What is better – a 20% tax rebate or 0.5% lower fees?
I have two investment options.
My 529 plan offers a 20% tax credit, so if I contribute $5000, I get $1000 back.
However, the fees are lower on investments in my Roth IRA – about 0.5% per year less for the average fund in the portfolio. So, instead of $5000, I would have $4000, but be paying lower fund management fees.
The Roth is also WAY more flexible in its investment options. With the 529, I’m pretty much straddled with a growth style asset allocation fund (90% diversified stock, 10% bond), unless I want to be screwed even more on the fees. The Roth lets me invest in anything.
Given an investment time horizon of 13-21 years, which is the better choice?
Here are the numbers if you expect to make 10% return (10.5% in the ROTH due to lower fees):
$5,000 invested 21 years @ 10% = $37,000
$4,000 invested 21 years @ 10.5% = $32,500
$5,000 invested 13 years @ 10% = $17,300
$4,000 invested 13 years @ 10.5% = $14,700
Both accounts have very similar tax advantages after the 20% credit is considered. The ROTH is much more flexible in many ways: It doesn’t have to be spent for education, you can withdraw the contribution at any time with no penalty or tax (although you may not withdraw the interest until retirement age), and as you mentioned you can invest it wherever you want (I recommend www.vanguard.com).
But the 20% bonus is very hard to pass up. If you’re pretty sure you’ll use the 529 as intened (education), it is almost certainly the way to go due to the extra ~$4,000 it will give you.
Best of luck in your investment future!
Thomas L. Hardin, CMT, CFP investment performance measurement, styles growth and value myths.