deferred compensation and college savings

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Topic Author
mad9q
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Joined: Sat Jan 21, 2017 7:35 am

deferred compensation and college savings

Post by mad9q » Sun Mar 31, 2019 11:11 am

Hi All.

I am looking for opinions on funding a 529 for our two oldest children (we have five in total). My DH recently left his job and can now access his deferred compensation account ($140K balance). We are thinking of pulling out this cash, paying the taxes and putting the money into two 529 accounts (one child almost 12 and the other just turned 11, so six and seven years out). They each have only about $20K in their accounts. Our goal is to pay for a state school. My thinking is to pay taxes now, assuming our income will increase over the next several years (at some point over the two 2-3 years I plan to go back to work), and put the money into an account where the growth will not be taxed.

My DH is 48. Retiring before 59.5 is most likely not an option, given the age of our children. We have $1.1M in an IRA and are currently putting in 12% of a $210K salary into retirement.

FoolStreet
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Re: deferred compensation and college savings

Post by FoolStreet » Sun Mar 31, 2019 12:43 pm

mad9q wrote:
Sun Mar 31, 2019 11:11 am
Hi All.

I am looking for opinions on funding a 529 for our two oldest children (we have five in total). My DH recently left his job and can now access his deferred compensation account ($140K balance). We are thinking of pulling out this cash, paying the taxes and putting the money into two 529 accounts (one child almost 12 and the other just turned 11, so six and seven years out). They each have only about $20K in their accounts. Our goal is to pay for a state school. My thinking is to pay taxes now, assuming our income will increase over the next several years (at some point over the two 2-3 years I plan to go back to work), and put the money into an account where the growth will not be taxed.

My DH is 48. Retiring before 59.5 is most likely not an option, given the age of our children. We have $1.1M in an IRA and are currently putting in 12% of a $210K salary into retirement.
Can you elaborate on your options? Can you leave the deferred comp money there to keep deferring?

I think your intent is to incur the deferred comp income now, in a year with lower income and lower tax rate, because your DH is between jobs. Seems reasonable.

But do you expect him to get a new job paying more in this tax year?

With so many kids, I would want max flexibility to keep my savings in one place. One kid may get scholarships, the other may go to military, another may marry at 19.

So, dividing a nest egg into compartments would seem risky. (To me)

Also, there is a debate as to whether it is better to just fund your own retirement accounts, then pay for college with cash flow or withdrawals. For example, do backdoor Roth or Mega Backoor Roth, since Roth has a ton of flexibility for withdrawals. Of course, you would have to roll your IRA *in* to the next employer’s 401k to make backdoors easier.

Topic Author
mad9q
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Re: deferred compensation and college savings

Post by mad9q » Sun Mar 31, 2019 2:19 pm

FoolStreet wrote:
Sun Mar 31, 2019 12:43 pm
mad9q wrote:
Sun Mar 31, 2019 11:11 am
Hi All.

I am looking for opinions on funding a 529 for our two oldest children (we have five in total). My DH recently left his job and can now access his deferred compensation account ($140K balance). We are thinking of pulling out this cash, paying the taxes and putting the money into two 529 accounts (one child almost 12 and the other just turned 11, so six and seven years out). They each have only about $20K in their accounts. Our goal is to pay for a state school. My thinking is to pay taxes now, assuming our income will increase over the next several years (at some point over the two 2-3 years I plan to go back to work), and put the money into an account where the growth will not be taxed.

My DH is 48. Retiring before 59.5 is most likely not an option, given the age of our children. We have $1.1M in an IRA and are currently putting in 12% of a $210K salary into retirement.
Can you elaborate on your options? Can you leave the deferred comp money there to keep deferring?

I think your intent is to incur the deferred comp income now, in a year with lower income and lower tax rate, because your DH is between jobs. Seems reasonable.

But do you expect him to get a new job paying more in this tax year?

With so many kids, I would want max flexibility to keep my savings in one place. One kid may get scholarships, the other may go to military, another may marry at 19.

So, dividing a nest egg into compartments would seem risky. (To me)

Also, there is a debate as to whether it is better to just fund your own retirement accounts, then pay for college with cash flow or withdrawals. For example, do backdoor Roth or Mega Backoor Roth, since Roth has a ton of flexibility for withdrawals. Of course, you would have to roll your IRA *in* to the next employer’s 401k to make backdoors easier.
]

Thank you for the reply! I appreciate it.

We have the option to keep the deferred comp where it is. My husband does have another job, starting April 1. His compensation is slightly higher than his previous job, but our income will be less this year due to the transition between jobs.

We are feeling the pinch of being behind on college savings. My thinking is if we take the DC now and take the tax hit now (when out tax liability will likely be lower than future years), we can get two accounts pretty much funded. Mentally it would be a relief knowing those two children are taken care of. The funds could be transferred penalty-free to a sibling should one of those two children not need the funds.

I would love to backdoor the IRA to a Roth -- but my limited understanding tells me we would need to pay taxes on the $1.1M IRA. Please correct me if I am wrong, or if there is a tax-efficient way to get this done. We do have a 401K Roth at his new employer and are contributing to that as part of our current retirement savings. My current thinking is we may be able to use those funds to help pay college costs for the other children.

livesoft
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Re: deferred compensation and college savings

Post by livesoft » Sun Mar 31, 2019 2:30 pm

It seems your family might fit the demographics of paying almost no income taxes. Check out this thread:
viewtopic.php?t=79510

Since tax rates have gone down since that thread was started, your taxes should be even lower. With such low taxes, are you contributing the maximums to each of your Roth IRAs? Note that the contributions to the Roth 401(k) will not reduce your MAGI and make front-door Roth IRAs easy.
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beyou
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Re: deferred compensation and college savings

Post by beyou » Sun Mar 31, 2019 2:33 pm

You make no mention of the current DC plan. What investment options ? How long can it stay ? I doubt I would keep it but wondering.

I agree that you have your near term opportunity to have lower income than possibly 2-3 years out (going back to work for both of you) does cause considerstion of taking some taxable income now vs in the future. You are considering a thougtful strategy.

Assuming you don’t have a great option in the DC plan, such as only company stock or cash w/mmkt rates, I would cash that in to get he $ into a better mix of invesments. Now if that should be a 529, I would say only if the money would go to taxable investments. I wound prefer more $ in IRA or 401k if I had the option and could not max out that IRA/401k options.

Skiandswim
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Re: deferred compensation and college savings

Post by Skiandswim » Sun Mar 31, 2019 2:41 pm

I would consider contributing DH increased salary from new position towards Roth IRA or 529 plans and build over time. This may create a more sustainable plan for all your children, without forgoing your retirement savings.

For most financial aid calculations (e.g. FAFSA) your 401K and IRA accounts will be exclude from support. The 529 Plans are taken into consideration for financial aid. Parent controlled 529s assets are usually assessed at up to 5.64 percent for expected family contribution (EFC). This may reduce your child's aid up to 5.64 percent of the 529 account asset's value. A minor point to think about if you are converting a 401K, paying taxes, to funds a 529 plan.

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willthrill81
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Re: deferred compensation and college savings

Post by willthrill81 » Sun Mar 31, 2019 4:06 pm

mad9q wrote:
Sun Mar 31, 2019 11:11 am
Hi All.

I am looking for opinions on funding a 529 for our two oldest children (we have five in total). My DH recently left his job and can now access his deferred compensation account ($140K balance). We are thinking of pulling out this cash, paying the taxes and putting the money into two 529 accounts (one child almost 12 and the other just turned 11, so six and seven years out). They each have only about $20K in their accounts. Our goal is to pay for a state school. My thinking is to pay taxes now, assuming our income will increase over the next several years (at some point over the two 2-3 years I plan to go back to work), and put the money into an account where the growth will not be taxed.

My DH is 48. Retiring before 59.5 is most likely not an option, given the age of our children. We have $1.1M in an IRA and are currently putting in 12% of a $210K salary into retirement.
You may have a bigger problem on your hands than figuring out how to pay for your kids' college in the most tax-efficient manner: your own retirement. Based on your current $1.1 nest egg and $25k annual contributions and assuming a 5% real rate of return, by the time your DH is age 60, your portfolio would be $2.38 million. That may sound great, but if you then used 4% withdrawals, that would only provide you with $95k of annual income. That's a little over half what you're spending now. Now if a large portion of your current expenses will be gone by then (e.g. paying for children, mortgage, taxes, moving to a lower cost of living area), that might be alright, but you would still have to pay out of pocket for health insurance until age 65 unless one of you continues working for an employer with a family plan. You seem likely to max out Social Security benefits, which would definitely help, but your DH won't even be eligible to start benefits until age 62, and deferring those benefits until further down the road is often recommended when possible.

This is just a friendly word of caution. But please don't sacrifice your own financial footing for the sake of paying for all of your kids' college expenses. As the saying goes, they can get a loan to pay for college, but you cannot get a loan to pay for your retirement. As much as your kids love you, I doubt that any of them want you and your DH to be forced to move in with them in your golden years. And 'boomerang parents' are a real phenomenon.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Topic Author
mad9q
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Joined: Sat Jan 21, 2017 7:35 am

Re: deferred compensation and college savings

Post by mad9q » Sun Mar 31, 2019 4:59 pm

Thanks everyone for the thoughtful replies. To answer a few questions,

- the DC is in a target fund. The returns parallel those of the overall market.

- my DH is planning to work past age 60. Our youngest child is only five, so we have a ways to go in terms of supporting a child, including providing health insurance for her.

- in the next few years, I plan to return to work in some capacity. So hopefully, we will have more income to set aside for savings, ideally a Roth.

- right now our annual expenses total $112,000. This includes a mortgage and high RE taxes ($11K annually). Our plan for retirement is to downsize and buy a house with cash using the equity (right now we have about $350K in equity). I do not have an exact breakdown but we spend a huge amount on our kids. A couple of kids play multiple instruments with lessons, we have year-round swimmers, etc.

Perhaps we should consider cutting back on their activities. Paying for their college is a top priority for us.

Thanks again for the feedback.

FoolStreet
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Re: deferred compensation and college savings

Post by FoolStreet » Sun Mar 31, 2019 5:21 pm

Skiandswim wrote:
Sun Mar 31, 2019 2:41 pm
I would consider contributing DH increased salary from new position towards Roth IRA or 529 plans and build over time. This may create a more sustainable plan for all your children, without forgoing your retirement savings.

For most financial aid calculations (e.g. FAFSA) your 401K and IRA accounts will be exclude from support. The 529 Plans are taken into consideration for financial aid. Parent controlled 529s assets are usually assessed at up to 5.64 percent for expected family contribution (EFC). This may reduce your child's aid up to 5.64 percent of the 529 account asset's value. A minor point to think about if you are converting a 401K, paying taxes, to funds a 529 plan.
I thought it was worse than that, which is why I never had contributed to one.

Option 1 - Say you have $100k of 529 for one kid. 5k is assessed as Family Contribution according to your numbers. But I thought the whole $100k was allocated for financial aid. So your kid gets less financial aid.

Option 2 - That 100k is in your Roth IRA. FAFSA doesn't count the retireement account and says, "this kid and family is broke" we better give the kid more financial aid.

Topic Author
mad9q
Posts: 17
Joined: Sat Jan 21, 2017 7:35 am

Re: deferred compensation and college savings

Post by mad9q » Sun Mar 31, 2019 5:29 pm

FoolStreet wrote:
Sun Mar 31, 2019 5:21 pm
Skiandswim wrote:
Sun Mar 31, 2019 2:41 pm
I would consider contributing DH increased salary from new position towards Roth IRA or 529 plans and build over time. This may create a more sustainable plan for all your children, without forgoing your retirement savings.

For most financial aid calculations (e.g. FAFSA) your 401K and IRA accounts will be exclude from support. The 529 Plans are taken into consideration for financial aid. Parent controlled 529s assets are usually assessed at up to 5.64 percent for expected family contribution (EFC). This may reduce your child's aid up to 5.64 percent of the 529 account asset's value. A minor point to think about if you are converting a 401K, paying taxes, to funds a 529 plan.
I thought it was worse than that, which is why I never had contributed to one.

Option 1 - Say you have $100k of 529 for one kid. 5k is assessed as Family Contribution according to your numbers. But I thought the whole $100k was allocated for financial aid. So your kid gets less financial aid.

Option 2 - That 100k is in your Roth IRA. FAFSA doesn't count the retireement account and says, "this kid and family is broke" we better give the kid more financial aid.
Interesting thought. I had always assumed at our income level we wouldn't qualify for financial aid. We will definitely still be working when the oldest two go to college. I will give this some more thought and see what we can do to get more cash into a Roth. I assume I can do a spousal IRA and then convert that?

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