Paying for College - 529s vs. Mutual Funds

[eastnortheast]

We currently have 2 kids in their first year of college. We had set up 529 plans for them a while ago and have been pretty good about putting money in them on a monthly basis. We currently have enough in each 529 to fully fund ~ 2.5 years college for each. In addition, we have ~ $80K in various mutual funds that are not part of our retirement planning/calculations. I have had these funds for 20+ years. Used to contribute monthly to each of them, but stopped about 15 years ago and put the money into 529s.

My question is if the wise minds here think it is better to completely deplete the 529 plans and then tap into the mutual funds, or draw down a little from the mutual funds over the course of their college careers to supplement withdrawls from the 529s?

With the mutual funds, figuring the cost basis would be difficult. I dont have the old statements from years ago. I was (am) very much a buy and hold investor.

We are eligible for some un subsidized college loans, but I would prefer not to go down that route so have not taken any and do not plan to. We have taken the (minimal) subsidized loans we were eligible for as the payment and interest will be deferred until after the girls graduate.

I dont see my job situation undergoing any major changes, so family income should be relatively constant for the foreseeable future.

As an FYI, there are other kids in the family coming up on their college years and we have separate 529 plans for each of them. I would prefer to keep the accounts separate and not raid the younger ones plans to pay the older ones college costs.

Thanks for your thoughts!

 

[rodi]

I would use the 529's first. The gains are tax free if used for qualified expenses. So that money has a tax advantage if used for college... might as well take advantage of that advantage.

When that runs out - use the other money.

 

[TallTim]

+1 to Rodi. That's the smarter play.
If you have UTMA or UGMA accounts, use them after the 529s as the gains would be taxed at the presumably lower rates of your kids.
Use your mut fund holdings last.

 

[pb4uski]

+2 And on the UGMA accounts the mutual fund company MAY have records of the cost basis. You may want to do some gains trading in those accounts annually to take advantage of the kiddie tax allowances if they are still your dependents.

See https://ttlc.intuit.com/questions/1900671-what-is-the-kiddie-tax

 

[LOL!]

In 2014, I had two kids in college at the same time.

Does your AGI / income allow you to get the American Opportunity Tax Credit of $2500? Is it per student? If so, then you want to pay $4,000 not from 529 in order to capture that tax credit. Where else can you get a $2500 return on $4000?

For the AOTC, qualified expenses are slightly different than for 529 plans.

Then you can use the 529 plans to pay for some more college expenses. We just divided our 529 plan money over the 4 years and did not try to spend it all at once.

With any other expenses, you can just use cash flow.

Also, look into using a 2% cash-back credit card for all expenses. Our university doesn't even charge a fee to use a credit card for tuition. So it is like a 2% discount on those expenses.

And there are other tax breaks for college. Be sure to read all of IRS Publication 970 for all the details.

BTW, UTMA/UGMA accounts can be helpful, but be aware of the so-called kiddie tax if your kids have too much unearned income. The reality is that you might save $300 on taxes total per kid. But hey, $300 is $300. And UTMA/UGMA is counted the mostest against financial aid.

 

[sengsational]

Since you have "taken the (minimal) subsidized loans", I presume you filled out the FAFSA. So you need to have the kids spend every dime they have in their name (529's are in your name, not theirs...they are the designated beneficiary). So if they have a UTMA/UGMA, you know that's a EFC killer. If you showed the kids had funds, then those funds evaporate beyond what the budget was for 1 year at their school, that might raise and eyebrow with the financial aid officer, though. But I suspect they don't have any significant assets in their name?

Another assumption is that you're dead-set on paying all of the college costs. There are plenty of kids "working their way through school", but I didn't go that route with my kids, and I'm not going to make a case either way, just presume that's what you're going to do.

I'm going to be a bit different in my recommendation for spending from the 529's or not. Let's presume that it's highly likely that the kids will finish their degrees. Even if they don't you could make the younger kids beneficiaries for the remainder of the older kids' account, so the money won't be "stuck" under a tax penalty. So, given that you know for sure that the money will be needed in the future for education expense, why not let it compound tax-free? That's the power of these kinds of accounts...you never pay taxes on earnings.

So not only do I say pay 100% for college out of your mutual funds, there's even an argument to be made to "anti-raid" the younger kids' accounts by funding your current kids without the 529 all the way to graduation and using the unused 529s (plus the untaxed compounding) against the younger kids education. Of course that involves a bit more risk because it's possible that the younger kids won't go to college or won't need the money (athletic scholarship, etc). And of course you'd have your own side calculation so that things would come up even between all of the kids.

 

[eastnortheast]

Very good replies. The advice is greatly appreciated.

To answer a couple of the above questions - none of the kids has a UTMA/UGMA. (I am a bit embarrassed to admit that I did not know what those were and had to look them up. ) They do not have any assets in their names.

We do plan on paying for their college (at least the first four years). May ask them to pay back the subsidized loans, but will determine that in another four years.

I will have to take a look at the American Opportunity Tax Credit. Just in the process of doing taxes this year, but will definitely see if I can take advantage of it for 2016. Same with IRS Pub 970.

Again, thanks for all of the good advice.

 

[jIMOh]

We currently have 2 kids in their first year of college. We had set up 529 plans for them a while ago and have been pretty good about putting money in them on a monthly basis. We currently have enough in each 529 to fully fund ~ 2.5 years college for each. In addition, we have ~ $80K in various mutual funds that are not part of our retirement planning/calculations. I have had these funds for 20+ years. Used to contribute monthly to each of them, but stopped about 15 years ago and put the money into 529s.

My question is if the wise minds here think it is better to completely deplete the 529 plans and then tap into the mutual funds, or draw down a little from the mutual funds over the course of their college careers to supplement withdrawls from the 529s?

With the mutual funds, figuring the cost basis would be difficult. I dont have the old statements from years ago. I was (am) very much a buy and hold investor.

We are eligible for some un subsidized college loans, but I would prefer not to go down that route so have not taken any and do not plan to. We have taken the (minimal) subsidized loans we were eligible for as the payment and interest will be deferred until after the girls graduate.

I dont see my job situation undergoing any major changes, so family income should be relatively constant for the foreseeable future.

As an FYI, there are other kids in the family coming up on their college years and we have separate 529 plans for each of them. I would prefer to keep the accounts separate and not raid the younger ones plans to pay the older ones college costs.

Thanks for your thoughts!

I would use the 529's first. The gains are tax free if used for qualified expenses. So that money has a tax advantage if used for college... might as well take advantage of that advantage.

When that runs out - use the other money.

I would use the mutual funds FIRST
then use the 529s to pay the balance

I would also ask different questions leading to the advice above...

First is do you qualify for the federal tax deductions for education. These used to be the hope credit, then it was something like the American opportunities tax credit, then it might get renamed again. These tax credits are better than any deduction a 529 can give you and should be how planning is done, is my opinion.

Use the mutual funds to pay for $X of college
the tax credits pay $1 for $1 on first $a of tuition
then pay a % on every dollar for next $b of tuition

x=a+b

Up to $2,500 credit per eligible student

$2500 is max credit

Figuring the Credit

The amount of the American opportunity credit (per eligible student) is the sum of:

100% of the first $2,000 of qualified education expenses you paid for the eligible student, and

25% of the next $2,000 of qualified education expenses you paid for that student.

x=$2000+$2000=$4000
Pay first $4000 per year from mutual funds (and create a solid paper trail for where $4000 is being paid to tuition.

No Double Benefit Allowed

You can't do any of the following.

Deduct higher education expenses on your income tax return (as, for example, a business expense) and also claim an American opportunity credit based on those same expenses.

Claim an American opportunity credit in the same year that you are claiming a tuition and fees deduction for the same student.

Claim an American opportunity credit for any student and use any of that student's expenses in figuring your lifetime learning credit.

Figure the tax-free portion of a distribution from a Coverdell education savings account (ESA) or qualified tuition program (QTP) using the same expenses you used to figure the American opportunity credit. See Coordination With American Opportunity and Lifetime Learning Credits in chapter 7 and Coordination With American Opportunity and Lifetime Learning Credits in chapter 8.

Claim a credit based on qualified education expenses paid with tax-free educational assistance, such as a scholarship, grant, or assistance provided by an employer. See Adjustments to Qualified Education Expenses next.

Just look up the following on IRS web site:
pub 970
https://www.irs.gov/pub/irs-pdf/p970.pdf
https://www.irs.gov/Individuals/Education-Credits:-Questions-and-Answers

529 monies can be used for more than what the credit pays for
Make sure you read up on which expenses are eligible for which tax benefit.

It is MY OPINION that the $2500 tax credit on federal return is a bigger benefit than the tax savings of the 529 going in combined with the tax free compounding of the 529 plan if you are eligible for the federal credits.

 

[dtbach]

I have 529s for my kids but well below what it will cost me to put them through college. So the first $4000 comes out of income (to get my $2500 AOC tax credit), then the next $3000 out of their 529, then X amount that covers tuition.

I told them that they are on their own for room and board. I put myself 100% through college on my own and feel that unless you have some of your own money in the game you won't expend the best effort. I've seen too many kids who got everything paid for and used school as a time to party.

to each his own