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529 or Not?
Old 02-17-2018, 06:06 AM   #1
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529 or Not?

Please make sure my thinking is correct...

We have 2 kids, 4 and 6 years old. I am 31 and DH is 41. Our current plan is to leave full time work in 5 years to travel with the kiddos in a tiny house. Our investments should be at about 1.2 million at that time with about 300,000-400,000 in low volatility non tax advantaged funds and 800,000-900,000 in a mix of traditional and roth 401ks/IRAs. In 2018 we will be in the 22% tax bracket. In "retirement" we will stick closer to the 0-12%/15% bracket because expenses will be lower.

We want to be able to pay for the tuition at a 4 year state school for each of them, should they choose to go that route.

My thinking is that it is smarter for us to forget about the 529 and to just focus our investing on our other accounts. The only plans that Maryland offers return about 4-5% after fees. The state incentive that is offered is a reduction of $2500 of state AGI per tax year if you make a contribution of that amount. Larger contributions can have that deduction carried forward to subsequent tax years. For us, that deduction would equal a $118 return per year, based on our current tax bracket.

The issue is that we are already maxing out our retirement accounts so the only place for the extra money to go would be into a non tax advantaged account. To me, it still seems to make sense, given our projected lower tax bracket, to invest in non tax advantaged accounts. We are going to pay our 22% tax on the money going in, regardless of where it goes. If we make 7% on a Vanguard fund we are still going to be better off, even after paying a 12-15% tax rate than we would have been making 4-5% and being guaranteed a 0% tax rate on returns.

I guess I'm also a little nervous to lock us into saving money for college when we have no idea what path our kids will take in 12-14 years. Throw in the possibility of scholarships and financial aid and it makes it even more uncertain.

I am still trying to learn about the tax implications of our financial decisions so if I've made any errors in my tax assumptions, please let me know.
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Old 02-17-2018, 06:18 AM   #2
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Originally Posted by Letsdoit View Post
I guess I'm also a little nervous to lock us into saving money for college when we have no idea what path our kids will take in 12-14 years. Throw in the possibility of scholarships and financial aid and it makes it even more uncertain.
Obviously you are planning for a ton of uncertainty if your family's life.

Remember, that the beneficiary of a 529 plan can be changed at any time. If one child doesn't use it, you could change the beneficiary to your other child. If neither use it, you an change the beneficiary to anyone else - another family member, a friend, or even yourself.

Also remember that you don't need to use a Maryland plan. You can invest in plans offered by any state you might like.

I don't know if that makes the decision easier or not.
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Old 02-17-2018, 06:36 AM   #3
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If they get a scholarship you can take the money out penalty free I believe. To me the 529 is most advantageous if you lump sum in at birth to maximize the tax free growth.

If you really think you will be in the low tax brackets at retirement (and plan to cover college costs, and that will fit within those tax brackets) I donít see a big advantage.

I however I do see difficulties in paying for 2 kids college at a time plus your own living expenses and maintaining a low withdrawal rate.

Iíd focus on your own savings, you can always take out a loan for 529. To me that would reduce uncertainty in your life
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Old 02-17-2018, 07:13 AM   #4
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Normally I would think a 529 investment now would be a good idea. However, given your facts I would say no. The other disadvantage with a 529 plan is that if markets decline significantly (like they did in the Great Recession), there is no way to harvest the loss for tax purposes.
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Old 02-17-2018, 07:24 AM   #5
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I had a 529 account for each of my two children. I started it too late to really get a big benefit. My daughter ended up going the Army route and didnít use hers so we transferred to my sons account. When it came time to use it I found the rules on bookkeeping a bit cumbersome. You only get to submit certain expenses for re-imburesement. You have a longer time period for the investment to accumulate so maybe it would be worth it. My son did end up getting a significant scholarship so this reduced the amounts that the 529 could pay for in any case (nice problem, I know). Itís probably more about discipline and making sure you donít get tempted to touch the money for other wants. If you can keep your hands off it donít bother with a 529, in my opinion, and make sure the kids keep doing their homework
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Old 02-17-2018, 07:27 AM   #6
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Note: All that said, if you have parents that feel better about contributing to a 529 for the kiddos, vs. handing money over to you for your investment account, this could be a good reason to establish one.
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Old 02-17-2018, 08:00 AM   #7
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First, I'd make sure that you maximize your Roth accounts before considering a 529. You can always withdraw your contributions out of the Roth account without incurring any penalty or taxation and use the funds for college expenses if you choose.

In savings for my two boys, the bulk of my 529 contributions were done when they were young (0-6) to give the account max time to grow. And even then, I only added funds through the years to aim for having about half the projected 4 year state school needs. Unexpected thing can happen over the 18 years before college and didn't want to be faced with left over money in the accounts.

Both are now in state colleges and drawing down their 529 accounts. Turns out the 529s will cover closer to three years of school as one son moved back home and the other went to one of the less costly state schools and has a partial scholarship. I don't find the expense record keeping very difficult, but then again I'm an engineer by training and a seasonal tax preparer as part of my 18 years of semi-retirement.
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Old 02-17-2018, 01:12 PM   #8
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I think you are best-off avoiding the Maryland plan since it's not on this page.

Since you do have so much time, you will be giving up a lot of potential tax-free compound growth if you don't go the 529 route. Maybe you could fund the 529 enough for one kid and just save after-tax for the other?

Here's a link to what happens if you have an over funded 529 account.
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Old 02-17-2018, 01:31 PM   #9
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The only plans that Maryland offers return about 4-5% after fees.
That sounds odd. Among most state offerings are a stock, or largely stock, index fund. Such funds track stock market performance and potentially return in excess of 4% annually, perhaps significantly more.
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Old 02-17-2018, 01:58 PM   #10
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Note that 529s can be used for vocational education as well as 4 year college. Essentially it is any post high school education. So if for example an offspring wanted to become a motorcycle mechanic, the 529 could pay the tuition there. In addition of course it can be used for grad or professional school expenses. As I read the documentation if a grandparent sets one up, it does not count in financial aid while if a parent does it does. Plus today the new tax law makes it prohibitively expensive with the new version of the kiddie tax using the estate and trust tax schedule to give money directly to the child even in US savings bonds (an old fashioned way to handle this) If worst comes to worst and there is no one in the family to need the money there is only a 10% penalty on the tax due.
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Old 02-17-2018, 02:37 PM   #11
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....If worst comes to worst and there is no one in the family to need the money there is only a 10% penalty on the tax due.
I thought it was that you paid 10% on the gains portion, and also those gains go into your income for normal taxation.

So, say you created an account with $50,000 and it grew to $100,000. Now, junior becomes a plumber, and doesn't use any funds for school.

You write yourself a check for $100,000. You show $50,000 in income, which gets taxed, plus you add a penalty of $5,000.
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Old 02-18-2018, 02:59 PM   #12
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So what if you skip a 529 plan and instead create an account at Vanguard in the name of your kid. Buy $x dollars of Life Strategy Growth Fund. The fund appreciates, but the kid only pays tax at his/her tax rate on any annual dividends, right? At college time - if they go to secondary education - they pull money out and are taxed on gains, but at impoverished student tax rate, correct? If the kid doesn't go to secondary school they have no problems using the money for whatever they want, right?

I'm seeing a much more usable universal fund for the kid with a tiny cost. Contributing parent loses what? $80 to $300/ year in state tax savings for an annual $2400 contribution? Seems like small cost for a bunch more freedom and lack of paperwork.
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Old 02-18-2018, 03:09 PM   #13
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Except that if the money is in the kid's name, you basically give up any hope of discounts (grants & scholarships) for need-based aid (FAFSA). The OP had the majority of assets in tax advantaged accounts, which escape scrutiny of FAFSA. The kids are 2 years apart, so both will be in school at the same time and the expected family contribution doesn't go up...it gets split.

Both public and private universities have little incentive to lower the sticker price since the high price adds prestige. What they do is discount through grants and scholarships. It would be a shame to walk away from the discounts because the kid had money in his/her name.
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Old 02-18-2018, 03:34 PM   #14
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So what if you skip a 529 plan and instead create an account at Vanguard in the name of your kid. Buy $x dollars of Life Strategy Growth Fund. The fund appreciates, but the kid only pays tax at his/her tax rate on any annual dividends, right? At college time - if they go to secondary education - they pull money out and are taxed on gains, but at impoverished student tax rate, correct? If the kid doesn't go to secondary school they have no problems using the money for whatever they want, right?

I'm seeing a much more usable universal fund for the kid with a tiny cost. Contributing parent loses what? $80 to $300/ year in state tax savings for an annual $2400 contribution? Seems like small cost for a bunch more freedom and lack of paperwork.
Actually if the unearned income exceeds 2100 you now pay taxes thru the kiddie tax at the following rates:
  • Up to $2,550 10%
  • $2,550 to $9,150 24%
  • $9,150 to $12,500 35%
  • Over $12,500 37%
(These are the estate and trust rates also).

Consider also the 529s are not just for 4 year college, but also for junior college and various trade schools. My guess the way things are going that a person is going to want some post high school training no matter what occupation they choose going forward.
As noted the worst case is to close it out and pay the 10% penalty if need be.
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Old 02-18-2018, 03:38 PM   #15
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I thought it was that you paid 10% on the gains portion, and also those gains go into your income for normal taxation.

So, say you created an account with $50,000 and it grew to $100,000. Now, junior becomes a plumber, and doesn't use any funds for school.

You write yourself a check for $100,000. You show $50,000 in income, which gets taxed, plus you add a penalty of $5,000.
That is what I meant:
But note if the child desires to get additional training at a junior college the 529 can be used to pay for it also. A number of junior colleges offer plumbing certificates, and in the future I would expect this training to be required before starting the apprenticeship program.
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Old 02-19-2018, 12:18 PM   #16
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Another aspect to consider with 529 plans is other benefits provided beyond potential tax-free growth for education expenses. For example, the state of Florida offers 2 different 529s. One is the traditional 529 plan discussed above.

The other Florida 529 offering is a prepaid tuition plan that carries with it the benefit of in-state tuition rates even if the beneficiary later moves out of Florida. Of course, you have to prove residency to initially obtain this offering, but given the mobile nature of our society and the offerings at Florida's public universities possibly being a good choice for some children, the value of this in-state tuition could be large for some folks--UF's out of tuition is an additional $22,278/year and FSU's adder is just over $15,100/year. To put this in perspective, the TOTAL cost for 4 years of prepaid university tuition in Florida for a resident, 11th-grade beneficiary is around $28k this year.

A further complicating issue is that federal tax law does not allow "double dipping" on tax benefits for higher education. In order to get the American Opportunity tax credit of $2500/year, assuming you otherwise qualify, you must leave at least $4000 of expenses that are not otherwise paid by 529 withdrawals or other tax advantaged programs.

The bottom line for us:
We have targeted having ~60-70% of our kids college expense paid out of 529s and the rest from after-tax sources. When we started saving for college expenses, it seemed to us to be the best balance of what we knew at the time and what reality may obtain as the kiddos enter college. Seems to have worked out okay for us.
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Old 02-19-2018, 05:25 PM   #17
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So what if you skip a 529 plan and instead create an account at Vanguard . . .
Contributing parent loses what?.
Loses any control over how junior uses the money? You thought you were buying tuition, but you were really buying a neck tattoo and a long road trip with a new friend.
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Old 02-19-2018, 05:36 PM   #18
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First, I'd make sure that you maximize your Roth accounts before considering a 529. You can always withdraw your contributions out of the Roth account without incurring any penalty or taxation and use the funds for college expenses if you choose.

....

.
We have 529 accounts for several of our grandchildren. In reflection I wished we had stuffed much of that money in our Roths. Our state 529 basically stinks, it doesn't give much in the way of tax deduction and the investments the last I looked are high cost.

The advantage of using Roth accounts in lieu of 529 is that that money will not be included in FAF when applying for college. The students have the opportunity for more income/asset aid based on student/parent resources.
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Old 02-20-2018, 09:18 PM   #19
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You may want to re-read the returns. There are several portfolio options you can choose, and performance varies by the stock/bond/mm ratio. You do not have to use Maryland's plan, you can use any other state. Our state does not give a tax benefit, so we are using the Utah's 529 due to the low Vanguard fees. The $2500 AGI is per beneficiary, so with two kids its $5000 per year. If Roth is an option, I would do both if possible. Sharpen your pencils and run different scenarios to see which works the best. https://maryland529.com/college-savi...nt-performance
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Old 02-20-2018, 09:32 PM   #20
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Not Sure how you calculated $118 per year at your current tax rate of 22%. What is the amount per child that you would be contributing in that year? Also not sure where you are getting the 4 to 5% return. It appears Maryland has several portfolios to chose from, not saying they have low expenses. https://maryland529.com/college-savi...nt-performance
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