Choosing a 529 and How Does Your 401(k) Compare

0:04How should you choose a 529 plan and how do you compare to the average 401k participant? You're listening to the weekend personal finance edition of Motley Fool Money.

0:20I'm Robert Brokamp. We're doing a trial run of something a bit different for our Saturday episodes in which, per usual, we feature a guest interview. And this week I speak with Martha Kortiak Mert, of SavingForCollege.com about the newly expanded uses of 529s and how to choose the right plan for you. But then I'll also offer some other personal finance tidbits and tricks. So let's kick things off with three items from the news in a segment we're calling Last Week in Money. First up, you know they say that comparison is the thief of joy, but that doesn't stop us from doing it, especially when it comes to our money.

0:52So if you're curious how your 401k behavior stacks up to the average workers, Vanguard has some answers in its recently released How America Saves report based on analysis of all the retirement plans with the firm in 2024. Here are some highlights. The amount you have in your 401K is highly dependent on how long you've been contributing. Here are the median account balances based on job tenure. For people who have been on the job for two to three years, the median account balance is a bit more than$20 ,000. Four to six years, a bit more than$44 ,000. Seven to nine years, almost$73 ,000. And more than 10 years, almost$166 ,000.

1:29How much are workers contributing to their accounts? Well, the median savings rate is 6.8 % just from the worker, and it's 11.5 % when you include the employer match. Now, that's below the 15 % savings rate that really most experts recommend nowadays, which means many folks might be behind in saving for retirement. Those workers might consider maxing out their accounts. The limit this year is$23 ,500. Then when they turn 50, contributing even more with catch-up contributions up to$7 ,500 or starting this year,$11 ,250 if you're 60 to 63 years old. What percentage of workers with Vanguard 401ks took full advantage of their accounts last year?

2:09Well, 14 % maxed out their accounts and 16 % of the 50 and older crowd made catch-up contributions. Of course, it really doesn't matter how you compare to the average person. What really matters is whether you're on track to retire when and how you want. To figure that out, you can start by using a good online calculator. One to consider is the CalcXML Comprehensive Retirement Planning Module. Just do an online search for it. You'll know you found it if it has 606 as the last three numbers in its URL. Next item on our agenda, article from The Wall Street Journal's Jason Zweig, who highlighted the woes of small cap stocks.

2:43Over the past century, small caps have outperformed large caps by two percentage points annually on average, but not so much recently. In his article, Zweig cited the following stat from Steven DeSantis, an equity strategist at Jefferies. Small caps have trailed large caps by more than seven percentage points over the last decade, which is the widest gap since 1935. Accordingly, money is just flowing out of ETFs that invest in small U.S. stocks, while money is just pouring into the ETFs that attract U.S. large companies. This also means that small caps are a good bit cheaper. The Russell 2000 Index of small companies trades at a price-to-earnings multiple that is almost nine points lower than the S &P 500's PE.

3:27So Zweig argues it might be time to go against the grade and grab some bargains by buying some small caps, which you can do pretty easily with a low-cost ETF such as the Vanguard Russell 2000 ETF, ticker VTWO, or the iShares Core S &P Small Cap ETF, ticker IJR. And finally, we come to the number of the week, and that number is$435 ,300. That is the median price of an existing home that was sold in June, an all-time high, according to a report published last week by the National Association of Realtors. But while prices are up, sales volume is actually down 2.7%, and year-over-year inventory is up more than 15%.

4:10There's a bit of a slowdown in the real estate market. Growth of prices has moderated somewhat this year, and it took a bit of a dip in 2022. But anyone who owns a home that they bought more than a few years ago is likely sitting on some pretty nice gains. According to the Case-Shiller National Home Price Index, home prices are up 49 % over the past five years, 91 % over the past decade, and 146 % since the bottom of the housing crash in February of 2012.

4:48Our team of passionate traders ready to tackle anything from the most complex trading questions to a simple strategy gut check. Need assistance? No problem. Get 24-7 professional answers and live help and access support by phone, email, and in-platform chat. That's how Schwab is here for you to help you trade brilliantly. Learn more at schwab.com slash trading. Putting a kid through college can easily cost well over$100 ,000. And one way to prepare for that cost is by contributing to a 529 college savings plan. But how do you choose the right one? Here to provide some pointers is Martha Kordiak-Mert, author and COO at SavingForCollege.com.

5:27Martha, welcome to Motley Fool Money. Hello, thanks for having me. So the benefit of 529 savings plans is that the growth and withdrawals are tax-free as long as the money is used for qualified expenses. And that used to mean pretty much just college costs. But the list of qualified expenses just keeps growing, including this month, thanks to the Big Beautiful Bill that was passed on July 4th. So let's start by you telling us a little bit about what a 529 can actually be used for. Sure thing. And you're right. That list is actually pretty long right now. So let's start with when your child is young.

6:00A few years ago, added to the list of qualified expenses was K-12 tuition. But with the passage of the One Big Beautiful Bill, you can now pay for a lot more than and just tuition at the K through 12 level. So you can pay for curricular materials, online materials, private tutoring. You can also, once your kid is in high school, you can pay for things like standardized tests, SAT exams, ACT. So those were things that people would often ask about, can I use my 529 plan to pay for this? Finally, the answer now is yes. And at the K through 12 level, withdrawals have been limited to$10 ,000 per year per beneficiary.

6:36that is going up to$20 ,000 per year starting in January. So that's just at the K through 12 level. And then once you get post-secondary education, you can pay for college tuition, room and board, books, supplies, computers, software, things that you need for your course of study. But in addition, you can also pay for trade schools. You can pay for vocational educations. And now you can pay for a range of credentialing and accreditations and continuing education as well. So this can include things like welding certification programs, HVAC. So there are a number of different programs that are now going to be considered eligible expenses for 529 plans, as well as, again, if you're in law school, if you study to become an accountant, any study that you're doing for your certification or your accreditation, like a CPA exam or bar exam, you can also now use a 529 plan to pay for those exam fees as well as educational courses that you're doing for those exams.

7:44So a much broader range of uses. So that might be appealing to anyone who's listening to this. So they think, okay, I maybe should open a 529. The interesting thing is, though, they're unique. If you want to open an IRA, you have to decide, well, yeah, I can go to Schwab or Vanguard or Fidelity or whatever. But with 529s, they're operated by states. So, you're like, well, do I go with Virginia or Utah or Alaska? So, how should someone go about choosing the right 529 for their student? Because you don't have to stick with your own state's plan. No, absolutely. And this creates a lot of confusion for people and it gives them a lot of choices, which can be a good thing, but sometimes too many choices makes things hard.

8:22right? So for one thing, we always suggest look at your state's plan. Now almost 40 states offer some type of state tax benefit. Most of the time you have to use your state's 529 plan to get that tax benefit, but not in all cases. So check if you are in a state where you have state income tax, check to see if your state offers a deduction or a credit for contributions that you make to a 529 plan and whether or not you have to use your own state's plan to get that. If you are not in a state that offers a tax benefit, and even if you are in one that offers checkout NC, we actually have an article on our site that sort of breaks this down how much is available and you say what's the actual benefit.

9:06You can see how much is that worth to you and look around and look at how different plans are rated. If you're in a state that maybe doesn't have, you know, the highest performing 529 plan. If your 529 plan doesn't offer some of the options that you'd be looking forward to invest in, shop around, see what else is out there. There are close to 100 529 plans of different kinds out there. About half of them or maybe a little over half are direct sold, meaning you can just go to the website and open those yourself. The remaining ones have to be open for you by a financial advisor or broker. You can transfer money from one 529 to another.

9:47So, can you try to game the system? Can you, like, I'm going to contribute to my state's mediocre plan to get that tax break, but then I'm going to transfer it to another 529? Or is there a catch there somewhere? No catch. Yeah, you can totally do that. And the other thing that happens is people move states sometimes, right? So, maybe you open your state's plan for that tax benefit, then you move to another state. So, depending where you're moving, you could transfer that money, or you could just keep it where it is and open a new 529 plan in that new state, if that offers a tax benefit as well.

10:18They're actually really flexible in that way. There's no reason that you only have to open one 529 plan if you have more than one child. It's probably a good idea to open a different one for each child. But for sure, you can max out your tax savings in one, your state tax benefit, and then open an additional one. You mentioned ratings of 529 plans. A few people do it, Morningstar does it, but you all do it at savingforcollege.com as well. So, what are some of the criteria you use when it comes to how you've ranked and rated 529 plans? Yeah, let's start with the rankings, because that feeds into our overall ratings as well.

10:54So, our rankings are an analysis we do of how all the 529 plans perform, so what their investment returns have been. Now, of course, within a 529 plan, you have multiple choices of how to invest your money. So you can choose from portfolio options that give you age-based or target year options. So you choose the one that corresponds to your child's age or the expected age of enrollment in college. And those funds will shift over time from more aggressive type of investments to more conservative investments as your child nears college age. But they will also offer different single fund and static blends and things like that.

11:33So you do have quite a range of investment options. So how do we compare the performance of one 529 plan to another 529 plan? We have to find a way to kind of normalize those things. So what we do is, in this case, we look just at the age-based and year-of-enrollment portfolios, and we basically calculate an average across the age range. So what would your average return be at any given point in time from 0 to 18-plus years of age? And then we compare that average performance for all of the different plans. And that's how we rank which are the best performing 529 plans. That performance component is definitely a big component for people.

12:12So when we think about the rating and how we rate 529 plans, we want to be able to rate them based on which are the plans that are going to most help you as a parent, as a grandparent, ensure that you're reaching your goals for your child or your grandchild. So performance is a big element of that. But we also think about things like saving success. That means, does the plan offer different types of features that will enable you to save more? This can include things like, does it have a gifting feature? How easy is it for you to, if you're a parent, have grandparents, family, and friends on birthdays and holidays make gift contributions into the 529 plan in lieu of a toy, for example?

12:56Ease of use. How easy is it to enroll in the plan? This is a place a lot of people drop off during the enrollment process because they really just get stuck. It's hard for them to figure out what these different options are that are being offered. And ultimately, program delivery. So how likely do we think it is that a 529 program manager is going to continue to deliver excellence to their investors? So those are some of the things we look at. We use both publicly available information and we also survey all the 529 plan program administrators with a series of questions that they provide answers to us.

13:32You mentioned various relatives there. And some people may wonder, well, how does a 529 affect my financial aid eligibility? And it comes down really to ownership. Tell us a little bit about the different financial aid treatment when the parent owns it versus the kid or maybe another relative like the grandparent. A 529 plan is considered on the financial aid form, the FAFSA form that you fill out for federal financial aid. Whether it's owned by the parent or the student, it is considered a parent asset. A maximum of 5.64 % of that asset value is included in the FAFSA form, ultimately. So you put the full amount, but what's actually considered in the calculation is just up to 5.64%.

14:17So basically, if you're saving in any way, whether that money is in mutual funds or in a bank account, that's going to be considered at the same rate. So that, if you can save, that's not a reason to not open a 529 plan. If a grandparent is considering whether to contribute to a parent's 529 plan or to open their own, The good news for grandparents now is that that 529, a grandparent 529 is not considered for financial aid purposes. Now, in the past, it used to be withdrawals that you made from a grandparent 529 plan and then used to help the student were considered as untaxed student income. And that was considered at a much higher rate.

14:57I think that was 20%. So that has gone away. That untaxed income is no longer considered. So any cash support that's provided to the student from a grandparent or a family friend or other family member, that is not considered on the FAFSA. So it does sort of give an additional bump for grandparents that are trying to decide whether or not to open a 529 plan. The other thing to consider, too, or just to be aware of, really, is that only one parent, if the parents are divorced, only one parent is filing the FAFSA form. that is the parent who provides most of the financial support to the student.

15:37So if both parents have a 529 plan, the other parent, the 529 plan that they have for that same student would also not be reported on the FAFSA. The whole grandparent thing to me feels like a huge loophole, right? It's basically completely ignored for financial aid purposes. Do you know why they made that change? I know that over time. I don't know exactly why that change was made. I know it was something, though, that had caused a lot of confusion over time. And there was a whole strategy and loophole around how to use grandparent funds to pay for college without affecting financial aid. And so, it used to be you would wait until the sophomore year to start withdrawing from a grandparent, 529.

16:19So, there was a loophole there already, and a lot of people were aware of it. And that's sort of gone away now, essentially. So, it just, I think made it a lot easier overall. I should say grandparent, but it's really anyone other than the parent. It doesn't have to be a grandparent. Let's move on to the final question. Are there any underappreciated or lesser known aspects of 529 accounts or just saving for college in general that you think more people should know about?

16:47Yeah. People are so concerned about what happens if I don't use it. I think especially in this day and age where there is so much focus and emphasis on the value of a college degree. Is it still worthwhile, especially given the student debt picture? And so a lot of people, you know, they have a lot of uncertainty and trepidation around opening a 529 plan. So for one thing, I do think that this expansion of benefits does help a lot because now you can say, look, your child is probably going to need something post high school, right, to make it in today's world. If that's not college, it's going to be something else.

17:29And so really, there's not a great reason to not open a 529 plan. The other thing, I mean, we didn't really talk about, which I think people are aware of, but, you know, if you think about that tax benefit that you get of a 529 plan, we just focused on the state tax benefits. But of course, the really big benefit of a 529 plan is that those withdrawals that you're making come out federal tax-free and state tax-free as long as it's being spent on qualified education expenses. We went through that list earlier. It's a pretty expansive list, right? That can add up to thousands of dollars, right? So yeah, you could put the money in a mutual fund.

18:07You're going to be taxed along the way. In the case of a 529 plan, all that tax is deferred. And you are going to have to pay thousands of dollars every time you're taking, which rolls are you're going to have to pay the capital gains tax rate, I should say. So depending on how much you have in there and how much you've earned over time, you're basically, you can't count on every dollar that you see in your account going to pay for college with 529 plans. I think that's really the beauty of it, that every dollar, when you go and look at your account statement online, every dollar that you see there is, can go toward education.

18:42And that's pretty huge. So yeah, I think, and there are other flexibilities, you know, you can transfer to another beneficiary if you end up, if you're in the enviable position of having more in your 529 plan than you need. And the other actually pretty recent development that we didn't talk about that is huge is if you do end up with leftover money in your 529 plan, You can now transfer up to$35 ,000 to a Roth IRA for your beneficiary. You have to do it within the Roth IRA rules. You can only transfer so much up to the transfer limit each year. But that's a great way to jumpstart your kid's retirement savings as well.

19:21So if you end up sort of not spending or not spending all the money. So I really encourage people to not delay. Start early. Put money away regularly. early. It's just, I've heard from so many parents, friends of mine that say, I didn't get it. I didn't start saving until middle school and I didn't understand the value of the compounding I would get if I'd started 10 years earlier, eight years earlier or something. So start early. You're going to use those funds one way or another. Well, Bartha, this has been great. Thank you for joining us. Thank you so much. As a podcaster, my voice is heard by thousands of people.

19:58And now with Vanguard Investor Choice, I can be heard by the companies I invest in too. Vanguard Investor Choice makes it easy for eligible Vanguard fund investors to have a say in how their funds vote at company shareholder meetings. With just a few clicks, you can set your proxy voting preference and make your voice heard on topics like executive pay, board director elections, and more. Investor participation is the heartbeat of a healthy corporate governance ecosystem. You have a voice. Let it be heard. Visit vanguard.com slash investor choice to learn more. Vanguard investors own shares of Vanguard index funds and those funds own shares of the companies they invest in.

20:38Available for Vanguard index funds that participate in investor choice. Vanguard Marketing Corporation Distributor. It's time for our final segment, Get It Done, in which we provide an actionable tip to make the most of your money. So you know, a few weeks ago, President Trump signed into law the one big beautiful bill, and there's a lot in that bill's 870 pages, including a higher standard deduction, a higher state and local taxes deduction, a bonus deduction for seniors, a higher child tax credit, and a deduction for tips received by some workers. But it's not all about the breaks. The bill also eventually eliminates energy efficiency tax credits, limits student loan repayment options, and makes some cuts to social welfare programs.

21:15But hey, whalers get a higher deduction for whaling-related expenses, so that's nice. In the end, how much the new tax law will reduce your tax bill will depend on all kinds of factors, including your income, job, your age, your address, things like that. But most middle-to-upper-income households could see their after-tax incomes rise 2 % to 4 % annually over the next few years. Think of it like a raise. With any raise, it's a good idea to be proactive about what you do with that extra money. My recommendation is to use most or even all of it to boost your savings rate, especially if you're behind in saving for retirement or any other goals.

21:52Right after you're done listening to this podcast, log into your 401k, IRA, brokerage account, or your high-yield savings account, and boost the amount that you have automatically contributed by a few percentage points. Because down the road, you may need that money. Estimates vary, but the big, beautiful bill could increase the federal budget deficit by$3 trillion to$6 trillion over the next decade. Meanwhile, it could move up the depletion of the Social Security Trust Fund a year earlier to 2032. Around that same time, one of the trust funds that supports Medicare will run dry. In other words, over the next several years, the federal government will be borrowing even more money, while two of its biggest and most important programs will become increasingly underfunded.

22:35Make the most of your tax cuts. Use that extra money to plump up your portfolio. At some point, Uncle Sam is going to have to shore up Social Security, Medicare, and the rest of his finances, possibly resulting in higher future taxes and or reduced retirement benefits. And that's the show. What do you think of this new format for Saturday? Email your feedback to podcasts at fool.com. That's podcasts with an S at fool.com. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear.

23:12While personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. I'm Robert Brokamp. Fool on everybody!