529 plan in tax free state, dont do it?

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striker79
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529 plan in tax free state, dont do it?

Post by striker79 » Wed Jan 03, 2018 11:18 pm

I was thinking of putting money into a 529 plan but now it seems like a dumb idea. I would need the money in 10 years, which limits my assett allocation to less aggressive vs in a taxable account where I wouldn't need the money for 30 years and do an aggressive portfolio with almost all stocks (money would be used in retirement. I can pay for college with ira or other funds). Basically I should have a better return without using the 529, im not forced to use the funds to pay for education. Lets say I got 5% compounded return which is the current average for vanguards 10 year plan (probably would be less than this) vs 7% for aggressive stock portfolio with a low cost mutual fund expense ratio of .06 (if market crashes I can ride it out as the money is not needed for 30 years), then the difference on 50,000 is 89k for the 529 plan and 107,000 for the regular taxable account. expense ratio for the 529 plan is about .9% so I would have to pay 4,500 in fees over 10 years assuming an initial lump sum of 50,000 and 0 growth, so it would be at least 5k im sure vs 8,550 in capital gains and $300 of expense ratio fees in the taxable account...89k-5k= 84 k which i am forced to use on education vs over 98,000 for the taxable account which I can use on anything.

Has anyone else done the math on this, and actually found it useful to use a 529 account in a state with no income tax??

EHEngineer
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Re: 529 plan in tax free state, dont do it?

Post by EHEngineer » Wed Jan 03, 2018 11:42 pm

I think you're not comparing apples to apples. First, You're compaing different asset allocations for the same 10 yr horizon. Whether you spend money from an IRA or from a 529, your allocation should be the same for a 10 year horizon. Second, you should not be paying 0.9% for a 529. I am paying 0.16% in vanguard's nevada 529. I believe UT, NY and IL direct sold plans are at least this cheap. Probably others too, 529s are very competitive these days

If you are unsure that you will have enough expenses to exhaust the 529, perhaps you should consider a smaller 529 contribution. Or, long term, you could save the extra and let it grow tax free until your grandchildren can use it.

Bottom line, if you know you have college expenses in 10 years, a 529 beats a taxable account even in a state with no income tax. But it doesn't beat a roth account, and it's unlikely it would beat a traditional IRA.
Last edited by EHEngineer on Wed Jan 03, 2018 11:46 pm, edited 1 time in total.
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camillus
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Re: 529 plan in tax free state, dont do it?

Post by camillus » Wed Jan 03, 2018 11:43 pm

1) You don't have to use the 529 in your state. You can use a low-fee Vanguard-based 529, like Utah or Nevada (not exactly sure).

2) You don't actually have to hold the an asset allocation designed to meet your "mid-range" (10 years) needs within the 529. You can be 100% aggressive in your 529, and treat it as only part of your total portfolio (the rest of your portfolio could be more conservatively shifted). This would take advantage of the 529's ability to shield gains from capital gains tax. You have nothing to lose with this vs. a taxable account or cashflow.

3) Given this, most people would advise maxing out your IRA and 401k space before contributing to 529.

striker79
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Re: 529 plan in tax free state, dont do it?

Post by striker79 » Thu Jan 04, 2018 3:47 pm

If I don't use the funds for my kids education in 10 years, I will have to defer it to grandkids or someone else, otherwise be forced to pay income tax and a 10% penalty on the gains (way more than the regular 15% capital gains in a regular taxable account). I'm only interested in setting it up for my kids, so for me I am forced to set it up with an asset allocation for withdrawal starting in 10 years. If im in a regular taxable account, I can be aggressive because I don't need that money in 10 years, as I can fund money from other sources.

I already max out 401k, mine and my wife's IRA's, and our HSA. 529 plan was the next thing up, but looks like I won't be doing that.

[OT comments deleted by admin alex]

swensen
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Re: 529 plan in tax free state, dont do it?

Post by swensen » Thu Jan 04, 2018 6:45 pm

I think about my asset allocation across all of my accounts, and then place the assets in the most tax-advantaged (and lowest cost) account for that type of investment.

Just because you will need to withdraw $x from your 529 in 10 years, does that mean you need to allocate the specific assets in the 529 conservatively? I think as long as you make sure you have the asset allocation you want overall, it doesn't matter where the assets sit. Once you withdraw the funds in the 529, you can then rebalance across all of your accounts again to take into account that you no longer need some money in 10 years, but have a longer time frame.

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grabiner
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Re: 529 plan in tax free state, dont do it?

Post by grabiner » Thu Jan 04, 2018 7:56 pm

striker79 wrote:
Wed Jan 03, 2018 11:18 pm
I was thinking of putting money into a 529 plan but now it seems like a dumb idea. I would need the money in 10 years, which limits my assett allocation to less aggressive vs in a taxable account where I wouldn't need the money for 30 years and do an aggressive portfolio with almost all stocks (money would be used in retirement I can pay for college with ira or other funds).
You will be investing both for college and for retirement either way, so your overall allocation should be the same regardless of which accounts you use. If you are planning to pay for college with IRA withdrawals, then that part of the IRA should be invested with a 10-year time horizon.

And you don't have to use your own state's 529 plan; you can use any state's plan for the same tax benefit if your state doesn't allow a deduction.
Wiki David Grabiner

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