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529 Plan Average Rate of Return
Tax-free growth is possible in 529 plans but is limited to qualified education expenses. In 2011, the average 529 plan rate of return was about 3%.
By comparison, the S&P 500 is expected to grow at a compound annual growth rate of 12% from June 2011 through June 2020. A $10,000 investment would yield $3,048 in tax-free growth over nine years or $17,731 at a 12% CAGR.
Fees
Before investing in a 529 plan, it is essential to consider its fees. These costs vary from plan to plan. Typically, they are measured as small percentages of the account’s total value.
However, even small portions can cut into the returns that you’ll get. Some of the best 529 plans will guarantee a certain percentage of the account’s growth each year.
The average cost of a four-year public college is approximately $10,740. A private university costs about $38,070. Most college savings calculators recommend that you save $500 a month to pay off the cost of tuition and fees. However, this amount leaves little money for retirement.
To find the best investment plan, you should consider the fees. A direct-sold 529 plan can have lower costs than one sold by an advisor.
However, an advisor can provide more personalized service to you. You should consider the fee structure before investing, regardless of the investment style. The best 529 plans have the lowest fees and offer various investment options.
Another benefit of 529 plans is their low maintenance cost. Investments are managed by professionals who assume your best interest.
This helps maximize the return on your investment. Although 529 plan investments were not always the best, they have improved over time due to greater competition, transparency, and alternatives.
In addition to saving for college, you can use your 529 accounts to pay for expenses related to K-12 education. In addition, there are tax breaks available for qualified withdrawals. You can claim a state income tax deduction on qualified withdrawals in some states. However, this tax benefit does not apply to all 529 accounts.
Investment Options
There are many ways to invest if you consider putting money into a 529 plan. A low-end plan can pay out between $9,600 and $10,000 per year for each school year, which could cover fifty percent of a child’s 4-year public school tuition in 18 years.
While you can invest in any 529 plan, you may want to choose your state’s program because it offers a tax deduction. California does not provide a tax deduction on 529 plan contributions, so be aware of the requirements for your state.
In addition to funds that invest in mutual funds, there are also age-based and static portfolios available.
For instance, tomorrow’s Scholar 529 program has nine age-based portfolios and five funding options. Aside from its age-based portfolio options, several funds use individual funds from different fund families.
Investment options for 529 plans vary by state, but some offer direct-sold 529 plans with lower fees. Iowa residents can benefit from a state tax deduction on their contributions.
A national 529 plan, the CollegeAmerica 529 in Virginia, has a wide range of investment options. It features American Funds’ target date, multi-fund portfolios, and individual mutual funds.
Contact a broker if you aren’t sure which investment option is best for you. An advisor can help you choose the best 529 plan and investment professional.
It is important to remember that the value of your account depends on the performance of the options you choose. As a result, the returns may be lower or higher than expected.
While investing in a 529 plan can help you save money for college, it has certain risks. The money you save may not grow as much as anticipated, and you may have to withdraw a portion of your investment. You may also face losing money if the market declines in value.
Contribution Limits
When you invest money in a 529 plan, you receive tax advantages depending on the type of plan. The IRS does not impose contribution limits on 529 plans, but some states do. You can contribute a large amount in one year, but you must not exceed the maximum amount allowed by your state.
The maximum amount you can contribute to a 529 plan is $235,000 per beneficiary. The lowest contribution limits are in Georgia and Mississippi, followed by North Dakota, Idaho, New York, and California. The maximum balance limits in each state are different and can vary depending on the amount of money you contribute.
You can contribute an unlimited amount to a 529 plan, but you should be aware of tax consequences. Contributions to 529 plans may be considered gifts so that they could impact your tax situation. The annual gift tax exclusion for individual taxpayers is $15,000 per individual for 2020, but this limit applies to gifts of cash or property.
An individual or a family can make contributions to a 529 plan. There is no yearly limit, but you must report them on Form 709 each year. In addition, you can apply the amount you have contributed to a 529 plan over five years. This is called superfunding.
There are many different types of investments available to 529 plan investors. Some invest in fixed-income securities, while others invest in equities. The best option for you depends on your time horizon and risk tolerance. However, investing in equities will likely give you a better rate of return than bonds.
Tax Free Growth
Tax-free growth in 529 plans is an attractive feature, but it also has a downside. The federal government has pledged to spend $30 billion on the plan over the next decade, and by 2026, it is expected to cost $4 billion annually.
Unfortunately, very few states break down their spending by household income, which is why up to 75 percent of state tax benefits go to households with incomes over $109,000.
For example, a woman with a high income might be able to invest $3 million for 20 years, meaning she would pay no taxes. However, this example doesn’t consider married couples’ annual gift tax exclusion. A married couple could front-load $80,000 into a super fund 529 plan to avoid paying the total tax bill.
In addition, the tax break only applies to qualified withdrawals, so non-qualified withdrawals are taxed on a pro-rata basis, which means that any money withdrawn from the account for non-educational purposes is taxable.
In other words, if parent J decides to take $5,000 out of the account in 202, the money will be considered earnings and taxed as earnings on Form 1099-Q.
If parent J’s marginal tax rate is 22%, he will pay $660 in additional taxes. This unexpected tax bill may wipe out the tax-free growth in 529 plans.
As a parent, you may want to consider a 529 plan as an alternative to a traditional 401(k) account. The tax-free growth of a 529 plan can give you extra money to spend on your child’s education.