Why was I advised against a 529?

[NHRATA01]

Maybe bogleheads could shed some light on this, because I'm coming up empty. Let me give some background

NY residents, so of course we would be looking for a NY plan. We are 32/31, have kids 4.5, 3, and 4 weeks.

Aside from retirement investments of course (401K/403b and a Roth IRA), I had opened a taxable account in an online brokerage last summer after the market dropped precipitously, picked a few individual stocks (I realize this is not boglehead-ian), but also used it to open a recurring $300 monthly investment in VFINX (with a $5K initial deposit). No particular goals for the money, just to earn some kind of return above and beyond the emergency fund in a savings account. But anyway, I also began heavily considering the college burden for our two (at the time!) children. I had started to research the 529, I could do one through the online brokerage, but my regional bank also advertised 529s, and I thought perhaps they would be the better choice and understand NY's plan.

A couple months ago I scheduled a meeting with their investment person and inquire about enrolling in a 529. To my surprise, he advises against one. He felt they were a bit too restrictive, and not flexible enough if our needs changed in 20 years, such as the child not going off to college, scholarship, inheritance, etc. His opinion was they were more ideal for the grandparents looking to transfer assets while avoiding estate taxes and such. Personally he felt investing in a mutual fund was a better idea. He did suggest one offered by the bank's investment arm but to his credit he wasn't trying to do a hard sell or anything (and in fact he easily could've steered me to the bank's 529 plan which I likely would've bought into), and even admitted if I had an online brokerage I could just set it up there and throw in contributions as they were available.

So I ended up going and transferring a few thousand the two children had gotten in random gifts over their short lives from their savings (still leaving $2K in each), as well as another $150 per month recurring, into a no-load, no-transaction fee, relatively low ER mutual fund through the online brokerage. The thought was as they have birthdays, etc, I could thrown in the gift money without paying hefty transaction fees for low contributions, and still generating a decent return (about 10% YTD). But as I research more, and read more boglehead posts on them, I can't find any rational reason not to enroll in one. In fact I even searched on here for dissenting opinions and couldn't find one. So now I'm looking to move that money over into NY's 529 and that's how I'll proceed.

A caveat maybe helping his case (which he was unaware of) - I am an only child and sole heir to inheritances from my mother, father and aunt (and possibly a 2nd aunt), all of middle-class backgrounds. Mother and aunt have clearly stated they will offer some help with college costs down the line (either if they are still here or have passed on). Conceivably this could crack the 7-figure range, which even with tuition inflation should cover 3 kids at even the most pricey private institution. But I suppose it's easy enough to withdraw the 529 money and make up the difference with inheritance, and use the leftover to buy a Corvette . In any event I prefer to plan as if that potential money doesn't exist since the future can never be predicted.

So sorry for the rambling. I think I know what my plan moving forward is now. But I'm still baffled by his advice, and just wondering if anyone can logically support it, if I'm missing something in my analysis?

Regards.

[ted123]

It's not clear whether you are talking about 529 plans owned by you or your spouse for the children's benefit, or 529 plans owned by the children for their own benefit.

Assuming you meant the former, here are some arguments against 529 plans (there may be others):

1) Saving for retirement should be a priority over saving for college.
2) The relative tax benefits of 529 plans might be overstated, especially as compared to stock mutual funds held in taxable.
3) 529 plans are at a disadvantage to retirement plans and mortgage debt reduction when student aid is calculated.
4) If your child doesn't use the 529 funds, you may struggle to avoid a penalty on withdrawal.

That said, assuming retirement savings and consumer debt are under control (and acknowledging that there are probably a hundred other relevant facts about you to consider), I'd at least maximize the NY state tax deduction for 529 plans, if possible.

[plannerman]

Let me give you a couple of additional 529 plan pros to consider.

1) 529 plans are an attractive place to put monies your mother and aunt might want to contribute every year to your children.

2) as your children get closer to college age, it is likely you will want to direct an increasing portion of their college savings into fixed income investments. The tax free aspects of a 529 plan will look a lot better then.

plannerman

[letsgobobby]

529s have restrictions, but the penalties are not that onerous. Further, it is hard to imagine oversaving for college when you have three young children. If one doesn't go to college, two will. If two don't go to college, one will. The beneficiary can be transferred repeatedly. In 20 years, private college may cost $600,000 for four years - per child.

Now if all three of your kids end up with full-ride scholarships, then you will have oversaved. But you will know that 10% penalty and ordinary income tax on your earnings will be a small price to pay for not having had to pay $1.8 million for college.

Other related threads:

viewtopic.php?f=1&t=90781&hilit=+529

viewtopic.php?p=1042362

viewtopic.php?p=600489

[NHRATA01]

Thank you all for the feedback.

Ted123, I think your conclusion at the end of the post is basically what I have arrived at now, start off contributing the amount allowed for the NYS income tax deduction.

Planner, yes mother had already opened a 529 for my daughter shortly after she was born, and has been contributing some funds. Not sure about aunt. In unison with the links from the third reply, I'm thinking about what you said and fathom utilizing the 529 for primarily tax inefficient investments (REITS and Bonds) while still contributing to stock index funds in my taxable account, while working out a suggest total AA amongst all of the college savings accounts.

[Live Free or Diehard]

Now if all three of your kids end up with full-ride scholarships, then you will have oversaved. But you will know that 10% penalty and ordinary income tax on your earnings will be a small price to pay for not having had to pay $1.8 million for college.

It's been a few years since I read through the IRS publication on 529 plans; but it's my recollection that if you have scholarships you can withdraw money from the 529 plan for the amount of the scholarships and the only penalty is that the gain is taxed as income. The 10% penalty doen't apply.

I looked in Publication 570 and on Page 58 it lists the exception to the 10%. One of the exceptions is tax-free scholarships or fellowships.

[letsgobobby]

great point, I completely forgot.

[travellight]

I find them too restrictive and am foregoing the 529 plans. I prioritize fully funding my 401K first, then my IRA, and then paying down my mortgages. If I had all three of these paid up/off, then I would do a 529 plan but I won't have my mortgages paid off till he starts college. His college education will then become my new mortgage.

[letsgobobby]

my only problem with that approach is that college tuition is inflating at 7% or more per year while my mortgage is only 4.25%. So the math doesn't work, I don't think.

[LH]

if you plan to pay for your kids college then 529s are the way to go.

Just project how much you plan to pay, and fund at least 1/3rd to 1/2. If you only fund 1/3rd, and only 1/3 kids goes to college, its ok.

Its a great tax break.

Now if you are not saving enough for retirement for yourself, its a different deal. But look hard at that, and then, if you are going to pay some/all of college, then putting money in 529 is a no brainer. You may get 1-2 doublings off money you put in now, tax free, hard to beat.

My kids are 9 and 10. I have 529s that half fund them to go to a reasonable private school if they choose, and fully fund a public one. But you definitely need to look hard at your retirement first, its a priority. But if you ARE gonna pay, you might as well get the big tax break from 529 by saving early in 529...

[LH]

I find them too restrictive and am foregoing the 529 plans. I prioritize fully funding my 401K first, then my IRA, and then paying down my mortgages. If I had all three of these paid up/off, then I would do a 529 plan but I won't have my mortgages paid off till he starts college. His college education will then become my new mortgage.

I would split the difference a little bit at least.

Put some in 529 and diversify.

[gwrvmd]

Two point that hasn't been made yet:
1) 529 plans are not sold through brokers so it obvious he would steer you to something that he sells. There are no sales commissions on 529 plans
2) You can use any state's plan and the available options vary considerably. I fund 529 plans for 6 grandvhildren through the Nevada 529 plan which is not where I live nor where the children live. I chose it because it had the most options from Vanguard. I chose 18 years of good options and low cost over a one time state tax deduction. Vanguard considers the Nevada 529 Plan "their plan" and if you contact them for a 529 plan, they will send you the Nevada Plan. I understand the Utah plan has multiple Vanguard options also as do some other states recently. 529 plans are relatively transparent and Vanguard has benefited from the published comparison of plans by financial publications. Initially some bank, brokerage and insurance options were borderline abusive, but published results got many of them replaced by Fidelity or Vanguard options. Anyway, you should know the options. If you don't like the NY State options, contact Vanguard for the Nevada Plan and then make your decision. All states would love to have you in their plan so any state will send you a 529 package. Incidently, you can change options once a year and even to a different state plan once a year..... Gordon

[LadyGeek]

Although I don't have the background to give advice here, I was wondering why no one has mentioned I Savings Bonds.

If I Bonds are redeemed for qualifying education expenses, the interest is completely tax free, provided certain conditions are met.

The wiki has additional background info: 529 Plans and New York 529 Plan

[ted123]

Two point that hasn't been made yet:
1) 529 plans are not sold through brokers so it obvious he would steer you to something that he sells. There are no sales commissions on 529 plans
2) You can use any state's plan and the available options vary considerably.

1) Actually, some plans are sold through brokers (not that I would recommend them). In fact, I think the OP asked the advisor about them because the bank he works at advertised them.

Virginia actually has two separate 529 plans, one self-advised (VEST) and one sold through advisors (College America).

2) It's true that you can use any state's plan and the options vary, but the OP is a NY resident and will receive state tax deductions for using the NY plan (which is fine, IIRC).

[blevine]

NY plan not only gives you a good tax break but it offers Vanguard funds at low fees,
and a variety of the more popular index funds (Total Bond and Total Stock, Inflation).

I really don't see what there is to think about. Put at least $5k/account for each of 2 kids
to get the $10k/year deduction from your NYS taxes. I rarely put more than that in, but
if you are already maxing out 401k or other tax deferred retirement vehicles and have more
to save, why not get the federal tax break on the earnings here as well ?

With just $5k/year you can easily save up 1/2 the cost of private school, maybe the full
cost if you start young.

As pointed out above, I bonds are another good way to save for college,
but you have to put up with the Treasury Direct site and it's rather sensitive security
and lack of timely support. I use it anyway as it's another way to defer Federal taxes
and save on NYS taxes.

[travellight]

If you are in a state like NY where you get to deduct it from your state taxes, it does seem like a no brainer to me.... do the 529 plan.

I am in California and I don't think that is the case here. I would fund a 529 plan before I fund a taxable investment account but I don't have any money in anything like that either.

I guess it is similar to an IRA in that it is after taxed money but grows tax free. It comes down to 529 versus prepaying down my mortgage..... tough choice. I will consider your advice about splitting the difference.

[supersharpie]

my only problem with that approach is that college tuition is inflating at 7% or more per year while my mortgage is only 4.25%. So the math doesn't work, I don't think.

I may be proven wrong but I think that college tuition is a bubble that is just about to burst. 7% inflation is simply not sustainable in the long run.

[letsgobobby]

my only problem with that approach is that college tuition is inflating at 7% or more per year while my mortgage is only 4.25%. So the math doesn't work, I don't think.

I may be proven wrong but I think that college tuition is a bubble that is just about to burst. 7% inflation is simply not sustainable in the long run.

Maybe. But it's been inflating that way for thirty years.

[Gray]

Most states with 529s offer tax breaks. You have to factor that into your evaluation.

So if this "investment advisor" wants to steer you into "flexible" actively managed funds with high expense ratios and under performing investments, tell him to get lost.

Use your State's 529, invest in an index fund that matches your risk tolerance and time horizon, and dollar cost average your investments each month.

I have a "2018" plan for MD via T Rowe Price as well as the MD Prepaid Tuition Plan (paid off)--both 529 plans.

My daughter is definitely college bound, and with these two funds, I could pay for 5 years of MD public university undergrad and 3 years of grad. I will recommend that she avoid private for undergrad unless she is offered a partial scholarship to equalize the cost, in which case I'd say go for it.

[arthurb999]

I'm not at a point where I have all my personal tax advantaged space filled in yet but I have a 529 anyway. It's really so grandparents, aunts, etc, feel comfortable depositing money for the kids and know it will be earmarked for college.

I tried pitching them to put it in my ROTH but it failed

[cyclysm]

Although I don't have the background to give advice here, I was wondering why no one has mentioned I Savings Bonds.

If I Bonds are redeemed for qualifying education expenses, the interest is completely tax free, provided certain conditions are met.

The wiki has additional background info: 529 Plans and New York 529 Plan

My guess is it has to do with the uncertainty of meeting the "certain conditions" in the future. If rules change regarding 529s, I believe (hope?) they would grandfather existing contributions. If they change the income limits, or even the education expense benefit of I Bonds, I'm less confident there would be a way to grandfather in your current savings. How would anybody know my I bonds were for college and yours were for inflation protection? A 529 is pretty obviously a college savings tool.

[chuck-lyn]

Some folks find the flexibility of a ROTH very useful for funding college expenses.

Cheers,

charlie

[555]

Some folks find the flexibility of a ROTH very useful for funding college expenses.

I believe Roth withdrawals count as income for FAFSA purposes, so a Roth is distinctly worse than a 529 in this regard.