California Finally Launches a Low Cost 529 Plan

This month the state of California switched the 529 Plan vendor from Fidelity to TIAA-CREF. The fees are much lower and now are even a tiny bit lower than some of the formerly lowest cost states. The equity index U.S. Large Cap and the Index U.S. Equity each charge only 0.18% which includes Plan Manager Fee and Administrative Fee. The passive Diversified Fixed Income Investment Portfolio is 0.29%. I am not recommending these, I am simply commenting that new Plans are available at lower prices. A 529 Plan allows investments in it to be tax free if the funds are used for college.

This is good news during a time when investors are finding there is a shortage of good news. There is no state income benefit to using an in-state 529 Plan so parents living in California could set up a plan out of state. But now people don’t need to use an out of state plan.

How should you invest in a 529 Plan?

The problem with 529 Plans is that they only allow one investment allocation change a year so if you have recently bought bonds in a 529 and then the stock market crashed that would require you wait until the annual opportunity to make a new allocation. This would be too long to wait. So the best use of a 529 Plan is for holding funds that will be in a long term commitment to investment grade bonds. However I am uncomfortable with that because I believe bonds should be used as a safe haven to hold assets while one is waiting for stocks to drop to a low enough level to justify buying stocks. Since a 529 Plan does not allow investment changes more than once a year then that voids my strategy of how I would invest and thus I am reluctant to recommend a 529 Plan. I am bearish on stocks and feel that it makes no sense to lose money in stocks while being mesmerized by the possibility of a tax savings in a tax free 529 account. Investors should remember to never get excited about tax savings and allow their excitement to distract them from a cold hard analysis of the fundamentals of investing. If P.E. ratios are too high then stocks will fall, and if they fall then the last thing you need is a tax shelter.

Perhaps one could put 10% of his or her assets into a 529 Plan (assuming he or she has a college bound child) and then have the other assets elsewhere, where there is freedom to switch allocations as needed. Then they could keep the 10% of assets in the 529 Plan in bonds.

There are techniques to get around the 12 month investment allocation rule such as changing the beneficiary or moving the funds to another state but those have complications that I’m uncomfortable with. Changing the beneficiary could result in gift tax if the account was more than $13,000 or five times that if using the rule that allows five years of gifting in advance.

About the author

Don Martin, CFP®

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