If you invest in low-cost, tax-efficient index funds, do 529 college savings plans still pay off? Yes, under straightforward assumptions. Assume you can put away $5,000 per year for your newborn child’s future college expenses.
Scenario I: You invest in an S&P 500 index fund that earns an assumed 8 percent per year.
Scenario II: You contribute to a 529 plan investing exclusively in that same index fund. The 529 plan charges an annual program management fee of 0.25 percent plus an annual account maintenance fee of $25.
Under these assumptions, the 529 plan wins. Assuming the tax laws enacted in 2001 and 2003 remain in effect, you’d have about $220,000 in the 529 plan but less than $200,000 with a direct investment. If you get a state tax break for your 529 contributions, the assumed differential would grow to more than $30,000. Thus, the tax savings of a 529 plan can more than offset the fees you’ll pay.
