Max a 529?

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Topic Author
casualflower
Posts: 382
Joined: Thu Jul 16, 2015 9:36 am

Max a 529?

Post by casualflower »

I'd like to provide money for my child's college education. She's 5 now. I don't know if I want to fund it all, I'd like her to contribute some and not take out substantial loans. In addition to maxing retirement accounts, maintaining an emergency fund, no debt, etc, I've got $120K in taxable accounts right now.

I was planning on putting a certain amount each year into a 529, but I just realized that I can withdraw the principal with penalty. I just can't withdraw the gains. So, upon reflection, why shouldn't I just shove most of what I have in taxable accounts into the 529? Like just put $120K right in there? And then contribute as much as I can to it, with the intention of pulling out principal as needed and after college is paid off?

The only downside I see are the taxes. I'd pay gains on my current holdings. That's not too bad, I've done some harvesting over the years.

Why shouldn't I use a 529 to make tax free gains and pull out the principal as needed?
inbox788
Posts: 8372
Joined: Thu Mar 15, 2012 5:24 pm

Re: Max a 529?

Post by inbox788 »

metrunt wrote:I'd like to provide money for my child's college education. She's 5 now. I don't know if I want to fund it all, I'd like her to contribute some and not take out substantial loans. In addition to maxing retirement accounts, maintaining an emergency fund, no debt, etc, I've got $120K in taxable accounts right now.

I was planning on putting a certain amount each year into a 529, but I just realized that I can withdraw the principal with penalty. I just can't withdraw the gains. So, upon reflection, why shouldn't I just shove most of what I have in taxable accounts into the 529? Like just put $120K right in there? And then contribute as much as I can to it, with the intention of pulling out principal as needed and after college is paid off?

The only downside I see are the taxes. I'd pay gains on my current holdings. That's not too bad, I've done some harvesting over the years.

Why shouldn't I use a 529 to make tax free gains and pull out the principal as needed?
Contribute to the gift tax maximum (5 years lump sum and wait to contribute more), unless you want to use up some of the lifetime exclusion. If you're never going to get near the max, then I guess it doesn't matter. Just do the paperwork.

BTW, how significant are the gains in the taxable account? TLH lowers your cost basis and if the stocks have recovered, they increase your tax liability.
Constant Chaos
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Joined: Fri Sep 06, 2013 11:45 am

Re: Max a 529?

Post by Constant Chaos »

To be clear, unlike an IRA, you can not solely withdraw principal or gain from a 529. Each withdrawal is made up, pro rata, of each.
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JonnyDVM
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Location: Atlanta, GA

Re: Max a 529?

Post by JonnyDVM »

A 10% penalty on gains is not an insignificant amount of money. Especially when talking about a large lump sum of money invested over a long time period. Also, if your state offers a tax deduction you may want to contribute the tax deductable maximum every year. There's nothing wrong with super funding a 529. I think super funding is a solid stategy. 120k at five and then still continuing regular contributions feels like you're overdoing it a little OP.

As for keeping all your money in there and withdrawing principal like it's a bank account- even if that were possible I'm not seeing much benefit to that strategy. Why wouldn't you keep it in a taxable account and compound gains without a penalty?
I’d trade it all for a little more | -C Montgomery Burns
Rupert
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Joined: Fri Aug 17, 2012 12:01 pm

Re: Max a 529?

Post by Rupert »

metrunt wrote:I'd like to provide money for my child's college education. She's 5 now. I don't know if I want to fund it all, I'd like her to contribute some and not take out substantial loans. In addition to maxing retirement accounts, maintaining an emergency fund, no debt, etc, I've got $120K in taxable accounts right now.

I was planning on putting a certain amount each year into a 529, but I just realized that I can withdraw the principal with penalty. I just can't withdraw the gains. So, upon reflection, why shouldn't I just shove most of what I have in taxable accounts into the 529? Like just put $120K right in there? And then contribute as much as I can to it, with the intention of pulling out principal as needed and after college is paid off?

The only downside I see are the taxes. I'd pay gains on my current holdings. That's not too bad, I've done some harvesting over the years.

Why shouldn't I use a 529 to make tax free gains and pull out the principal as needed?
Because, as another poster mentioned, you can't pull out just principal as needed. And gains are taxed at ordinary income tax rates, in addition to the 10% penalty. In a taxable account, they'd be taxed at longterm capital gains rates. So the penalty for overfunding a 529 is pretty substantial.
objectivefunction
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Joined: Wed May 04, 2016 10:20 am

Re: Max a 529?

Post by objectivefunction »

As a single income family, I've been jealous of people who have $36,000+ in tax deferred space each year. I get $18,000 401k + $5,500 for my wife's traditional IRA and maybe $6,500 in an HSA if I'm adventurous. So I was seriously crunching some numbers to see if I could hack my kid's 529's (or even 529's for myself or my wife) into tax deferred space.

What I found is it doesn't make sense. There might be some extra gains to be had, but it is very sensitive to the ratio of your income tax rate to capital gains rate and the amount of time you keep the money in.

In my state I get a state income tax deduction. If I withdraw for non-educational purposes, I will have to pay state income tax on my contributions (but no federal or penalty) and state + federal income tax + 10% penalty on gains. As was mentioned before withdraws, are pro rata, so you can't take out just your contributions.

I can get a little boost from deferring the state tax, but it is not enough to make up for the fact that my gains are taxed as income + a 10% penalty instead of at lower capital gains rates.

If you want to over contribute to a 529 with the idea that you can pass it on to nieces and nephews or grandkids for their education expenses, then I guess you could do that. But if you want to try to hack it into some kind of tax deferred account, I don't think the numbers will work.

529's seem designed to penalize you pretty heavily for over contributing, my plan is to try to get somewhere between 50 and 80% funded for my kids, and have some taxable accounts to make up the difference.
Topic Author
casualflower
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Joined: Thu Jul 16, 2015 9:36 am

Re: Max a 529?

Post by casualflower »

Constant Chaos wrote:To be clear, unlike an IRA, you can not solely withdraw principal or gain from a 529. Each withdrawal is made up, pro rata, of each.

I did not realize that. That does invalidate my 'brillant' plan.

Thanks!
M
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EATaxGuy
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Re: Max a 529?

Post by EATaxGuy »

JonnyDVM wrote:Also, if your state offers a tax deduction you may want to contribute the tax deductable maximum every year.
Virginia offers such a tax deduction on VA529 contributions.
Virginia also offers the opportunity to pay that tax deduction back if you use the money for something other than qualified higher education expenses (and the normal 6 year statute of limitations does not apply to this payback).
You may have been handed a cactus, but sitting on it is up to you.
antheus
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Joined: Thu Apr 21, 2016 2:20 pm

Re: Max a 529?

Post by antheus »

As has been stated a 529 is not a great vehicle for avoiding taxes. It may be worthwhile to fund if you have a state deduction or if you have everything else squared away and would like to contribute money to an education fund that, if it is not used up by your own children, you would be happy transferring to nieces or nephews.
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