529 Plans: Fees More Important than Deductions

529 Plans: Maryland vs. Nevada PlansUsually. 🙂

My friend just had their first child and began researching 529 plans. A 529 plan is an education savings plan run by a state or an educational institution, it’s named after Section 529 of the Internal Revenue Code. The plan offers tax benefits to individuals saving for future education. In his case, he was looking at a savings plan, rather than a prepaid plan*.

And now he had a choice: an in-state plan with a tax deduction or an out-of-state plan with potentially cheaper funds. Specifically, he wondered if he should open a Maryland 529, which offers a tax deduction to Maryland residents, or a state plan offering Vanguard funds, which is known for lower mutual fund fees. The state plan he found was Nevada’s, which is run by Upromise but offers Vanguard funds. (Plan data provided by Saving For College, run by Bankrate)

College Investment Plan (Maryland)

  • Program Manager: T. Rowe Price Associates, Inc.
  • Residency Requirement: No.
  • Maximum Contributions: No annual limit until account balance for beneficiary reaches $320,000.
  • Account Maintenance Fee: $25 / yr, waived with automatic investments or balance greater than $25,000.
  • Management Fees: 0.28% manager fee, 0.25% once program assets reach $2 billion.
  • Tax Deductions: $2,500 per beneficiary per year by account owner is deductible with a 10 year carryforward on excess contributions.

The Vanguard 529 Savings Plan (Nevada)

  • Program Manager: Upromise Investments, Inc. and Vanguard Group, Inc.
  • Residency Requirement: No.
  • Maximum Contributions: No annual limit until account balance for beneficiary reaches $310,000.
  • Account Maintenance Fee: $20 / yr, waived if account owner or beneficiary is a Nevada resident or assets in account exceed $3,000.
  • Management Fees: 0.65% manager fee, include underlying fund expenses.
  • Tax Deductions: None.

Comparing just the Nevada plan against the Maryland plan, it appears that the Maryland plan is superior. What you’re trading off is the tax deduction versus the mutual fund fees, but the tax deduction is only available the year you contribute. In Maryland, the $2,500 deduction is worth $125 (5% state income tax) making it nearly a wash between the slightly higher account fees in Nevada.

It’s really a choice between T. Rowe funds vs. Vanguard funds. If you’re an index fund type of investor, the T. Rowe Price Equity Index 500 (PREIX) has an expense ratio of 0.35%. Vanguard’s 500 Index (VFINX) expense ratio is 0.15%, meaning T. Rowe’s ratio is more expensive by 0.20%. On a balance of $10,000, that’s a difference of $20 being whisked out of the account each year for nothing. While $20 doesn’t seem like much, that’s a fee taken out each year and one that will erode your investment’s growing potential.

If it were me, I think the Nevada plan is superior of the two because it offers access to cheaper Vanguard funds.

Five Best 529 Plans

Liz Pulliam Weston of MSN money recently looked at the 5 best college savings plans and listed Nevada as one of the top five. The other states included were Alaska, Nebraska, Rhode Island and Virginia. The Virginia plan offers access to some Vanguard funds too.

* A prepaid plan is an option where you “lock in” the price of an in-state public college education right now. You can always convert it to a private or out of state school later on based on some conversion tables.

(Photo: lednew)


Tax Credit vs. Tax Deduction

A tax credit is not the same as a tax deduction.

Tax Deduction

A tax deduction, such as contributions to a Traditional IRA or 401(k), reduces your adjusted gross income. How much that deduction is worth to you depends on your marginal income tax rate (2008 Federal Tax Brackets).

If you are in the 25% tax bracket, a $1000 tax deduction means you will pay $250 less tax that year. If you are in the 10% bracket, a $1000 tax deduction means you’ll pay $100 less tax that year. If you have a simple tax situation, with little income outside of your regular job, this translates to a larger tax refund.

Common tax deductions are the two mentioned before, Traditional IRA and 401(k) contributions, as well as mortgage loan interest, student loan interest, and charitable donations.

Tax Credits

A tax credit is a dollar for dollar reduction in your income taxes. If you have a $1000 tax credit, you will pay $1000 less tax that year regardless of your tax bracket. A good example is the $1000 child tax credit. If your child applies and you don’t exceed the income limits, you get $1000 for each dependent child you claim on your tax return.

Common tax credits are the child tax credit, Hope Scholarship and Lifetime Learning Credits (education related), retirement savings credit, and the adoption tax credit.

 Devil's Advocate 

Save Money, Get A Divorce!

Devils Advocate Logo
This is a Devil's Advocate post.

Marriage is a beautiful and wonderful thing. I just joined the club several months ago and it’s not too bad so far. I’m not saying that you shouldn’t fall in love and spend the rest of your life with someone, I just think that the accounting details make it a raw deal. I’ve talked about how you shouldn’t get married in the past, but if you’ve already let the cat out of the bag and paid for the license, here are some more reasons why you should considering going back to the courthouse to get your money back (it’ll be pricey but think of the ROI!).

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Reduce Your Capital Gains Tax Bill: Wash Rule

This morning, I wrote a post advocating that you donate your appreciated stock to a charity because it’s the only option I can think of where someone other than you also benefits. Well, here’s an option where you will benefit – sorta. The wash rule is based on the idea that your stock profits can be offset by your stock losses. It’s a principle that businesses use all the time and one that You Inc. should take advantage of. I’ve written about the wash rule in the past but I figure a refresher can’t be bad for both of us.

This year, we have some realized mutual fund gains that I’m looking to potentially wipe away with some mutual fund losses. Since the gains have been realized (I sold the stock), we’re already on the hook for them and there’s no way around it. (Unrealized gains are invisible, if it appreciates and you don’t sell it, then it doesn’t count) We also have some funds in which we have some unrealized losses so in order to offset them I’ll sell enough stock to balance out the gains and Uncle Sam will end up with nothing.

The only part of the wash rule that you need to pay careful attention to is that you don’t buy back into the stock you just sold for a loss within thirty one days. If you do, then the wash rule is nullified. So if you sell FiveCentNickel Inc. because it tanked this year to offset the tremendous gains of BFP Inc., you can’t buy back into FiveCentNickel for thirty one days. Now, in the case of mutual funds, you can always buy a similar mutual fund; so it’s really a non-issue. (incidentally, FCN is a great investment, you should buy back in as soon as you can!)

So, got a realized winner and some unrealized losers? Pit them in a deathmatch and you can come out a winner (tax-wise anyway).


Comprehensive Guide to IRS Income Phase Outs Rules

As you may well know, your modified adjusted gross income (MAGI) will determine what sort of tax benefits you’ll be eligible for. What you may not know, is how your MAGI will determine those benefits and what benefits fall under the phase out rules. You probably don’t know that because it’s not all written down in one place… until now. The majority of these fall into one of two categories, education-related or retirement-related, and it’s a great example of how you can change behavior through tax laws. The government wants to help you prepare for the future and stop being stupid.

First off, the IRS defines adjusted gross income as your gross income minus adjustments, which happen to all be deductions but do not include the standard or itemized deductions. Some of these adjustments are the IRA deduction, student loan interest deduction, tuition and fee deduction, moving expenses, etc. The modified adjusted gross income is your AGI plus some of the stuff that you deducted put back. For more information, please refer to on both topics.

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Morality of Deducting Charitable Contributions

I was poking around Debt Hater this morning when I found her post about how she wasn’t deducting her charitable contributions to her church on the grounds that her donations (tithe) should be 10% gross, not net, and you shouldn’t be rewarded for doing it (the deduction). Here’s what she said:

My church provides every member with a receipt for the money they’ve given — in tithes and/or offerings — for tax purposes.

But I didn’t claim that on my taxes. It seems wrong to me. If you believe in tithing, you know that you tithe 10%. That’s gross, not net, because if you tithe net, then you’re paying the government before you’re paying God. So, if you get the money back through taxes, then you’ve gotten your blessing that way, and not God’s way, whatever way that may be.

The fundamental difference in thinking is probably with the perception of the deduction – DH sees it as the government giving you money (a reward) whereas I see it as you keeping your money. If you donate 10% of your gross income, you’ve actually lost 12.5% of your gross because 25% of that has gone towards the government. So if you’re paid $100, you donate $10, you’re actually down $12.50 because $2.50 of that $10 donated goes towards the government in taxes on income. The government has decided that donations are not considered income (in effect) so they let you deduct it, thus you get the keep the $2.50 because you gave away the $10 (the government is not rewarding you, you are merely paying less because you’ve in effect, out of your generosity, earned less).

Now, let’s say you still aren’t convinced that you should deduct it. If you deduct it, you can donate $12.50 instead of just $10 – thus not only are you not keeping it, you’re making your gift that much larger. Of course, now you deduct $12.50 on your taxes instead of $10 and the never-ending math cycle continues, but you get the idea.

As for the question of “Are you doing it to provide something to your community or are you doing it to hide money from Uncle Sam?” I don’t see how donating money is hiding any money because you don’t get that money back later.

DH, I think you should take the deduction.

What do you all think?

 Debt, Education, Personal Finance 

Deducting Student Loan Interest

I receive the following email the other day and I am posting it to see if anyone else has some advice for a fellow reader with regards to his situation:

From: Dave
Subject: Tax Breaks for Student Loan
Hi Jim,

I’ve got a question on a difficult situation.

My girlfriend’s brother exited an Indiana university early with a 4.0 GPA several years ago, and when he wanted to go back he didn’t have the resources to get started. My girlfriend got a $3k student loan for him, as well as a laptop she put on her Discover card, with the idea that he would buy books and give her the rest back to immediately pay back Discover. Long story short, he never paid her back, ended up running away to the Southwest, and pawned her laptop. There’s not much that the authorities can do, since she applied for the loan and essentially gave him a gift on her credit card, but I was wondering if there was anything that she could redeem from the student loan on her taxes. All police reports have been filed at present.

Any help, as you could imagine, would be an enormous help. We have a mortgage to pay and would like to afford to have a child. I just want to see some of that back, if at all possible.

My response:

Thanks for the email and that’s unfortunate what’s happened between your girlfriend and her brother, but sometimes that’s life. In general, student loan interest is deductible if you make under $50,000 (after adjustments) and I would think that since she is a cosigner on a student loan, she could claim the deduction as long as she’s not a dependent on someone else’s claim (her parents?). If she just got a regular loan from the bank (not a student loan), and lent it to him, she may not have any options in terms of deductibility.

Anyone have any thoughts?


Start Thinking About Filing Your 2006 Taxes

Thanksgiving is over (even though the leftovers are still packed into the fridge), the Happy Holidays are just around the corner, now is the time to make those end of the year tax decisions before you get overcome with all the craziness of the holidays. So, I dove into the archives and saw that last year I wrote a whole bunch of posts related to year-end tax moves that still apply (most of them) to this year, so I thought I’d link to them so I’d know where they were:

And, if you don’t like taxes, read this argument about how the tax system will collapse in ten years.

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