529 plan, soon to be dad

[Jbird]

Thats right, DW is pregnant and if all goes well we will have our first this year. I've been reading about state sponsored 529 plans and have a question that I'm sure many of you have thought through. How much do you plan to save? The calculators set up by investment companies seem to over estimate how much college will cost (for their own good). What happens if you end up with too much money in a 529 account? Do you get penalized on funds left over?

I'm nervous because I married a very intelligent person and if our child gets her genes she might be thinking ivy league. Hopefully our child will get my mental capacity and go to a state school and kill the rest of their brain cells there.

Thanks for any info.

 

[LOL!]

You don't need to save anything until you contribute the maximum legally possibly to your retirement plans. That means you have to be putting $16.5K into your 401(k), $16.5K into her 401(k), $5K into your Roth, $5K into her Roth for a total of $43K a year. Only then should you think about a 529 plan. Use your mental capacity to see why this is what you should do.

 

[Jbird]

We max out our 401Ks and have traditional iras b/c our AGI is above the eligibility mark for a roth. We do not max out trad. iras however.

So why should I not look at th 529?

 

[LOL!]

Now that you are contributing the maximum to retirement plans, you can consider a 529 plan. You cannot borrow for your retirement, so get that secure before thinking about 529 plans. If you continue to max out your retirement plans for the next 18 years, you will discover that (a) you will have enough to retire any time you want and (b) you can simply stop contributing to retirement plans and use that cash flow to pay for college. Also by contributing the max to retirement plans, you force yourself to save and invest instead of spending it. That's a powerful live below your means behavior.

I'm not a fan of non-deductible traditional IRAs because investing in a taxable account in a tax efficient manner can be more productive and flexible. I suppose you will be converting the tIRAs into Roths next year.

We have 529 plans, but only started them after we were set for retirement. In just a few years, they have grown to tidy sums. We could also pay for college from current cash flow. In essence, high income folks like yourselves will have no problem paying for college with or without saving for it. But saving for retirement is another matter because it is more expensive and lasts longer than 4 to 8 years.

 

[FUEGO]

I was initially opposed to 529's in my state. However they have recently revamped the plans in my state and include a nice variety of low cost Vanguard and fidelity funds that are 4x cheaper than the previous offerings. They do add a 0.25% "administrative fee". However we get a state tax deduction up to $4800 per married couple that works out to $350 per year in tax savings from contributing that $4800.

My limited understanding of the withdrawal rules are that they are tax free for the contribution component of withdrawals but not the earnings except to the extent you have qualified education expenses. So the penalty for oversaving (ie 10% penalty plus ordinary tax rates) is only applied to earnings, not principal contributions (correct me if I am wrong here folks as I just skimmed the tax pubs recently on this and haven't double checked this). There is a waiver of the 10% penalty for amounts withdrawn that were qualified education expenses but were paid for by scholarships or were claimed as tax credits. So the oversaving penalty exists, but it is nowhere near as painful as I originally thought. And you can transfer beneficiaries to name anyone related. Even yourself, your spouse, nieces/nephews, grandkids, etc.

Qualified education expenses include almost all of the "cost of attendance" estimates that colleges' financial aid or registrar's offices provide except transportation and miscellaneous. Specifically, room, board, tuition, fees, books, required materials (ie laptop if req'd). At my local State U, that is $14-15k a year, and I'm assuming a 5% inflation figure on the whole amount.

I don't have my spreadsheet in front of me, but I figured out what saving the max to get the tax deduction ($4800 per annum) would do for my kids. My two kids are 14 and 15 years away from college, respectively. Based on my assumptions and a 9% growth rate, I was looking at having enough to pay for about 1/2 the "estimated cost of attendance". I figure this is a safe amount. Not too much to risk saving too much, and at least enough to pay the tuition and fees at a couple of great State U's, if nothing else.

I expect my kids will have a good shot at some limited form of scholarship or grant money, and heck, with the way things are going, higher ed may be extremely cheap or free (a la european model) in 15 years time. And there are always student loans and my regular portfolio to make up the difference.

Edit to add: I figured in the 529 plan I would have around $18000 per year for 8 years of college, and the cost of attendance would be $29000 to $36000 in 15-19 years. My total tax savings from the initial tax deductions plus not paying taxes on divs/CG's each year minus the extra 0.25% admin fees were something like $9000 or $11,000 total.

 

[Lusitan]

What happens if you end up with too much money in a 529 account? Do you get penalized on funds left over?

This seems to be your biggest concern. I believe that you can easily change the beneficiary of the 529 to someone else, such as:

- yourself, if you want to take some classes
- your spouse
- nieces, nephews,, or even grandchildren

Bottom line is that I think as long as it's used for educational purposes, you don't suffer any penalty. I also think educational purposes are defined broadly, and would include study abroad, trade school, etc.

In terms of how much to aim for, I am aiming to save up 4 years worth of undergraduate tuition at a good state school (using in-state tuition rates). Right now, that's about 100K in today's dollars. I'll know I have "enough" for each kid once I hit the "4 years of tuition in today's dollars" point, and from there I'll probably stop contributing and focus on the next kid's stash ... (and I'll just assume that my investments will keep up with inflation).

I think giving a kid a full-ride to a solid state school is a pretty good middle ground between paying for everything and having him shoulder the entire burden himself. YMMV

 

[FUEGO]

I forgot to add study abroad in there. It qualifies as far as I know, and I suppose one could "study abroad" themselves and use the $$ as long as the program if ran through the proper channels. And it would be a great enrichment experience for kids if you have the money to spend on it.

 

[angelbaby]

We max out our 401Ks and have traditional iras b/c our AGI is above the eligibility mark for a roth. We do not max out trad. iras however.

So why should I not look at th 529?

Here is what you should do to maximize your dollars, (in this order):

(1) Contribute to your 401k *up to the max that they'll match*.
(2) Max out your Health Savings Account (HSA).
(3) Max out your IRA(s).
(4) Max out the rest of your 401k.
(5) Put whatever remains into your 529 plan.***

If you make less than about $55,500 AGI married ($41,625 for head of household and for $27,750 single) AND less than $300 in investment or interest income, you should reverse 2 & 3 for now (until you get at least $2,000 contributed to either your IRA or 401k), because you would rather take advantage of the Saver's Credit (IRS Form 8880) instead of just getting a plain-old off-the-top tax deduction for your HSA contributions. In this case, by choosing the Saver's Credit you could reduce your monthly paycheck's withholding and have that amount automatically re-invested in your retirement account(s) prior to tax filing (so that it may grow for a whole year) instead of waiting for it come back in the form of a refund. But, you said that you make too much money to be eligible for a Roth, so you probably don't fall into that camp.

The reason I say you do these steps first and not the 529 is because:
(1) You can borrow for your kid's college education, but you can't borrow for your retirement.
(2) If your IRA grows large enough, any extra money can be used for education or buying a "first" home. IRA's a more flexible than 529 plans. 529 plans can only be used for education purposes.
(3) Not taking advantage of the 401k match, Saver's Credit and the HSA tax deduction is like throwing free money away.

*** The only exception with the 529 is if you have one of those 2% cashback Fidelity 529 College Savings credit cards, like I do. In which case, you open a Fidelity 529 Plan with the bare minimum amount (think it's $50 now) and link it to the credit card. Place all of your regular monthly purchases and bill on the card (groceries, utilities, cell phone bill, and maybe rent or mortgage) and get back 2% cashback of everything each month automatically put into your 529 plan.

To top this off, I registered the card with free my UPromise account, which is also linked to the Ohio 529 College Savings Plan (don't have to be from Ohio, BTW). I usually get back a variable percentage of cashback whenever we eat at a UPromise partner restaurant, buy groceries or shop online. I don't specifically go looking for UPromise partners. I just shop and eat where I want and the card automatically picks up the extra savings. When the Ohio Plan's balance is large enough, I'll do a rollover over of that money into the Fidelity 529 Plan.

These extra steps have allowed me to contribute $15-$20 a month free to automatic investments that I don't even have to think about or come out of pocket for, so I place them at the most aggressive investment plan risk. I'm young and don't have kids yet. When I actually have enough money to start contributing to one of these plans on my own and the money starts coming out of my own pocket, I'll moderate the risk of the portfolio abit and change the beneficiary away from myself and to my kid(s). For now, it's a cool experiment to watch the wild swings in the portfolio.

 

[Urchina]

Congratulations on your first baby! It's really exciting, but also a little nervewracking.

First things first: Have you got a will set up? Do that pronto. Don't wait until the baby is born, you'll be too busy then. Do choose guardians, etc. Also, now's the time to look into term life insurance if you don't already have it, or to up your coverage if you do.

As for whether or not to do a 529... we've chosen to keep our college savings for our kids in a taxable account for now, because we didn't really like the 529 in our state. It's improving, so what we'll probably do in the future is split our college savings -- 1/2 to the 529, 1/2 in the taxable account. This may not be the most tax-advantageous way to go, but I like the flexibility it gives us.

We fund these accounts automatically, with direct-deposit from our checking account. Each time our income goes up we bump up the contributions, so the raise goes directly into college savings. I'm amazed at how quickly these accounts have grown with what feels like minimal effort.

Of course, we max out our 401ks and IRAs before we do any college savings. Like a PP said, you can't take out government loans or get scholarships for retirement, and the last thing I want to do is send my kids to school and then ask them to support me because I didn't secure my own future.

Good luck and have fun with the little one!

 

[Maurice]

I did some research on the topic a year ago - in my case my planning was focused on the contingency of the child going to a very expensive school. Here's what I found. I've since updated the analysis with the latest year's Harvard Fact Book.


http://www.early-retirement.org/forums/showpost.php?p=599998&postcount=17

I'm nervous because I married a very intelligent person and if our child gets her genes she might be thinking ivy league. Hopefully our child will get my mental capacity and go to a state school and kill the rest of their brain cells there.

As a hedge you could always feed your child lead paint chips as a toddler....


Holy cow, did I just say that?

 

[Maurice]

More on the previous, my assumption at the time was to fund virtually all of it using iBonds, which I already own.


However, having investigated this more, i realized that ibonds redeemed for tuition are tax advantaged, but not ibonds redeemed for non-tuition expenses such as room and board. I therefore intend to use a mix of 529 assets plus my ibonds.

 

[Spanky]

I did some research on the topic a year ago - in my case my planning was focused on the contingency of the child going to a very expensive school. Here's what I found. I've since updated the analysis with the latest year's Harvard Fact Book.
http://www.early-retirement.org/forums/showpost.php?p=599998&postcount=17

Colombia - 44,812
Chicago - 44,613
U Penn - 44,212
Cornell - 43,757
Brown - 43,754
Harvard - 43,655
Stanford - 43,651
MIT - 43,550
Dartmouth - 43,341
Yale - 43,050
Princeton - 42,870

Outrageous cost!! It's hoped that a degree from one of these institutions will provide future earnings far greater than those from a less expensive one, i.e., University of California, University of Wisconsin (Madison), Ohio State.

Anyway, it's better not to put too much money into a 529 plan. Room & board and non-tuition related expenses are not eligible for disbursement from 529. Any amount taken for non-tuition related expenses will be penalized at 10% and any gain be taxed as income. If a scholarship is received, the amount used for non-tuition purposes taken out from 529 must be less that from the scholarship to avoid the penalty.

 

[Maurice]

Spanky, are you sure? I was under the impression that 529 plans could be used for non-tuition expenses such as R&B. If that's not the case, I won't bother opening one when DS is born.

 

[Maurice]

Spanky, FWIW Wiki thinks you can use 529 distributions for R&B, fees, and 'required' supplies.

 

[LOL!]

Uh, only folks with lots of money pay list price to go to college. Don't be put off by the costs. Get in first, then decide later how to pay for it.

 

[Spanky]

Maurice,

You are correct. Since my daughter receives a scholarship, the distributions under the the amount from the scholarship is not penalized but treated as income.

Thanks for pointing out the discrepancies.

Spanky

 

[Maurice]

Uh, only folks with lots of money pay list price to go to college. Don't be put off by the costs. Get in first, then decide later how to pay for it.

Are you serious? Should we retire first, then figure out how to pay for it?

Seriously, forgive the snarkiness, but aren't most of us here because we're the kind who plan ahead financially?

 

[stephenandrew]

Room & board and non-tuition related expenses are not eligible for disbursement from 529.

I believe money from a 529 can be used for room and board, as long as the fund beneficiary is at least a half-time student. Off-campus housing costs are covered up to the allowance for room and board that the college includes in its cost of attendance for federal financial-aid purposes.

 

[LOL!]

Are you serious? Should we retire first, then figure out how to pay for it?

Seriously, forgive the snarkiness, but aren't most of us here because we're the kind who plan ahead financially?

I am serious. I went to an elite private university like those listed above. Most people don't go to such expensive places. I worked during college 20 to 30 hours a week in order to pay for it. I worked during high school and saved money to pay for it. My roommates, in contrast, used their high school jobs to pay for cars, stereos, music, concerts, etc. They spent all their earning before college. They saved nothing, so then they didn't have any money for college. They got alot more financial aid than I got. In essence, they got the same education I got, but they also had cars, stereos, music collections, etc.

One of the reasons that college has gotten expensive is that people are willing to save up money and pay for it. Tuition prices simply increase to what the market will bear. Suppose the government announces a $5,000 per student grant to all incoming freshman. Guess what will happen? The cost of college will magically and instantly go up by $5,000.

By the same token, 529 plans are also increasing the cost of college. Those plans are simply money earmarked for the universities and colleges. They have no other purpose and universities know that. Their goal is simply to suck in all the money.

First you gotta get into that list of a dozen colleges before any of them will try to make you pay for it.

Sure you can save in 529 plans. We have even done so. But I see no reason to sacrifice my retirement plans just so some college can suck away that money.

 

[Darryl]

Maurice, my income is to high to to get the tax break on ibonds used to pay for college and I believe yours is too. I'm still buying though who knows maybe I'll retire before they go to school.

 

[Maurice]

Darryl - I will certainly be long retired when my kid goes to college, so I plan on having a rather low income. Nevertheless its good advice.

 

[Maurice]

Sure you can save in 529 plans. We have even done so. But I see no reason to sacrifice my retirement plans just so some college can suck away that money.

That seems to be a different argument - namely that one should only plan for what he can swing without sacrificing retirement plans. I certainly can't disagree with that.

 

[FUEGO]

Anyway, it's better not to put too much money into a 529 plan. Room & board and non-tuition related expenses are not eligible for disbursement from 529. Any amount taken for non-tuition related expenses will be penalized at 10% and any gain be taxed as income. If a scholarship is received, the amount used for non-tuition purposes taken out from 529 must be less that from the scholarship to avoid the penalty.

Can you verify this?

Here's what my 529 plan says in response to the question "what are qualified expenses?":

"These are expenses incurred for college such as tuition, fees, room, and board. Qualified expenses even include a range of things such as supplies and equipment that the institution requires the student to obtain as a condition of attendance. Net earnings in your 529 account are tax free when used for these expenses at an eligible educational institution."

My take is that basically everything that the colleges include in the estimated cost of attendance is "qualified" except "misc" and travel/transportation (and beer money).

I'd like to know, since these would dramatically impact my method of college savings.

edit: nevermind - I see my question has been answered. I forgot to refresh the thread for a few hrs and got distracted.

 

[FUEGO]

Sure you can save in 529 plans. We have even done so. But I see no reason to sacrifice my retirement plans just so some college can suck away that money.

This is my general approach. Max out the 401k, IRAs, etc. Then if I have the $4800 each year to take advantage of the 529 tax deduction, I'll do so. If I do it each year, I should have enough for the tuition plus a little more at a State U for 4 yrs for each of my kids.

But if I can't contribute that each year, then it won't matter too much. I'll just fund it out of the portfolio. I also plan to be ER'd before the kids hit college, so I'll just have to make sure I have that money sitting around somewhere if I think I'll need it. But you can always find money for college somewhere.

 

[Matt in OH]

Jbird, I am new to this forum so sorry for the tardy comment but I think I have a helpful strategy for you. I agree with most comments here that you should given your situation, be more concerned with saving for retirement as opposed to using a 529 plan.

However why not do both with one strategy. You are already maxing out your 401(K) and IRA contributions aren't deductible due to high income but why not contribute to nondeductible IRA's? If you don't have any taxable IRA's currently you could convert the nondeductible IRA's each year and not have any tax due on the conversion. If you have any appreciation, only the appreciation would be taxable but that would be minimal if you do the conversion right when the nondeductible contribuion is made. If you do have taxable IRA's, you may still want to consider this but when you convert to Roth IRA the conversion would not be tax free as the conversion would be partly taxable based on the value of all the IRA's. You can currently fund upto $5K in a nondeductible IRA each year for you and your spouse ($6k each if over 50 year old).

This stategy effectively removes the income limitations that currently prevent you from making contibutions to a Roth IRA.

Another idea if you currently have taxable IRA's would be to convert them to your 401(k) if you plan allows it. After doing this this would allow you to convert any future nondeductible IRA's tax free as you would no longer have any taxable IRA's.

I think you know the benefits of the tax-free Roth IRA which are basically the same as a 529 plan. The downside to the Roth is you can't take the earnings out until you are 591/2. However, you can always take out your contributions/conversions tax free which in itself should cover the tuition when you get to that point. If it doesn't the contributions/conversions to a Roth will be a very nice supplement to other college savings.

If you don't end up needing the money for college, the Roth isn't taxed like a 529 and continuies to benefit you and the beneficiary tax-free over your lives.

Sorry for the long reponse.

Happy new Year to all.