College savings for a high-income household

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nobility
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College savings for a high-income household

Post by nobility » Mon Dec 30, 2013 6:02 pm

We're having our 1st child (of potentially 3) in a few months and I've started to think about college savings.

My background:
Age: 29
Net worth: $1.3 million (~500k in tax-advantaged accounts)
Tax bracket: 33%, approaching 35%
Mortgage: 240k @ 4.37%, prefer to keep for tax deductions
Maxing out 401k.
Contributing ~31k to Roth IRA anually (5.5k via IRA backdoor, and ~25.5k via 401k after tax)
Rest goes into taxable

The 529 plan I'm considering:
Colorado (my state) 529 plan: https://www.collegeinvest.org/our-savin ... io-details
Investments: Good vanguard funds, I can pick essentially an allocation based on Total Us, Total Intl, Total Bonds.
Expense ratio: .46%, this probably atleast 5x higher than the equivalent admiral shares of US & Intl I can get in my taxable account
Tax benefits: Deductible against 4.63% flat state tax. Lower state tax also means less deduction against Federal so my real tax benefit for contribution is 4.63%*(.77)=3.56%

Assumptions (for the purpose of keeping this discussion focused):
- I want to finance 100% of my kids college education. Assume that 4-years of college, 18-20 yrs from now, will cost $300k/child. We want to have 3 kids total.
- My wife's parents intend to leave all their assets (enough to pay for college) in my wife's name which can eventually go towards paying for the kids college (or if I fund from a 529 plan, can go to our existing portfolio).

Upon reading several threads, I've come to realize that I don't need a 529 plan for the sole purpose of college savings. I can tap into my roth or taxable if needed. However, it may make sense as a tax-sheltered investment account (assume that I'll spend atleast some amount towards college in my lifetime). I'm not thrilled about the .46% expense ratio but the state tax deduction seems worthwhile.

Questions
1. Should I invest in the Colorado 529 plan?
2. Should I invest in a 529 plan if it didn't come with a state tax deduction? (I ask because I may move states in a couple of years).
3. If yes on either, any guidance on how to determine the contribution amount? Obviously costs & life events are uncertain and I don't want to risk overfunding the 529 plan.
4. Do you think the Coverdell plan may also be appropriate for me? I would have to circumvent the income restriction by having the child make the contributions.
5. Any other observations?

Thanks for the help!

Grt2bOutdoors
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Re: College savings for a high-income household

Post by Grt2bOutdoors » Mon Dec 30, 2013 6:33 pm

nobility wrote:We're having our 1st child (of potentially 3) in a few months and I've started to think about college savings.

My background:
Age: 29
Net worth: $1.3 million (~500k in tax-advantaged accounts)
Tax bracket: 33%, approaching 35%
Mortgage: 240k @ 4.37%, prefer to keep for tax deductions
Maxing out 401k.
Contributing ~31k to Roth IRA anually (5.5k via IRA backdoor, and ~25.5k via 401k after tax)
Rest goes into taxable
You are contributing 5.5K to a Roth, the 25.5K is in the equivalent of a non-deductible IRA - the principal is not taxed upon withdrawal, interest and capital gains are fully taxable upon withdrawal and depending upon if you take it before 59.5 subject to penalties unless you elect rule 72T - equal payments over retirement at an earlier age
The 529 plan I'm considering:
Colorado (my state) 529 plan: https://www.collegeinvest.org/our-savin ... io-details
Investments: Good vanguard funds, I can pick essentially an allocation based on Total Us, Total Intl, Total Bonds.
Expense ratio: .46%, this probably atleast 5x higher than the equivalent admiral shares of US & Intl I can get in my taxable account
Tax benefits: Deductible against 4.63% flat state tax. Lower state tax also means less deduction against Federal so my real tax benefit for contribution is 4.63%*(.77)=3.56%

Assumptions (for the purpose of keeping this discussion focused):
- I want to finance 100% of my kids college education. Assume that 4-years of college, 18-20 yrs from now, will cost $300k/child. We want to have 3 kids total.
- My wife's parents intend to leave all their assets (enough to pay for college) in my wife's name which can eventually go towards paying for the kids college (or if I fund from a 529 plan, can go to our existing portfolio).

Upon reading several threads, I've come to realize that I don't need a 529 plan for the sole purpose of college savings. I can tap into my roth or taxable if needed. However, it may make sense as a tax-sheltered investment account (assume that I'll spend atleast some amount towards college in my lifetime). I'm not thrilled about the .46% expense ratio but the state tax deduction seems worthwhile.


Questions
1. Should I invest in the Colorado 529 plan?It sounds like a great deal, deducting up to the extent of your Colorado taxable income in 529 plan contributions.
2. Should I invest in a 529 plan if it didn't come with a state tax deduction? (I ask because I may move states in a couple of years).Tax free withdrawals of gains and interest income is a strong motivator for doing so. There are other states which have even lower expense ratios - NYSDirect529 Plan - 17bps, UTAH plan at about 26bps.
3. If yes on either, any guidance on how to determine the contribution amount? Obviously costs & life events are uncertain and I don't want to risk overfunding the 529 plan. You estimated a need of 300K in 20 years per child - $650 a month for 240 periods (20 years) at a conservative 6% annual return gets you to $300K.
4. Do you think the Coverdell plan may also be appropriate for me? I would have to circumvent the income restriction by having the child make the contributions.Not really, with such a low annual maximum investment I think the 529 plan offers a better avenue for maximum captial gains/interest and unused principal could be used for a future generation or your own use.
5. Any other observations?

Thanks for the help!
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

letsgobobby
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Re: College savings for a high-income household

Post by letsgobobby » Mon Dec 30, 2013 6:54 pm

0.46% isn't bad.

You can invest in CO 529 up to the max state tax benefit, then the rest elsewhere, cheaper - like NY or possibly UT.

$300,000 in 20 years? Are you smoking the soon to be legal intoxicant a little prematurely?

My alma mater costs $265,000. Today. Try $500k per child in 18-20 years. It could be $600,000 for rich blokes like you. I am not joking.

There are other benefits to 529s:

estate planning
asset protection (state dependent)
tax-deferred growth, avoiding 18.8-23.8% taxes on QDI and LTCG, and 37.63%+AMT for non QDI and STCG. This becomes very attractive.

In your position I would continue to put as much as possible into the 529s as early as possible. In 2012, when it was unclear what federal tax law would look like in 2013, we opted to skip taxable investing in favor of 529 investing. We don't have any regrets about that decision, even though tax law turned out not quite as bad as we feared. We are in a lower tax bracket than you (33%, and no state tax) and still put a lot into 529s each year.

Topic Author
nobility
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Re: College savings for a high-income household

Post by nobility » Mon Dec 30, 2013 7:30 pm

Grt2bOutdoors wrote:
nobility wrote: Contributing ~31k to Roth IRA anually (5.5k via IRA backdoor, and ~25.5k via 401k after tax)
Rest goes into taxable
You are contributing 5.5K to a Roth, the 25.5K is in the equivalent of a non-deductible IRA - the principal is not taxed upon withdrawal, interest and capital gains are fully taxable upon withdrawal and depending upon if you take it before 59.5 subject to penalties unless you elect rule 72T - equal payments over retirement at an earlier age
No, the full 31k goes into a Roth IRA and shouldn't be treated any differently. My 401k plan has a "segregated" after-tax component which I immediately covert into my Roth IRA each year. I assume your comment was based on the assumption that my money was being left in the 401k after tax. Sorry for not clarifying that further.

Topic Author
nobility
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Re: College savings for a high-income household

Post by nobility » Mon Dec 30, 2013 7:57 pm

Thanks for the comments thus far. How would you suggest that I treat the funds I put in the 529? Should it be part of my wider asset allocation or should I treat this as a separate portfolio that is geared for an investment horizon of 18-20 years? The latter seems ideal for someone truly relying on that money to fund college. Given that my goal is to primarily use this as an investment vehicle, is there a more optimal way to look at it?

Bacchus01
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Re: College savings for a high-income household

Post by Bacchus01 » Mon Dec 30, 2013 8:02 pm

At 29, how did you get 500k into tax advantaged?


Oh, and you are right on the after-tax Roth conversion. I've done the same.

letsgobobby
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Re: College savings for a high-income household

Post by letsgobobby » Mon Dec 30, 2013 8:20 pm

nobility wrote:Thanks for the comments thus far. How would you suggest that I treat the funds I put in the 529? Should it be part of my wider asset allocation or should I treat this as a separate portfolio that is geared for an investment horizon of 18-20 years? The latter seems ideal for someone truly relying on that money to fund college. Given that my goal is to primarily use this as an investment vehicle, is there a more optimal way to look at it?
We will continue to leave everything in stocks indefinitely - I'm not prepared to 'waste' tax free forever space with fixed income. Our kids are 4 and 6. I might rebalance into a little fixed income if stock valuations got crazy, but since I'm willing and able to shoot for the moon here, I see no reason to own bonds. If I overshoot, I can't complain. If stocks fall hard and late, I'll cash flow college. The consequences of not meeting my goal are far less severe than the consequences of not meeting a retirement goal, so my ability and willingness to take risk is much higher.

island
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Re: College savings for a high-income household

Post by island » Mon Dec 30, 2013 10:12 pm

nobility wrote:
Grt2bOutdoors wrote:
nobility wrote: Contributing ~31k to Roth IRA anually (5.5k via IRA backdoor, and ~25.5k via 401k after tax)
Rest goes into taxable
You are contributing 5.5K to a Roth, the 25.5K is in the equivalent of a non-deductible IRA - the principal is not taxed upon withdrawal, interest and capital gains are fully taxable upon withdrawal and depending upon if you take it before 59.5 subject to penalties unless you elect rule 72T - equal payments over retirement at an earlier age
No, the full 31k goes into a Roth IRA and shouldn't be treated any differently. My 401k plan has a "segregated" after-tax component which I immediately covert into my Roth IRA each year. I assume your comment was based on the assumption that my money was being left in the 401k after tax. Sorry for not clarifying that further.
Hi Can you explain further how you are able to exceed the 5.5K limit and contribute an additional 25.5K annually to your Roth thru a conversion from your 401K? I thought the limit was 5.5K no matter where it came from...unless converting a traditional IRA and paying the tax to do it.
Thanks.

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Re: College savings for a high-income household

Post by Bacchus01 » Mon Dec 30, 2013 10:49 pm

island wrote:
nobility wrote:
Grt2bOutdoors wrote:
nobility wrote: Contributing ~31k to Roth IRA anually (5.5k via IRA backdoor, and ~25.5k via 401k after tax)
Rest goes into taxable
You are contributing 5.5K to a Roth, the 25.5K is in the equivalent of a non-deductible IRA - the principal is not taxed upon withdrawal, interest and capital gains are fully taxable upon withdrawal and depending upon if you take it before 59.5 subject to penalties unless you elect rule 72T - equal payments over retirement at an earlier age
No, the full 31k goes into a Roth IRA and shouldn't be treated any differently. My 401k plan has a "segregated" after-tax component which I immediately covert into my Roth IRA each year. I assume your comment was based on the assumption that my money was being left in the 401k after tax. Sorry for not clarifying that further.
Hi Can you explain further how you are able to exceed the 5.5K limit and contribute an additional 25.5K annually to your Roth thru a conversion from your 401K? I thought the limit was 5.5K no matter where it came from...unless converting a traditional IRA and paying the tax to do it.
Thanks.

There are a couple of threads on this after-tax 401k to Roth conversion.

IF your plan allows after-tax (not Roth) 401k contributions, and IF your plan allows for in-service withdraws of those after-tax contributions, you can have them "rolled over" in the distribution to your Roth IRA. I do the same for about $20K a year. If there are earnings within the rollover, you will owe taxes on those earnings, but otherwise the rest goes into the Roth directly. I contacted Wells Fargo (my 401k provider) and Vanguard before I started doing mine and they said they do it all the time.

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ERMD
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Re: College savings for a high-income household

Post by ERMD » Mon Dec 30, 2013 10:51 pm

letsgobobby wrote: $300,000 in 20 years? Are you smoking the soon to be legal intoxicant a little prematurely?

My alma mater costs $265,000. Today. Try $500k per child in 18-20 years. It could be $600,000 for rich blokes like you. I am not joking.
While your point is well taken, four years of tuition for my wife at a large, well-respected state school cost about $80,000. Will college cost a lot more in the future? Sure. But I'm also sure there will be plenty of great educations at good academic centers in the 100-200k range. (And obviously, this excludes grants/scholarships/etc.) If my 529 is above 150k by the time my son is 18, I will be satisfied.

Also, it might be less complicated to have a mildly underfunded 529 versus an overfunded one that requires financial gymnastics in order to tap the rest. But maybe that's just being a bit too simple!
between scotch and nothing, i'll take scotch. -- faulkner

letsgobobby
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Re: College savings for a high-income household

Post by letsgobobby » Tue Dec 31, 2013 12:07 am

The OP said he wanted to pay for 100% of college, not 100% of college but only at public schools. There is no way a private university will cost $300k in 20 years.

lrak
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Re: College savings for a high-income household

Post by lrak » Tue Dec 31, 2013 2:48 am

nobility wrote:Mortgage: 240k @ 4.37%, prefer to keep for tax deductions

5. Any other observations?
You prefer to pay up to $10.5k in interest to save up to $3.5k in taxes? :oops:

Otherwise, I think you are on the right track with your numbers and thoughts. Most people tell me I'm crazy when I say I need to save 1/2 million just to send both young kids to the flagship State U. If they choose to go to something like the schools my wife and I went to, historical tuition increases would make it over a million. :shock:

Bracket
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Re: College savings for a high-income household

Post by Bracket » Tue Dec 31, 2013 6:10 am

letsgobobby wrote:
$300,000 in 20 years? Are you smoking the soon to be legal intoxicant a little prematurely?

My alma mater costs $265,000. Today. Try $500k per child in 18-20 years. It could be $600,000 for rich blokes like you. I am not joking.

I wonder if they'll increase the limits on 529 contributions. In the VA 529 that I use once you hit 350k you are done contributing. My son is only 3, so I have some time, but I suppose opening a second 529 with another state is one way around this problem.

HopeToGolf
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Re: College savings for a high-income household

Post by HopeToGolf » Tue Dec 31, 2013 6:49 am

Yes fund the 529. If you do really well and do not need the money, the worst case is you keep it as part if your estate and it gets passed to your kids and used as a college fund for your grand kids or great grand kids.

While the 529 for most people does not provide a life changing tax benefit, I think there are nice advantages for those who can use it for future generations. I use it and if everything stays on track, the untaxed gains will be nice but not really magical compared to my contributions.

By the way, rethink the cost of college. I have a 529 for my child and he will turn college age in about 10 years. Unless there is MAJOR disruption in the system (style of education, delivery method, demands by employers, etc.), I estimated it will cost $200K for public school and $400K for private. I can only assume those amounts roughly double if you are talking 20 years from now.

The good news for you is I think the system will break before your children go to school. Then again, when I was in college I thought the system would have broken by now.

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youngindexer
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Re: College savings for a high-income household

Post by youngindexer » Tue Dec 31, 2013 9:14 am

These numbers being posted are obnoxious at least for Florida. Since your income is high I'm guessing you will get the best education for your children K-12. If they are intellectually able this will cause high GPA and test scores from A ranked schools(if they don't screw around). My siblings were in this category and were paid to go to public university. One went to private grad school on a full ride out of state as well. Our parents were high income so this is with no help from FAFSA. I fell into a lower GPA and test score category and still only drop 7-10k a year on public university tuition currently(with no scholarships, grants and cheaper options). As a disclaimer we were schooled in Florida where bright futures covered 75-100% of tuition if your GPA was high enough. My parents didn't drop a dime on our education and unless you want to send your kids to Ivy League I wouldn't worry about maxing out 529s :oops:

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ERMD
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Re: College savings for a high-income household

Post by ERMD » Tue Dec 31, 2013 9:18 am

letsgobobby wrote:The OP said he wanted to pay for 100% of college, not 100% of college but only at public schools. There is no way a private university will cost $300k in 20 years.
Actually, he said he wanted to fund 100% of their college education, not fund their education at 100% of available colleges. :happy
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Re: College savings for a high-income household

Post by letsgobobby » Tue Dec 31, 2013 10:52 am

Bracket wrote:
letsgobobby wrote:
$300,000 in 20 years? Are you smoking the soon to be legal intoxicant a little prematurely?

My alma mater costs $265,000. Today. Try $500k per child in 18-20 years. It could be $600,000 for rich blokes like you. I am not joking.

I wonder if they'll increase the limits on 529 contributions. In the VA 529 that I use once you hit 350k you are done contributing. My son is only 3, so I have some time, but I suppose opening a second 529 with another state is one way around this problem.
I can only speak to UT's UESP, which is one I use, but in that case the limit increases annually. And yes you can (and we do) have more than 1 529 per child.

marek
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Re: College savings for a high-income household

Post by marek » Wed Jan 01, 2014 1:52 am

Bacchus01 wrote:At 29, how did you get 500k into tax advantaged?


Oh, and you are right on the after-tax Roth conversion. I've done the same.
You can save ~51k per year in Employee Saving Account - if your company offers it. The federal limits are $16k pre tax, the rest after tax.

If you are an owner of a smaller company you can save even more per year.

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Re: College savings for a high-income household

Post by yogesh » Wed Jan 01, 2014 4:13 am

Due to these after tax 401K provisions allowing one to put 50K in tax deferred; I stopped the non deductible traditional IRA contributions and the backdoor completely. After-tax 401K allows that with much higher limit and less painful way.

Agree with rest here on funding 529s to the fullest possible per gift tax rules.
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Re: College savings for a high-income household

Post by Kevin M » Wed Jan 01, 2014 7:15 am

I would use the CO Stable Value Plus plan. Hard to beat 2.64% tax free, on top of the state tax deduction. I am using it, and I'm not even a CO resident. Where else can you get 2.64% after-tax with minimal credit risk and no interest-rate risk? Take advantage of this great deal for the fixed income portion of your portfolio.

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zzcooper123
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Re: College savings for a high-income household

Post by zzcooper123 » Wed Jan 01, 2014 8:14 am

Think outside the box.
You will never qualify for financial aid and probably shouldn't even apply (the FAFSA form is very intrusive).

Try:
http://www.paulahogan.com/images/FE/cha ... %20JFP.pdf

or:
"Strategy and Simplicity" by Troy Onink

Both publications are old, but you may find some pearls.
Consider starting a taxable account and gift the proceeds to your children when needed.

No investment will likely keep up with college costs over the next 18 years. My college costs began right after the 2008 crash.That hurt.

WorkToLive
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Re: College savings for a high-income household

Post by WorkToLive » Wed Jan 01, 2014 9:52 am

One reason to consider opening a Coverdell is that it is the only tax-deferred account that can be used to fund K-12 private school education. If you think your kids will go to private school, it might be worth funding.

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Re: College savings for a high-income household

Post by MnD » Wed Jan 01, 2014 10:04 am

You can get the CO state tax deduction without actually "saving" anything in the 529.
Just deposit an amount equal your qualified educational expenses in any given year and take it back out again a few days/weeks later.

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Re: College savings for a high-income household

Post by Laura » Wed Jan 01, 2014 11:55 am

Watch out for putting assets in the kids name. Gifting them money for a taxable account would really impact any financial aid option they might have.

I am in the middle of college applications for a child starting university in fall 2014 and for in state tuition, room, board I am looking at $20k per year which goes up to closer to $70k per year or more for private schools. The reality of the situation is that you probably won't qualify for any type of need based financial aid no matter what you do or the kind you qualify for will be a loan which won't make sense in your situation either. Your child may receive scholarship offers and may have a few other possibilities but the rest will fall on you.

Using the 529 plan to receive the deduction makes sense but you can either put the rest of your annual contributions in another lower cost 529 plan or consider the deposit then transfer option unless Colorado takes back the deduction if you withdraw the money.

Coverdell is another decent option but there are income limits of $110k so I bet you would not qualify.

If you do end up with taxable money it is probably best to keep it in your own name for financial aid, especially since it won't make a difference for taxing (kids are taxed at your rate on investment income).

Laura
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Re: College savings for a high-income household

Post by Grt2bOutdoors » Wed Jan 01, 2014 9:45 pm

Laura wrote:Watch out for putting assets in the kids name. Gifting them money for a taxable account would really impact any financial aid option they might have.



If you do end up with taxable money it is probably best to keep it in your own name for financial aid, especially since it won't make a difference for taxing (kids are taxed at your rate on investment income).

Laura
Only partially true - the first $1,000 in investment income has a tax rate of 0%, the second $1,000 of investment income is taxed at a 10% rate, any amounts after the first $2,000 are taxed at the parents tax rate (kiddie tax). So, if you did choose to utilize a UTMA account the child could earn up to $2K annually (indexed to inflation) and pay minimal, if any taxes. Of course, Laura does make some great points - monies in kids names is subject to higher capture rates by those FAFSA rules for financial aid. Given the OP's financial status it won't make much of a difference as expected family contribution will likely exceed the annual cost of college (little or no price break!).
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Re: College savings for a high-income household

Post by Laura » Wed Jan 01, 2014 9:49 pm

Grt2bOutdoors,

Thanks for clarifying the tax rates. I was referring to a high income investor but your points are very important for others who are not in exactly the same situation. For those lower income investors who may be able to qualify for financial aid, having assets in the child's name to benefit from a bit of a lower tax rate probably isn't worth it.

Laura
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Re: College savings for a high-income household

Post by livesoft » Wed Jan 01, 2014 10:04 pm

My daughter finished undergrad a couple weeks ago and starts grad school this month, so this shades my perspective.

Let's suppose that undergrad costs $250,000 for four years. Further suppose that one can contribute 1 cent to a 529 plan and this grows to $250,000.01. The tax savings of using that 529 plan for college expenses is not that much for a high-income household. Let's say instead of 529 plan, the month grew in a tax-efficient way in a taxable account. $250K of long-term capital gains would cost me $37.5K, so I consider that the tax savings. Spread that out over 4 years of college, that's less than $10K a year for the 529 plan savings versus other tax-efficient methods.

OK, I don't walk by $10K dropped on the sidewalk each year, but we're not talking about saving $50K a year or anything like that. Furthermore, that $10K of tax savings assumes an astounding 529 plan return. If one makes the return more reasonable, then I would not be surprised if the tax savings are less than $20K overall or $5K per year of college. And don't forget that using 529 plan money prevents the use of education credits which amount to a few thousand a year for some folks (credits are going away). So the benefit of a 529 plan vis-a-vis other methods is probably even less than $5K a year. Maybe it's about the same as keeping a Lexus or Mercedes a couple years longer before you trade it in.

What does that mean for high-income folks? I think it means all this college financial planning is much ado about nothing. I would not have said that 4 years ago, but personal experience informs me differently.
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letsgobobby
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Re: College savings for a high-income household

Post by letsgobobby » Wed Jan 01, 2014 11:51 pm

You're neglecting the absent drag of taxes on annual distributions of capital gains and dividends, which may be taxed up to 23.8% for qualified or, what, 50%+ for non qualified? And of course you maxed out your educational credits before using 529 money, if you qualified to use them at all.

Who pays 15% capital gains taxes anyway? I'm surprised you do.

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Re: College savings for a high-income household

Post by livesoft » Thu Jan 02, 2014 12:00 am

letsgobobby wrote:Who pays 15% capital gains taxes anyway? I'm surprised you do.
Well, you are right: we don't pay CG taxes since we have carryover losses to offset them. But we engineer our income to be well down in the 25% marginal income tax bracket with above-the-line deductions: 401(k)s, HSA, FSA, pre-tax insurance, capital losses.

The drag on taxes from annual distributions is very small, say 0.3% of value of assets. Of course, that assumes tax-efficient investing.

OK, we are not really high-income for the purposes of this thread.
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letsgobobby
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Re: College savings for a high-income household

Post by letsgobobby » Thu Jan 02, 2014 12:49 pm

So going back to the OP's premise, compared to yours (a high income household which isn't high income for the purposes of this thread), a high-income household will be:

-taxed short-term/non-qualified at 33% up to 50% plus depending on state
-taxed long term/qualified at 18.8%-23.8% federal, plus state up to 13.3% (so as much as 36% or more)
-unable to use either of the educational credits due to income phaseouts

The first two issues increase the tax drag on an account, doubling or tripling the drag from your reported 0.3%.

Also - and correct me if I'm wrong - wouldn't realizing gains from the sale of appreciated securities increase taxable income, and therefore by itself potentially increase marginal tax rates and disallow educational credits?

Not everyone has hundreds of thousands of dollars of carryforward losses on the books. Without those (per your other thread) your situation could be very different.

And of course the 'wealthy' plan to pay for their grandkids' college expenses using 529s, so instead of 20 years of tax-free gains, they're going to get 50 years of tax-free gains.

I think your larger point that the tax breaks of 529s aren't as immense as some imagine is a good one. Likewise we shouldn't minimize the potential benefits for wealthy taxpayers. After all, isn't that who 529s are really designed for?

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Re: College savings for a high-income household

Post by BHCadet » Thu Jan 02, 2014 2:07 pm

nobility wrote: Tax bracket: 33%, approaching 35%
Mortgage: 240k @ 4.37%, prefer to keep for tax deductions
Maxing out 401k.
Contributing ~31k to Roth IRA anually (5.5k via IRA backdoor, and ~25.5k via 401k after tax)
Rest goes into taxable
At your income level, you have to pay Alternative Minimum Tax (AMT), keeping the mortgage for tax deductions purpose will not save you any money in taxes.
Besides, you only get back the most 1/3 of what you paid.

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Re: College savings for a high-income household

Post by HomerJ » Thu Jan 02, 2014 2:13 pm

letsgobobby wrote:My alma mater costs $265,000. Today. Try $500k per child in 18-20 years. It could be $600,000 for rich blokes like you. I am not joking.
It might not be...

Trees don't grow to the sky... College costs cannot grow faster than wage growth forever. We're pretty close to an inflection point, where college costs will have to start increasing much more slowly.

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Re: College savings for a high-income household

Post by HomerJ » Thu Jan 02, 2014 2:15 pm

letsgobobby wrote:There is no way a private university will cost $300k in 20 years.
Then there will be a lot less private universities, since there won't be enough rich kids to fill the seats.

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Re: College savings for a high-income household

Post by Grt2bOutdoors » Thu Jan 02, 2014 2:17 pm

BHCadet wrote:
nobility wrote: Tax bracket: 33%, approaching 35%
Mortgage: 240k @ 4.37%, prefer to keep for tax deductions
Maxing out 401k.
Contributing ~31k to Roth IRA anually (5.5k via IRA backdoor, and ~25.5k via 401k after tax)
Rest goes into taxable
At your income level, you have to pay Alternative Minimum Tax (AMT), keeping the mortgage for tax deductions purpose will not save you any money in taxes.
Besides, you only get back the most 1/3 of what you paid.
Mortgage interest deduction is unaffected by AMT - it's personal exemptions, property taxes and itemized deductions that are affected. Run it through taxcaster, you'll see what I mean.
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Re: College savings for a high-income household

Post by Grt2bOutdoors » Thu Jan 02, 2014 2:23 pm

HomerJ wrote:
letsgobobby wrote:There is no way a private university will cost $300k in 20 years.
Then there will be a lot less private universities, since there won't be enough rich kids to fill the seats.
Letsgobobby is suffering from recency bias. The endless supply of capital will not increase ad infinitum if the loans are not performing. Of course, they're not dischargeable under current law but that does not change the fact that a non performing loan is a non performing loan - accounting rules require a writedown of non recoverable assets - the real issue is when does the lender throw their hands up in the air and finally admit what everyone else knows. We saw that with the zombie subprime real estate loans - folks were borrowing 100% plus on an asset whose valuation was diminishing day by day, when the stuff hit the ceiling the economy tanked - that day of reckoning is coming for the higher educational institutions - the gravy train has just about run its course.
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Re: College savings for a high-income household

Post by letsgobobby » Thu Jan 02, 2014 3:49 pm

Grt2bOutdoors wrote:
HomerJ wrote:
letsgobobby wrote:There is no way a private university will cost $300k in 20 years.
Then there will be a lot less private universities, since there won't be enough rich kids to fill the seats.
Letsgobobby is suffering from recency bias. The endless supply of capital will not increase ad infinitum if the loans are not performing. Of course, they're not dischargeable under current law but that does not change the fact that a non performing loan is a non performing loan - accounting rules require a writedown of non recoverable assets - the real issue is when does the lender throw their hands up in the air and finally admit what everyone else knows. We saw that with the zombie subprime real estate loans - folks were borrowing 100% plus on an asset whose valuation was diminishing day by day, when the stuff hit the ceiling the economy tanked - that day of reckoning is coming for the higher educational institutions - the gravy train has just about run its course.
If by recency you mean "all of recorded history in America" then maybe you are right. Tuition has inflated at 7% per year for more than two generations. I would have said exactly what you said about my own education, which cost $100k all in in the early-mid 90s. I would have been wrong. Now it's $260k. Why wouldn't it increase another 100-150% over the next generation?

The real recency bias is thinking that only American students are going to pay for American universities. I suspect that the exploding middle class and wealthy classes in China, India, Singapore, Hong Kong, the Middle East, South Africa, and Latin America will be more than willing to pay $100,000 per year for their children to attend 1st and 2nd tier universities in America. The real competition is not with 3.3 million graduating high school seniors in America each year, the real competition is with the 20 million annual high school graduates anticipated in India by 2017, and a similar number in China right now. Those two countries alone will produce ten times as many high school graduates annually as all of the United States. And what of the rest of the world?

The University of Washington recently asked permission of the state legislature to increase its percentage of out-of-state and international matriculants, since they have a lower rate of acceptance to begin with (on average, they are more qualified than in-state applicants; and international applicants are more qualified than out-of-state applicants) and they may substantially higher rates of tuition. This is only the beginning. Like anything else it can't grow to the sky forever but it really is at trough of the wave, not the crest.

Since we are talking about 'high-income households' there is a lot of potential tax benefit to be realized, and not a lot of downside to overfunding.

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Re: College savings for a high-income household

Post by HomerJ » Thu Jan 02, 2014 4:10 pm

letsgobobby wrote:Like anything else it can't grow to the sky forever but it really is at trough of the wave, not the crest.
How many of those 20 million Chinese high school students will be able to afford $600k educations?

You may be right, and I may be wrong. I think it's more fair to say neither of us know where we are on the curve. But like you said, it's been going on for 2 generations... At some point it will have to stop. Education costs can't double twice as fast as wages forever

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Re: College savings for a high-income household

Post by Grt2bOutdoors » Thu Jan 02, 2014 4:19 pm

letsgobobby wrote:
Grt2bOutdoors wrote:
HomerJ wrote:
letsgobobby wrote:There is no way a private university will cost $300k in 20 years.
Then there will be a lot less private universities, since there won't be enough rich kids to fill the seats.
Letsgobobby is suffering from recency bias. The endless supply of capital will not increase ad infinitum if the loans are not performing. Of course, they're not dischargeable under current law but that does not change the fact that a non performing loan is a non performing loan - accounting rules require a writedown of non recoverable assets - the real issue is when does the lender throw their hands up in the air and finally admit what everyone else knows. We saw that with the zombie subprime real estate loans - folks were borrowing 100% plus on an asset whose valuation was diminishing day by day, when the stuff hit the ceiling the economy tanked - that day of reckoning is coming for the higher educational institutions - the gravy train has just about run its course.
If by recency you mean "all of recorded history in America" then maybe you are right. Tuition has inflated at 7% per year for more than two generations. I would have said exactly what you said about my own education, which cost $100k all in in the early-mid 90s. I would have been wrong. Now it's $260k. Why wouldn't it increase another 100-150% over the next generation?

The real recency bias is thinking that only American students are going to pay for American universities. I suspect that the exploding middle class and wealthy classes in China, India, Singapore, Hong Kong, the Middle East, South Africa, and Latin America will be more than willing to pay $100,000 per year for their children to attend 1st and 2nd tier universities in America. The real competition is not with 3.3 million graduating high school seniors in America each year, the real competition is with the 20 million annual high school graduates anticipated in India by 2017, and a similar number in China right now. Those two countries alone will produce ten times as many high school graduates annually as all of the United States. And what of the rest of the world?
The housing market was growing at inflated rates over the past two generations as well, that came to a screeching halt when the punch bowl was taken away. Take away the punch bowl in education, much like healthcare, let me see how fast costs rise. Costs can be managed.
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Re: College savings for a high-income household

Post by letsgobobby » Thu Jan 02, 2014 4:22 pm

I think you're both right for average private schools - and we've already seen pressure on those schools and their tuitions. University of Concordia type of places.

But for the really star schools - of course the Ivies, but also the flagship state universities (Michigan, UNC, Berkeley, etc) and the premier liberal arts schools (Amherst, Claremont schools, etc) - I suspect there are *many* Chinese, Singaporean, Indian, Russian, Saudi/Israeli, Mexican, Brazilian, etc families who are willing and able to pay those prices for the name recognition and the education. If there are 37 million Indian and Chinese HS grads each year, and millions more from the rest of the world, the pool of potential international matriculants is easily 10 if not 20 times the American pool. If only 1% of American HS grads are qualified and only 0.1% of international HS grads are qualified to attend 1st and 2nd tier universities, that still doubles the pool of applicants. I don't see an inflection point in that environment.

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Re: College savings for a high-income household

Post by BHCadet » Thu Jan 02, 2014 5:40 pm

Grt2bOutdoors wrote:
BHCadet wrote:
nobility wrote: Tax bracket: 33%, approaching 35%
Mortgage: 240k @ 4.37%, prefer to keep for tax deductions
Maxing out 401k.
Contributing ~31k to Roth IRA anually (5.5k via IRA backdoor, and ~25.5k via 401k after tax)
Rest goes into taxable
At your income level, you have to pay Alternative Minimum Tax (AMT), keeping the mortgage for tax deductions purpose will not save you any money in taxes.
Besides, you only get back the most 1/3 of what you paid.
Mortgage interest deduction is unaffected by AMT - it's personal exemptions, property taxes and itemized deductions that are affected. Run it through taxcaster, you'll see what I mean.
:oops: I didn't realize mortgage interest deduction isn't affected by AMT.
It didn't show up in my Turbo Tax return because I paid off my mortgage long time ago.
However, from IRS Instructions for Form 6251 Alternative Minimun Tax –Individuals, line 4 – Home Mortgage Interest Adjustment:
A mortgage whose proceeds were used to refinance another mortgage is not an eligible mortgage.

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Re: College savings for a high-income household

Post by island » Sat Jan 04, 2014 2:41 pm

Bacchus01 wrote:
island wrote:
nobility wrote:
Grt2bOutdoors wrote:
nobility wrote: Contributing ~31k to Roth IRA anually (5.5k via IRA backdoor, and ~25.5k via 401k after tax)
Rest goes into taxable
You are contributing 5.5K to a Roth, the 25.5K is in the equivalent of a non-deductible IRA - the principal is not taxed upon withdrawal, interest and capital gains are fully taxable upon withdrawal and depending upon if you take it before 59.5 subject to penalties unless you elect rule 72T - equal payments over retirement at an earlier age
No, the full 31k goes into a Roth IRA and shouldn't be treated any differently. My 401k plan has a "segregated" after-tax component which I immediately covert into my Roth IRA each year. I assume your comment was based on the assumption that my money was being left in the 401k after tax. Sorry for not clarifying that further.
Hi Can you explain further how you are able to exceed the 5.5K limit and contribute an additional 25.5K annually to your Roth thru a conversion from your 401K? I thought the limit was 5.5K no matter where it came from...unless converting a traditional IRA and paying the tax to do it.
Thanks.

There are a couple of threads on this after-tax 401k to Roth conversion.

IF your plan allows after-tax (not Roth) 401k contributions, and IF your plan allows for in-service withdraws of those after-tax contributions, you can have them "rolled over" in the distribution to your Roth IRA. I do the same for about $20K a year. If there are earnings within the rollover, you will owe taxes on those earnings, but otherwise the rest goes into the Roth directly. I contacted Wells Fargo (my 401k provider) and Vanguard before I started doing mine and they said they do it all the time.
Nobility I realize it's OT, but I really appreciate this info from you and Bacchus. I never heard of this before and will definitely check it out. My 401k plan does allow after tax contributions and I believe it would be held in a separate bank. Never saw the point of contributing after tax, but last time I gave it any thought was before Roths existed. My 401K is with Vanguard and will call on Mon to see what's allowed. Would love to sock more away in a Roth! Thanks.

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Re: College savings for a high-income household

Post by lrak » Sun Jan 05, 2014 8:16 am

HomerJ wrote:College costs cannot grow faster than wage growth forever. We're pretty close to an inflection point, where college costs will have to start increasing much more slowly.
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Re: College savings for a high-income household

Post by sscritic » Sun Jan 05, 2014 8:23 am

Grt2bOutdoors wrote: Only partially true - the first $1,000 in investment income has a tax rate of 0%, the second $1,000 of investment income is taxed at a 10% rate, ..
Which for qualified dividends and long-term capital gains is 0% as well. [You might ask how 10% is the same as 0%; hint: bracket and rate are different objects]

Added hint: the child only gets the 0% rate if the child files the child's own return.

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Re: College savings for a high-income household

Post by MooreBonds » Sun Jan 05, 2014 10:53 am

nobility wrote: 5. Any other observations?
2 things to not forget:

1. EE Bonds - If EE bonds are cashed in to pay for educational expenses (such as college tuition), the interest earned is tax-free. Currently, the EE bonds are guaranteed to double in 20 years, which works out to roughly a 3.5% annual compounded interest rate, which would be tax-free. (I-bonds offer the same education benefits, and you could put some into those if the fixed portion bumps up a little more down the road).

http://www.treasurydirect.gov/indiv/pla ... cation.htm

The challenge is that if you cash it in before 20 years, your earnings plummet to an absurdly low #, based on current rates for the EE. The I-bonds don't have as bad of a current rate. Are you interested in a 3.5% tax-free yield on a AAA-rated bond? I'd think about putting at least a little in there to diversify. You are limited to annual purchasing limits, but between you and your wife, you should be able to sock away a decent amount each year if you do a little of this.

[edited to add] If the 3.5% sounds too low, don't forget that you pointed out the 529 plan investments have expense ratios that are about .4% higher than your Vanguard funds. Add that 0.4% expense ratio to the EE bond and you've boosted the return to almost 4% tax-free. (I realize you can't 'add it' to the bond, but I'm trying to point out that 0.4% may not sound like much since the overall ER is still low, but it doesn't matter if you're talking about going from 0.1% to 0.5%, or 1.5% to 1.9% - a difference in 0.4% is the same result).


As another poster mentioned, to spike this return even more, you could put money in EE/I-bonds, cash them after 20 years, immediately deposit some funds into a 529 account, get a tax-deduction, then withdraw them 2 months later to pay tuition. It would be a little boost to the yield over and above 3.5% tax-free.



2. Vanguard's householding - if you do decide to put assets in your childrens' names, don't forget that Vanguard lets you use everyone in the household for your status. So your children should also qualify for Flagship accounts/expense ratios.
Last edited by MooreBonds on Sun Jan 05, 2014 11:03 am, edited 1 time in total.

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Re: College savings for a high-income household

Post by livesoft » Sun Jan 05, 2014 10:57 am

MooreBonds wrote:1. EE Bonds - If EE bonds are cashed in to pay for educational expenses (such as college tuition), the interest earned is tax-free.
This does not apply to high income folks because of the income limit for this or is that just for I bonds? Nope, it is for both and the income limitations are right there in the link provided by MooreBonds.
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Re: College savings for a high-income household

Post by HomerJ » Mon Jan 06, 2014 10:33 am

livesoft wrote:
MooreBonds wrote:1. EE Bonds - If EE bonds are cashed in to pay for educational expenses (such as college tuition), the interest earned is tax-free.
This does not apply to high income folks because of the income limit for this or is that just for I bonds? Nope, it is for both and the income limitations are right there in the link provided by MooreBonds.
I plan to retire when my kid is starting his junior year, so my income will be low enough for me to cash in all those I-bonds to pay for his senior year. :)

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Re: College savings for a high-income household

Post by travellight » Mon Jan 27, 2014 12:53 am

I also thought we must be close to an inflection point but I think letsgobobby has some good points about the demand in the international market continuing to be high for the prestige schools which will keep the costs high for those schools.
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