. Is it worth investing the money we would have put towards a 529 plan in other areas, for example mutual funds or ETFs? Should we choose a different state's 529 plan?
You are correct, New Jersey does not give you a deduction against your current year state income taxes for a 529 plan. You don't get that particular tax benefit; however, there is still another tax benefit for investing in a 529 plan that you CAN get.
If you have a very young child and you know you will be paying for higher education years down the line, investing in a 529 plan allows you to put money in and let that money grow inside the plan without paying tax--then, when it's time to pay for college, draw down on the money (including accumulated earnings) for qualified education expenses, also without paying tax. Therefore, the tax benefit you get is that you do not pay taxes on the earnings that accumulate inside the 529 plan as long as you use the funds to pay for qualified education expenses.
Because New Jersey isn't offering a deduction, you might as well shop around and look at other states' plans for the one that gives you the most investment flexibility and the lowest fees. My personal recommendation is to go to Fidelity and check out their UNIQUE 529 plan which is offered through the state of New Hampshire. I like this 529 plan because there are no gimmicky plan administration fees and you can invest in low-fee index funds. The initial investment minimums are pretty low, too.
I don't know what your financial situation is or how old your child is, but for wealthier parents with newborns, I like to point out the following: You and your spouse can jointly contribute a maximum of $140,000 per child to a 529 plan without incurring a gift tax, using the 5-year front-loading method (14k per year maximum, times 5 years, times 2 people is 140k). In 18 years, the cost of college tuition could easily be $100,000 per year or more. Therefore, it's a no-brainer for wealthy parents with very young children to front-load $140,000 into a 529 plan and invest in the ultra-low-cost S&P 500 index fund for 18 years.
If your child is a teenager and just a few years away from college, and you are considering investing a small amount relative to the overall cost of college, it may not be worth the hassle to set up the plan. Also, if college is just a few years away, your investment time horizon inside the 529 plan is shorter; if we hit a bear market in the next few years, the plan assets could actually be less than what you put in by the time you need them for college expenses--and that won't do you any good. So, really, the people who benefit most from a 529 plan are parents with young children, when they have a long time horizon to let the assets grow--especially if they can front-load the plan, i.e. put a lot in to start.
Hope this helps.
529 plans offer generous income tax breaks. Although your contributions are not deductible all growth and earnings in the account grow tax-free and will not be taxed when the money is taken out to pay for college.
If you are you fairly certain your child/ren will be attending college, then I would wholeheartedly recommend choosing a different state’s plan and investing the funds in it.
Now, let’s talk about moving out of New Jersey….
I am not a big fan of 520 Plans at all (unless simply for estate planning for high net worth individuals) because you are very limited in investment choices and can only make one or two changes per year. Also most are based upon the child's age rather than the markets themselves (risk). I would rather keep my assets for my kids college in a taxable account in an account I can control. But I think you have already figured that out, especially if no tax benefit. I would not make new contributions to the plan and would invest differently. Whether ETFs, mutual funds, indvidual stocks, etc... are right for you, I have no idea without knowing more about your background, amounts to be invested, when the money is needed, etc... so am flying blind.
Regarding the assets already in the 529 Plan, you need to spend them on "approved" expenses. I would spend those first and foremost and invest monies outside the plan with more flexibility. And you can look at the diffferent 529 Plans for your particular state and I hope you find one that suits you. You must ask about the investment vehicles themselves, and all fees & costs. I would also ask how defensive the funds can be if the market looks to be headed for trouble. Can you move to some shorter term safe haven if you like? If so, how often? Then you will find what I am talking about.
I wish you the best of luck, Dan Stewart CFA®
Hi, although your contributions are not deductible at the federal and state level if you live in NJ, the earnings are tax free if you use funds towards qualified education purposes. There is also no tax consequence of changing the beneficiary to another family member. So, a 529 plan can be a powerful pay to save for education.
Funds from the 529 plans can be used for qualified expenses for college and post-secondary training at an eligible institution for designated beneficiary. Qualified expenses include: tuition, fees, books, computer, internet access as well as room and board net of any cost covered by tax free educational assistance. Further the IRS states: "An eligible educational institution is generally any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education."
Based on your question, it seems you are differentiating between a 529 plan and mutual funds/ETFs- just to clarify a 529 is a tax advantaged plan that allows you to invest in investment products such as mutual funds and ETFs depending on what is offered by the state that runs the plan
Since you do not have a state tax benefit, you can choose any state's 529 plan without any disadvantage. Choose a state's plan as you would choose any investment based on: investment choices, fees, asset allocation options, flexibility, performance etc.
Not all states offer tax benefits through a state-sponsored 529 plan. However, it doesn’t mean your state offer is a bad one. I live and practice in TN. Since we don’t have the state income tax, there’s no tax incentives either to open a 529 plan in TN, except a $50 credit when you first sign up. However, when I look at our state 529 investment menu, it was an awesome line-up. It consists of low-cost broad index funds from Vanguard and other fund families. So, unless there’s an overwhelming advantage from other states’ plans, it’s easy to select our own home state plan.
Also, you need to decide the investment strategy: an actively managed fund or passively managed fund for your 529 plan. The difference is the cost, and usually the active ones cost more than the passive index funds.
Lastly, you always have the choice to sign up directly at a fund family by using the dollar-cost averaging method. In doing so, the fund family may waive the ticket charge when you purchase each time with the new money.
It’s not a bad idea to consult with your financial advisor to review all of your options. Best!