State or Vanguard 529??

[MizB]

Hello all! We are expecting our first child in January 2021 and I'd like to set up a 529 now. It looks like a Maryland 529 plan has a state tax benefit of $5000 year and, obviously, Vanguard does not have a similar benefit. However, in looking at the Maryland 529 fees it looks like their total annual asset fees are as follows:

Portfolio 2039: .58%
Equity Index 500 Portfolio: .16% (looks like this was .26% in 2019)
Vanguard: .14%

*There are several other MD 529 investment options with fees ranging from .22% to .65% (https://maryland529.com/Portals/0/Files/cip_disclosure.pdf)

Should I invest in Vanguard given the lower fees or Maryland given the additional tax benefit? Will the fees for the MD 529 change each year or is it based on the year I invest money? Would it be best to invest in the Maryland 529 and then transfer it over to a Vanguard 529? Are there any penalties for doing so?

I am really new to all of this and would greatly appreciate any advice you all have.

[maizefolk]

Fees in 529 plans change each year, you aren't able to lock them in based on which year you open the account or invest the money. Which option comes out ahead depends a bit on the assumptions you make, but it may be that in this case

It's important to separate out different types of tax benefits (for example credits vs deductions). Could you provide a bit more background in the $5,000 tax benefit? I tried to read about Maryland plans but all I could find was that you're able to take a $2,500 tax deduction against your state taxes if you are a resident of Maryland and contribute to their state run plan.

Assuming you make enough money to pay the maximum marginal income tax rate in Maryland (5.25%), and contribute $2,500/year to your child's 529 plan, the $2,500 deduction has an actual benefit to you of $131/year in taxes. If you contribute $2,500/year for 18 years, paying an expense ratio of .58% and your underlying investments grow at 9.1%* you'll pay a bit more than $4,200 in expense ratio fees (an average of $234/year) and another $850 in expense ratio fees over the next four assuming you spend down the 529 linearly over four years to pay for your child's college.

Comparing to the Vanguard plan with a 0.14% expense ratio and, factoring in the lost compounding of money that is instead paid as expense ratios, you'd be able to pay about $5,400 more for college out of your 529 plan if you go with Vanguard vs the Maryland Portfolio 2039, while having saved $2,358 in taxes.

All the factors that could shift the answer

1) If you actually get a $5,000/year deduction per child instead of $2,500. (Better for Maryland plan.)
2) If you are in a lower marginal income tax bracket in Maryland than I assumed (Better for Vanguard).
3) If you plan to put more than $2,500/year into the plan (Better for Vanguard*)
4) You plan to put to use some of the money in the plan to pay for your child's grad school or anticipate they may wait a few years before going to college (Better for Vanguard)
5) If the $5,000/year tax benefit is actually a tax credit (much MUCH better for Maryland).

*This one is a little counterintuitive. But remember that if you invest more than you can deduct you get no more tax benefit but still have to may more money towards expense ratios.

*Long term CAGR of the stock market before inflation and with dividends reinvested.
If you are confident that the "Equity Index" Portfolio is going to stay at

[MizB]

@maizefolk Thank you SO much for taking the time to reply! As I mentioned I am new to this so your feedback is incredibly helpful. To answer your questions:

1. You are correct; the tax benefit is a deduction, not a credit. Also, my husband and I would each contribute 2,500/year totaling $5,000 so I believe we would each get the benefit. I found more helpful info on the tax benefits here: https://maryland529.com/basics-of-529-college-savings-plans/tax-advantages-of-529-plans

2. We are in a higher tax bracket (I make 170K and my husband makes 86K/we file jointly)

3. Not sure if this matters but we plan to do at least $5,000 for the next several years to be able to take advantage of compound interest and time. We may not always contribute that amount in the future. Would depend on a number of factors including if I FIRE, if my husband's income goes up, if we have another child, etc.

Please let me know if this is helpful or if you have other questions.

[maizefolk]

Oh it's $2,500 per person. That makes a lot of sense and I feel silly that I didn't think of that.

For your point #3, roughly how much are you hoping to have in the plan by the time your child is old enough to be able to attend college? If you put in $5,000/year for 18 years you'd end up with on the order of $200k in the 529 in 18 years when you might start spending it.

The timing of contributions matters only in so much as for early contributions the overall hit from expense ratio is much higher than for later ones while the benefits of tax savings are constant regardless of which year you contribute the money in.

• If you invest $5,000 this year and then nothing else for 18 years, your household saves $232/taxes once but the 529 pays the expense ratio every year on a growing balance for 18 years ($1,142).
• If you put the same $5,000 into the plan the year before college, you'd save the $232 in taxes but only pay the expense ratio for a single year ($29).

Of course $5,000 invested today could grow to $20,000 in 18 years (not correcting for inflation) so the above shouldn't discourage you from starting to save earlier.

This isn't my area of expertise, but in googling it sounds like you should indeed be able to open a 529 plan with the state, contribute, and then roll it over to get the best of both worlds. To me this would be past the point where the amount of extra hassle it'd take would no longer be worth a couple hundred dollars in tax savings every year vs just opening a plan with Vanguard and contributing to it. But I know other folks on this forum who are willing to put in a lot more work for the same amount of annual savings, so I do want to emphasize that part is my personal opinion, not anything inherent in the numbers themselves.

Either way, congratulations on the upcoming addition to your family.

[MizB]

Once again, super helpful. I think I was arriving at the same conclusion as you but wanted to make sure I am not missing anything. Seems like best option would be to start a state 529 and roll it over but I am also not sure I am willing to put in the work of rolling it over versus just starting with Vanguard.

Also, right now we are planning to save between 60 and 80K for college but I really have no idea if this is a reasonable amount to save or not (too high? too low?). I guess I have the next 18 years to continue researching. In the meantime, I believe if we invest $5K for the next 3 years and even if we do nothing else after, we would get to the $60K figure by the time our little girl turns 18 so the plan is to focus on that for 3 years and then go from there.

Thanks again for the help!

[secondcor521]

A few comments:

First, maizefolk has done a great job of doing the math.  I think his analysis does miss one thing, though, and that is the opportunity cost on the tax benefit over those 18 years.  In other words, if you take that $232 in tax savings and invest it, the growth on that $232 will offset some of the annual fees and expense ratio costs mentioned over that 18 year period.  Depending on what you do with the tax savings, that could matter a lot or not much at all.

Second, as to how much to save, it's highly personal, highly variable, and the amount can change even up through the college years.  Personally what I chose to do is look at the College Boards Trends in College Pricing report, figure out what I wanted to contribute, and then use their numbers for both the current cost and the inflation adjustment to generate a targeted future amount.  I then calculated what I had already contributed and what it would grow to, and then I just kept shoveling money in until what it would grow to equaled that targeted future amount.

When my kids started into the college years, I gradually switched from College Board numbers to actual numbers based on the tuition bills I was receiving.  I've gone from "I don't know if I'm saving too much or not enough" to "Oh my gosh, I've over saved by a lot" to "I don't know if I'm saving enough, but probably not" as my three kids have changed their plans.  At this point I have one who is graduating next month, and two who are approximately sophomores.  My plan now is to monitor the situation, use their college funds until they're gone, and then figure it out from there if I happen to need more.  Fortunately by the time you get to my point in life, if you've planned well and done all of the good financial moves, a year or two of college tuition is probably a somewhat large rounding error in the big scheme of things.

One last comment:  I believe some plans restrict the number of rollovers you can do per year or per 12 month rolling period, so if you do decide to do the extra work to have the best of both worlds, be sure to research that as part of your planning.

Congratulations on the daughter!