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Alternatives to 529s for kids educations?
Old 02-05-2008, 07:57 PM   #1
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Alternatives to 529s for kids educations?

Hi, new to the boards. My DH and I just did the math and realized that with some belt-tightening we can semi-FIRE in about 8 years. We'll be 41 and 42, respectively, and our kids will be 10 and 8, respectively.

We've been saving for their educations in a taxable high-interest savings account, but now have enough saved to start looking at investments with a better return. By all accounts our state 529 (California) is a pretty good one, but my concern is the penalty you pay (in addition to taxes) on money withdrawn if your child doesn't go to college. I think this penalty would probably erase any gains and might even erase some principal. I'd like to keep our options open -- maybe we have an artist or entrepreneur here, and I'd like to keep the money available and maximized for their future dreams.

Our goals for this savings are:
1. Flexibility of final use (college or trade school or art school or small business, etc.)
2. We don't want to hand the money over, carte blanche, when the kids turn 18 or 21 or even 25. We'd like final control and say over where the money goes and at what time.
3. Tax-advantaging.

Any suggestions?
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Old 02-05-2008, 08:56 PM   #2
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You have the flexibility to change the 529 beneficiary. So, make the bet that at least one of your kids will go to college, for example. Savings bonds can be used tax-free for college (assuming your AGI is low enough), and you'd only have to pay normal taxes if you used the proceeds for yourself. But the returns ain't great.

We pretty much split it down the middle for our 4-yo. Half in a stock-based 529 plan, and half in savings bonds. If she doesn't go to college, maybe I'll go myself.
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Old 02-05-2008, 09:14 PM   #3
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I use my 401k, but I've never seen anyone else endorse this idea. IRA early withdrawals are penalty free if used for dependent college expenses. My 401k permits rollovers to an IRA and then I withdraw from the IRA. I believe the tax consequences are comparable to a 529 plan unless your tax bracket changes between the time you put the funds in and the time they are withdrawn. You have to pay regular income tax for whatever bracket you are in, but no penalty.

When I first started saving for college, 529s did not exist so I just put everything into my 401k figuring I would use a 401k loan or 72t to get the money out. By the time I got comfortable with the 529 plan, I realized I had more flexibility with my 401k/IRA scheme.
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Old 02-05-2008, 10:29 PM   #4
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If you use your IRA, the money is only tax deferred. Whereas the 529 is tax free if used for education purposes.
On the other hand, if you set up the 529, you are still owner and therefore can change beneficiaries to a grandchild, nephew, neice, or use it for yourself later in life to go to golf school.
Thus far, the rules are very liberal on how the money is used. I looked into buying a house to use as rental property near my daughter's school and let her live there(you can use it for room and board), then sell it later, and all using tax free money. Surprisingly, there are really no rules in place against this.
BTW, you don't have to use the California 529 just because you live in that state, you can use any state's.
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Old 02-06-2008, 12:20 AM   #5
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I use Coverdell Educational Savings Accounts for my grandchildren. They are as flexible as a self-managed IRA in terms of investment choices and the money is tax free when used for a wide range of educational expenses including elementary school, high school, trade school, college and related expenses. They can be transferred from one child to another. They are offered by all the major investment companies such as Vanguard, Schwab, Fidelity, etc.

The main drawback is that you can only contribute $2k/yr per child. I have three grandkids and the total of $6k I contribute is about all I can afford anyway, so, no issue for me. I start the year they're born, so it'll eventually add up to a year or two of school. Their parents can do the rest!

Before you make your decision, do an internet search and read a few articles about them. BTW, they were previously called Educational IRA's.

edited to add: Publication 970 (2007), Tax Benefits for Education
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Old 02-06-2008, 12:31 AM   #6
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I was too late to use 529s for my kids but I have one each for my 4 grandkids. I contribute the max. for tax savings for me each year. If any one of them chickens out their funds can be transfered to the other acccounts. I own the account so I can move $$, pick what funds to invest in, and I also do the payout directly to the school for tuition or books. Worse case is none of them go and I am stuck with several thousand $$$ in 529 accounts. If no direct relation is around to sent to school I would then have to eat the tax defered gains and pay back the tax savings but the original invested cash and the gain is still mine. We see it as a good gamble. It makes the grandkids aware that there is money there to help them WHEN they do to college. If they drop out the get Zip! They know how much is in there because we tell them each Dec. 31. We are trying to incent them to want to go for higher education. Their parents were not able to do so but I am pushing hard to get them interested and motivated. I hope I am successful.

For my kids, it did it with US Savings bonds but mostly out of my paycheck. The left over bonds I gave them when they graduated. They both worked part time while in school and helped pay their own way. No loans for either of them.

The 529s are with Vanguard and are state specific so I save state taxes on them each year I contribute which is great.
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Old 02-06-2008, 07:50 AM   #7
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If you use your IRA, the money is only tax deferred. Whereas the 529 is tax free if used for education purposes.
.
529 plan WITHDRAWALS are tax free. Your contributions are after tax and they do not tax you on the gain if used for education.

So if you are in a 25% tax bracket and you earn $100, you could:
  • put $75 in a 529 plan and if it doubles in x years you'd have $150.
  • put the full $100 in a 401k and if it doubled in x yrs you'd have $200 - $50 (tax @ 25%) = $150 to pay education expenses.
I AM NOT saying this is better than a 529, just saying there's not that much difference tax-wise. Some states do have a deduction for in-state plans. If I was starting now, I would use probably use a 529 as well as some of the other vehicles.
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Old 02-06-2008, 09:19 AM   #8
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I was too late to use 529s for my kids but I have one each for my 4 grandkids. I contribute the max. for tax savings for me each year. If any one of them chickens out their funds can be transfered to the other acccounts. I own the account so I can move $$, pick what funds to invest in, and I also do the payout directly to the school for tuition or books. Worse case is none of them go and I am stuck with several thousand $$$ in 529 accounts. If no direct relation is around to sent to school I would then have to eat the tax defered gains and pay back the tax savings but the original invested cash and the gain is still mine. We see it as a good gamble. It makes the grandkids aware that there is money there to help them WHEN they do to college. If they drop out the get Zip! They know how much is in there because we tell them each Dec. 31. We are trying to incent them to want to go for higher education. Their parents were not able to do so but I am pushing hard to get them interested and motivated. I hope I am successful.

For my kids, it did it with US Savings bonds but mostly out of my paycheck. The left over bonds I gave them when they graduated. They both worked part time while in school and helped pay their own way. No loans for either of them.

The 529s are with Vanguard and are state specific so I save state taxes on them each year I contribute which is great.
I'm not sure I'm interpreting what you are saying correctly, however, just to clarify, if you don't use the 529 money for education, then you pay TAXES on the gains. You don't pay back the gains. The IRS also says that a 10% penalty MAY apply. Not quite sure about the exceptions?
A side note, having a 529 may affect the amount of Pell Scholarship a child can qualify for, so if you're a grandparent aiding a child and the parent is paying the lion's amount, you just may want to consider whether or not your contribution will get cancelled out.

On a side note, check out UPromise.com. This is where all your money can be going by all those little discount cards the grocery stores issue out now. That 1 or 2% savings could be going directly into a 529 plan for your kids and it will cost you nothing. Some restaurants and stores will pay in even more. It may not be that much, but it paid for my daughter's SAT prep course.
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Old 02-06-2008, 10:14 AM   #9
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The main drawback is that you can only contribute $2k/yr per child. I have three grandkids and the total of $6k I contribute is about all I can afford anyway, so, no issue for me. I start the year they're born, so it'll eventually add up to a year or two of school. Their parents can do the rest!

Before you make your decision, do an internet search and read a few articles about them. BTW, they were previously called Educational IRA's.
That works as long as the parents don't have their own Coverdell setup for each of their kids.

I use a Coverdell account but am considering switching it to a 529. I think in 2010 the max contribution is scheduled to drop to $500
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Old 02-06-2008, 10:29 AM   #10
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That works as long as the parents don't have their own Coverdell setup for each of their kids.

I use a Coverdell account but am considering switching it to a 529. I think in 2010 the max contribution is scheduled to drop to $500
So folks don't get confused......... The contribution limit of $2K is per child, not per contributor. So, yes, if the parents are also contributing to each child's Coverdell, or to Coverdells they set up for each child, the total contribution can only be $2K combined.

I'm counting on the 2010 reversion to $500 to be cancelled and the higher limit extended. If it isn't extended, I'll open 529b's but won't transfer the Coverdells. I like the investment flexibility of Coverdells I can't find in 529b's.
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Old 02-06-2008, 11:34 AM   #11
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I'm not sure I'm interpreting what you are saying correctly, however, just to clarify, if you don't use the 529 money for education, then you pay TAXES on the gains. You don't pay back the gains. The IRS also says that a 10% penalty MAY apply. Not quite sure about the exceptions?
A side note, having a 529 may affect the amount of Pell Scholarship a child can qualify for, so if you're a grandparent aiding a child and the parent is paying the lion's amount, you just may want to consider whether or not your contribution will get canceled out....
According to the UESP (Utah) plan, Fed. taxes are deferred on the gains within the account if used for higher education by the account beneficiary. If the account is not used for this purpose, then the GAIN is then taxable. A 10% penalty is also imposed. From a State tax standpoint, any tax credits taken over the life of the account would have to be paid back to the state for any disallowed distributions.

Since we will be paying the lion's share of their college expenses (at this point) we don't see an issue with financial aid. But that could change. It is a risk we accept with this plan.
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Old 02-06-2008, 11:43 AM   #12
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Again, I'm confused. If we're talking about a 529, then the taxes if used for the beneficiary are tax free, not deferred. If not used for this purpose, then the taxes have already been deferred (since they haven't yet been paid). As to state taxes, I'd have no idea what they are in Utah.
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Old 02-06-2008, 12:10 PM   #13
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Wow, thanks for all the responses. We may split up the savings into several different pots, since we are maxing out our IRAs (not eligible for Roths anymore), and my parents are also interested in contributing. So, what we might do is open a 529 for grandparent contributions and some additional money from us, and then open a taxable brokerage account for money that we want to keep more flexible. We may also look at a Coverdell, too, but the tax savings appear to be pretty minimal for us.

Along this thread as well, has anyone considered a UTMA or an educational trust? Any experience with either of these?
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Old 02-06-2008, 12:14 PM   #14
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Again, I'm confused. If we're talking about a 529, then the taxes if used for the beneficiary are tax free, not deferred. If not used for this purpose, then the taxes have already been deferred (since they haven't yet been paid). As to state taxes, I'd have no idea what they are in Utah.
The UESP manual states "tax deferred" for Fed. taxes. I agree they are tax free to the beneficiary if used for higher education. I believe they are trying to state a tax would be due if you don't use the account for higher education.
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Old 02-06-2008, 12:17 PM   #15
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I looked all the plans over up and down. Found something in each one that I really, really hated.

If I was working and making big money, I guess I'd hold my nose and contribute to a 529 for Gabe.

Given I have a good measure of control over our tax rate in retirement, I decided to just include college expenses in our regular taxable account planning and pay for school, business or whatever I want to spend on him from that and just pay the single digit taxes on it.

Or if he's a little **** when he's a teenager (highly plausible considering that I was), I'll just keep it and he can have it eventually when I kick the bucket. Unless he continues to be a little ****, in which case I'll buy a cat and leave it to the cat.

The sad part is that when he reaches college age, we'll almost be old enough to pay for his school out of our IRA's... :
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Old 02-06-2008, 12:35 PM   #16
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Urchina,

If you trust your parents and/or they live in a state with a better 529 plan or better tax benefits associated with the 529, there would be some advantage in having them open the 529 accounts and be the account owner instead of you, because their assets are not considered for financial aid purposes.

I'm not sure if it has been noted in this thread, but there are many states that provide some sort of state tax benefit for contributions to 529's. In Idaho, for example, I can deduct contributions up to $4K as a single taxpayer off my state taxable income, which amounts to about an 8% savings.

My kids each have a UTMA account, but I am shifting assets from these to 529's and ESA's. I am shifting primarily to simplify my life (going from 9 college accounts to 6), to increase the flexibility (UTMA money belongs to the specific child, 529's and ESA's are more flexible), and to have more control over how those funds are used. With the new kiddie tax rules, the advent of 529's, and the increased contribution limit on ESA's (from $500 to $2000), I don't see any real reason for UTMA accounts.

Can't speak to an educational trust. My guess is that they would be more expensive to set up than any of the other kinds of accounts.

My plan is to have most of the money in 529's, some in ESA's, and supplement as needed from a Vanguard taxable account. Then there are scholarships, tax breaks, the kids' earnings, my salary, student loans, financial aid, etc.

To be honest, my concern is more about just having enough money in the accounts for all three of my kids, and then how to be reasonable and fair to each of them as they will all take different paths in life. I have some ideas in this area but they are not fully fleshed out. In general, I am considering their three college educations collectively; funds will be shifted among them and passed down as necessary. In general, if I have surplus funds when all three are done, I will distribute them to each child in some proportion to how much their college cost. If I have a lack of funds, my youngest will end up with student loans which I will pay back.

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Old 02-06-2008, 02:00 PM   #17
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Urchina,

If you trust your parents and/or they live in a state with a better 529 plan or better tax benefits associated with the 529, there would be some advantage in having them open the 529 accounts and be the account owner instead of you, because their assets are not considered for financial aid purposes.

I'm not sure if it has been noted in this thread, but there are many states that provide some sort of state tax benefit for contributions to 529's. In Idaho, for example, I can deduct contributions up to $4K as a single taxpayer off my state taxable income, which amounts to about an 8% savings.

My kids each have a UTMA account, but I am shifting assets from these to 529's and ESA's. I am shifting primarily to simplify my life (going from 9 college accounts to 6), to increase the flexibility (UTMA money belongs to the specific child, 529's and ESA's are more flexible), and to have more control over how those funds are used. With the new kiddie tax rules, the advent of 529's, and the increased contribution limit on ESA's (from $500 to $2000), I don't see any real reason for UTMA accounts.


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Uhhh, I don't think so. When filling out your college paperwork (just did this last year), they don't ask who has 529 plans for you, just if you have one. So, whether or not it's in your name, or someone else's, if it's for your kids, you have to list it.
With that said, if your parents live in a state that offers better tax benefits, it may be prudent to let them set them up. For instance, in Texas, being that we have no state tax, it's easier for me to consider any state's 529 plan vs. a state which may offer state tax relief if using their plan.
As to your thoughts on UTMA/UGMA's, I'd agree. I can't think of any reason to start one now either....ok, perhaps to avoid a potential 10% penalty later.
Oh yeah, as mentioned elsewhere, when applying for a PELL grant (which you will most definitely want to do no matter how much money you have), they don't consider the 529 money as strictly as if the kid had his own UGMA or you have the cash set aside.
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Old 02-06-2008, 02:19 PM   #18
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We may also look at a Coverdell, too, but the tax savings appear to be pretty minimal for us.
Fed tax savings would be the same for a Coverdell as for a 529b.
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Old 02-06-2008, 02:37 PM   #19
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Uhhh, I don't think so. When filling out your college paperwork (just did this last year), they don't ask who has 529 plans for you, just if you have one. So, whether or not it's in your name, or someone else's, if it's for your kids, you have to list it.
Good to know, Art. I was not speaking from personal experience; I was relaying what I had read in various personal finance articles. Guess I forgot they sometimes don't get everything right ;-).

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Old 02-06-2008, 02:41 PM   #20
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Good to know, Art. I was not speaking from personal experience; I was relaying what I had read in various personal finance articles. Guess I forgot they sometimes don't get everything right ;-).

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No prob. At least I hope I'm remembering that right. Anyway, I just received a tax form regarding my daughter's scholarship, so I'm trying to determine whether or not I'm going to get hit for taxes now?
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