Using 529 for retirement rather than just education?

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e_swami
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Using 529 for retirement rather than just education?

Post by e_swami » Sat Jan 19, 2019 6:06 pm

It seems to me that if you u let the money stay long enough in a 529 without paying taxes on interest and dividends, you would be better off paying the 10% penalty at the end for "non educational" use of money. Am I making a mistake in looking at it this way? If I am correct, I should look at my 529 as an IRA with no contribution limits.

Also, if u have money from elsewhere for retirement, cant you just change the beneficiary of the 529 to your grandchildren and let that money be used for their educational purposes? That would avoid even the 10% penalty

I would appreciate any thoughts

Thank you

Swami

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Ben Mathew
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Re: Using 529 for retirement rather than just education?

Post by Ben Mathew » Sat Jan 19, 2019 6:17 pm

No, because in addition to the 10% penalty, non-qualified distributions from a 529 plan is subject to ordinary income taxes. A taxable account would not be subject to the 10% penalty, and would benefit from lower long term capital gains tax rates on the growth.

hotelcalifornia
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Re: Using 529 for retirement rather than just education?

Post by hotelcalifornia » Sat Jan 19, 2019 6:24 pm

10% penalty plus income tax. Not a good retirement vehicle.

letsgobobby
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Re: Using 529 for retirement rather than just education?

Post by letsgobobby » Sat Jan 19, 2019 6:43 pm

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momvesting
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Re: Using 529 for retirement rather than just education?

Post by momvesting » Sat Jan 19, 2019 8:05 pm

If there is a state income tax incentive, that could sway your results because, as I understand it, the 10% penalty is only on the earnings.

While I do not plan on using my daughter's 529 for retirement, I have always considered it sort of a back up emergency fund because we have stable jobs and could live on just one of our incomes, so we keep a rather small regular emergency fund. I figured if we had an emergency that was large enough that we needed to tap the 529, the regular taxes on the earnings wouldn't hurt very much as presumably we would have very low or no income at the time we have exhausted our other emergency fund and needed to tap the 529.

Spirit Rider
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Re: Using 529 for retirement rather than just education?

Post by Spirit Rider » Sun Jan 20, 2019 12:13 am

Non-qualified 529 distributions are subject to state income taxes, penalties and deduction recapture provisions in many states.

So depending on the state, a non-qualified 529 distribution could be subject to:
  • Federal and state income taxes
  • Federal and state penalties
  • State deduction recapture.

Kennedy
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Re: Using 529 for retirement rather than just education?

Post by Kennedy » Sun Jan 20, 2019 12:19 am

When I was young and stupid, I believed a Waddell and Reed 529 salesman who told me that one could use 529 money for retirement income without any penalty. He also sold them to me for a 6% load. I still have bitter feelings toward that ultra-slimy man.

aristotelian
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Re: Using 529 for retirement rather than just education?

Post by aristotelian » Sun Jan 20, 2019 5:40 am

This would only be true if you are in a state with massively high taxes and you plan to have zero state tax in retirement. There is no federal deduction, so aside from state tax you would be better off just saving in taxable.

Topic Author
e_swami
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Re: Using 529 for retirement rather than just education?

Post by e_swami » Mon Jan 21, 2019 10:04 am

Income taxes should not matter for this calculation because my alternative to the 529 is to put the money in a taxable brokerage account on which case I pay taxes every year on interest and dividends. In both cases, I have to pay taxes. In the case of the 529, there is the extra 10% penalty but the benefits of compounding over a couple of decades or more may leave me better off even after paying the 10% penalty

What am I missing here?

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e_swami
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Re: Using 529 for retirement rather than just education?

Post by e_swami » Mon Jan 21, 2019 10:07 am

Ben Mathew wrote:
Sat Jan 19, 2019 6:17 pm
No, because in addition to the 10% penalty, non-qualified distributions from a 529 plan is subject to ordinary income taxes. A taxable account would not be subject to the 10% penalty, and would benefit from lower long term capital gains tax rates on the growth.
Income taxes should not matter for this calculation because my alternative to the 529 is to put the money in a taxable brokerage account on which case I pay taxes every year on interest and dividends. In both cases, I have to pay taxes. In the case of the 529, there is the extra 10% penalty but the benefits of compounding over a couple of decades or more may leave me better off even after paying the 10% penalty

What am I missing here? Are u saying that with the 529, i would be paying ordinary income taxes on capital gains in the 529?

Rupert
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Re: Using 529 for retirement rather than just education?

Post by Rupert » Mon Jan 21, 2019 10:47 am

e_swami wrote:
Mon Jan 21, 2019 10:07 am
Ben Mathew wrote:
Sat Jan 19, 2019 6:17 pm
No, because in addition to the 10% penalty, non-qualified distributions from a 529 plan is subject to ordinary income taxes. A taxable account would not be subject to the 10% penalty, and would benefit from lower long term capital gains tax rates on the growth.
Income taxes should not matter for this calculation because my alternative to the 529 is to put the money in a taxable brokerage account on which case I pay taxes every year on interest and dividends. In both cases, I have to pay taxes. In the case of the 529, there is the extra 10% penalty but the benefits of compounding over a couple of decades or more may leave me better off even after paying the 10% penalty

What am I missing here? Are u saying that with the 529, i would be paying ordinary income taxes on capital gains in the 529?
Yes, 529 distributions are taxed at ordinary income tax rates, not capital gains rates. That's what you seem to be missing.

Spirit Rider
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Re: Using 529 for retirement rather than just education?

Post by Spirit Rider » Mon Jan 21, 2019 10:58 am

e_swami wrote:
Mon Jan 21, 2019 10:04 am
Income taxes should not matter for this calculation because my alternative to the 529 is to put the money in a taxable brokerage account on which case I pay taxes every year on interest and dividends. In both cases, I have to pay taxes. In the case of the 529, there is the extra 10% penalty but the benefits of compounding over a couple of decades or more may leave me better off even after paying the 10% penalty

What am I missing here?
What you are missing is the tax drag in taxable will be your marginal ordinary income/capital gains tax rates on maybe a few % of the total taxable portfolio. You can control the taxable portfolio to have minimal distributions almost all of which at capital gains tax rates.

While the 529 non-qualified distributions will be the difference between your marginal ordinary income tax rates and your marginal capital gains tax rates on 100% of your 529 earnings plus a 10% penalty on those earnings.

It is not even a close call.

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Ben Mathew
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Re: Using 529 for retirement rather than just education?

Post by Ben Mathew » Mon Jan 21, 2019 11:44 am

e_swami wrote:
Mon Jan 21, 2019 10:07 am
Ben Mathew wrote:
Sat Jan 19, 2019 6:17 pm
No, because in addition to the 10% penalty, non-qualified distributions from a 529 plan is subject to ordinary income taxes. A taxable account would not be subject to the 10% penalty, and would benefit from lower long term capital gains tax rates on the growth.
Income taxes should not matter for this calculation because my alternative to the 529 is to put the money in a taxable brokerage account on which case I pay taxes every year on interest and dividends. In both cases, I have to pay taxes. In the case of the 529, there is the extra 10% penalty but the benefits of compounding over a couple of decades or more may leave me better off even after paying the 10% penalty

What am I missing here? Are u saying that with the 529, i would be paying ordinary income taxes on capital gains in the 529?
Yes, besides the 10% penalty, the earnings will be taxed at the ordinary income tax rates, which are usually much higher than capital gains tax rates. A taxable account will be better, and a tax-advantaged retirement account will be much, much better.

SimonJester
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Re: Using 529 for retirement rather than just education?

Post by SimonJester » Mon Jan 21, 2019 11:47 am

I would also add that many of the 529 plans have restrictions on how many times you can reallocate between funds. Vanguards 529 only allows two reallocation per calendar year.

Also many 529 plans do not have access to the number of funds you get in taxable account. Ie Vanguards 529 does not offer Admiral funds in their 529, thus you pay a higher expense ratio as well 0.15% for total stock market vs 0.04% with Admiral
"They who can give up essential liberty to obtain a little temporary safety, deserve neither liberty nor safety." - Benjamin Franklin

HereToLearn
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Re: Using 529 for retirement rather than just education?

Post by HereToLearn » Mon Jan 21, 2019 11:53 am

SimonJester wrote:
Mon Jan 21, 2019 11:47 am
I would also add that many of the 529 plans have restrictions on how many times you can reallocate between funds. Vanguards 529 only allows two reallocation per calendar year.

Also many 529 plans do not have access to the number of funds you get in taxable account. Ie Vanguards 529 does not offer Admiral funds in their 529, thus you pay a higher expense ratio as well 0.15% for total stock market vs 0.04% with Admiral
I believe the two times per year allocation rule is a feature of all 529 plans, not the administrator. Agree that fund choices are limited.

staythecourse
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Re: Using 529 for retirement rather than just education?

Post by staythecourse » Mon Jan 21, 2019 12:01 pm

letsgobobby wrote:
Sat Jan 19, 2019 6:43 pm
A 529 is an excellent retirement vehicle if part of your retirement plan is paying for the educational expenses of your children, grandchildren, or yourself.
Agreed. The 529 plan is a poor man's educational trust. IF you don't expect to use all the money in your lifetime and want to contribute to your progeny education it is great option to keep loading it. IF you want t have it for yourself then NO.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

Spirit Rider
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Re: Using 529 for retirement rather than just education?

Post by Spirit Rider » Mon Jan 21, 2019 3:38 pm

Notwithstanding all the good reasons why in general this is a bad idea. I think there could be some small direct uses for a 529 as a deferred investment vehicle. Here is one targeted use.

Some 529 plans have rather good stable value plans with above average interest rates. Sometimes by more than 10%.

Now consider that you are in early retirement using the ACA marketplace for health insurance. You struggle to keep your ACA MAGI low enough for a subsidy because of interest income, even tax-exempt.

So you open a 529 account in the state with the best stable value plan with yourself as beneficiary. Either you don't take any distributions until you are on Medicare or because only a tiny pro-rata amount of any distribution is earnings subject to income tax and the 10% penalty. Also, in my state distributions from 529 plans, qualified or not are not taxable.

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