529 or retirement accounts

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bru
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529 or retirement accounts

Post by bru » Fri Sep 03, 2010 6:15 pm

I've been debating whether or not to open a 529 plan for my 27 month old son. My wife and I are both older parents so we will be able to tap our retirement accounts (Roth IRA, Rollover IRA, 401(k)) without penalty when he is college age. By then hopefully all our investments should be over seven figures.

Although a 529 will provide an additional tax advantaged account and state tax savings I still wonder whether it is worth it. If he doesn't go to college, we will not have any other children to transfer it to. The thought of potentially paying a penalty is concerning. If we do contribute we may have to reduce some of our other tax advantaged and taxable investing.

A plus for the 529 is I believe the money withdrawn does not count toward potential financial aid. But I think we will have too high of an income regardless so I wonder if that should even factor in the decision.

A local financial columnist told me that using retirement accounts would be better but I still am confused. There's a saying that you can borrow for college but not retirement.

Any one else go through a similar thought process? If I didn't provide enough information please let me know.

livesoft
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Post by livesoft » Fri Sep 03, 2010 6:22 pm

Do NOT contribute to a 529 plan until your retirement account contributions are maximized each year.

According to the federal formulas, a 529 plan does count against potential financial aid, while retirement accounts do not count.

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bru
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Post by bru » Fri Sep 03, 2010 6:34 pm

Knock wood we should have no trouble funding our Roth IRAs (10K now and eventually more when eligible for the catch-up) for the foreseeable future. I'm the only one with a 401(k) at the moment and it is a lousy plan. I am contributing enough to get the company match. I plan to increase contributions a bit but I doubt I will ever max it out. So right now I think we do have funds available for the 529. I just can't decide if it's really needed given the potential size of our nest egg when our son is college age.

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Post by livesoft » Fri Sep 03, 2010 6:41 pm

You might like this idea:

Borrow from your high-fee 401(k) and put the proceeds in a low-fee 529 plan. In order to do this, you will need to contribute to your 401(k). This way you get to max out your 401(k) contributions and fund the 529 plan ... all while reducing your costs. We do this.

Bob's not my name
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Post by Bob's not my name » Fri Sep 03, 2010 6:53 pm

If your 401k is lousy you need to look at how lousy your state's 529 is, and compare that, combined with any state tax benefits, to going out of state for a 529. Then you need to predict what Congress is going to do to the tax code over the next 16 years to thwart your investing decisions. Then you need to consider that, penalty or no, a tIRA withdrawal in a college year can totally screw you. Forget financial aid if you're well off with one kid, but consider that a tIRA withdrawal can throw you into an AGI-based phaseout or the AMT.

You could spend a lot of time doing math, but it could all be rendered irrelevant by tax law changes and changes to your situation and how colleges compute wealth redistribution -- I mean financial aid -- in the remote future when your kid is in school. My gut instinct is that you should focus on retirement plan savings for the next decade and then look at the question again. I expect you'll be able to handle his college expenses out of current income and maybe a Roth withdrawal and/or 401k loan.

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bru
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Post by bru » Fri Sep 03, 2010 8:18 pm

I guess livesoft really wants me to contribute the max to my 401(k) even if it is lousy :wink:. What if I can max it out and still make 529 contributions, would I still want to take a loan out? I can't seem to wrap my head around the idea of taking out a loan from a retirement account.

As for Bnmn's post, you bring up all the points that keep me up nights as I ponder this situation. The tIRA is indeed a thorn in my side. A substantial sum that I just can't bring myself to convert to a Roth because of the tax hit. I want to do it piece meal but it will take 40 years. Maybe I should just convert a significant chunk now because I agree that it will burn me in several ways when I start withdrawing from it.

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Post by letsgobobby » Fri Sep 03, 2010 8:24 pm

utilizing retirement accounts to fund college is a great idea - if you can afford it. Will you be able to afford cash-flowing college in 16 years - either from then-current income or from SWR withdrawals from your tax-advantaged retirement plans?

You have identified the potential drawback to a 529 in your situation. But from that you can't conclude that your retirement plans will be able to fill the bill unless you know you'll be able to foot the bill.

Being perhaps 10-20 years away from retirement age introduces a lot of uncertainty into this kind of question.

We resolved this by just saving in both places.

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Post by livesoft » Fri Sep 03, 2010 8:25 pm

bru wrote:I guess livesoft really wants me to contribute the max to my 401(k) even if it is lousy :wink:. What if I can max it out and still make 529 contributions, would I still want to take a loan out? I can't seem to wrap my head around the idea of taking out a loan from a retirement account.

Not to worry. My spouse had a problem with it until she learned that she could save money and stiff her 401(k) administrator on their fees.

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Post by Bob's not my name » Sat Sep 04, 2010 3:21 am

bru wrote:The tIRA is indeed a thorn in my side. A substantial sum that I just can't bring myself to convert to a Roth because of the tax hit. I want to do it piece meal but it will take 40 years. Maybe I should just convert a significant chunk now because I agree that it will burn me in several ways when I start withdrawing from it.
Well, that's an entirely different subject on which you can find many good threads here. If you're in a high bracket now it probably doesn't make sense to convert.

bru wrote:I can't seem to wrap my head around the idea of taking out a loan from a retirement account.
A 401k loan can be an excellent borrowing option if you do have to borrow. Lots of threads on that here, too. I say again, though, that you'll probably be fine if you have only one child in school. livesoft points out, for example, that if you've established a practice of contributing the maximum to your 401k, spouse tIRA or Roth, and your Roth ($34,000/year when you're 50), suspending those for the college years makes college pretty easy -- you'll probably find that you don't need to, but it's a good thought exercise to reduce tuitionophobia.

Now that I've argued against a 529, I'll switch sides and suggest that you put a modest amount in one anyway. Look very carefully at the expenses and state tax treatment and then if it still makes sense throw a few thousand in there and let it ride for 16 years. The experiment will be good learning. In addition, you'll have a little hedge against tax law changes. Both benefits -- learning and tax hedge -- might pay off if, for example, your state currently provides no tax deduction for 529 contributions, but when your kid's in high school they introduce one. Then, with a 529 account already in place and understood, you could launder a lot of money through it in a few years to milk the state tax deduction.

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bru
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Post by bru » Sat Sep 04, 2010 8:28 am

My state does currently offer a tax deduction for 529 contributions but we (for now) have a pretty low state tax rate so the deduction won't be huge, at least initially.

You've made things a bit clearer, thank you. One other thing I have been debating is pre paid vs. 529. Our state offers a prepaid plan but again so many unknown issues that I'm leaning against it. I've read a few threads about that issue but it seems as if there is no clear cut consensus.

So I think I'll do a moderate 529 contribution. I'll also take a look at retirement accounts including my current 401(k) and see what steps can be taken now in case they need to be tapped for college expenses.

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Post by bc3x » Sat Sep 04, 2010 10:17 am

Most people would prefer to deal with problems of embarrassment of riches rather than that of lack of means.

Even if the 401(k) is not optimal, if it is stuffed to the gills with contributions, it would be better protection to the preservation of the present life style in the event of another major downturn in the future.

The average cost of a four private college runs about $40k while that of a public college is about $20k at present. Who knows what these costs will be in 16 years. Better to have these funds ready than to scramble for them later, despite the fact that the 529 is considered the child's assets in calculating financial aid. The adage about a bird in hand... If family income is too high for financial aid, is that not a argument for self-funding for college?

If the child decides to attend Le Cordon Bleu Paris instead of a traditional university, the 529 funds can be used at "eligible educational institutions (which) include accredited postsecondary educational institutions in the United States, and certain foreign institutions, offering credit toward an associate’s degree, a bachelor’s degree, a graduate level or professional degree, or another recognized postsecondary credential, and certain postsecondary vocational and proprietary institutions".

If he wins a full scholarship, the funds can be withdrawn without the 10% federal penalty but the earnings will be subject to federal and state taxes, which is only fair.

The funds can also be transferred to other family members. Image
As this list is fairly extensive, the unused funds can be given to grandchildren or reverted back to you, should you decide to attend Le Cordon Bleu Paris as part of retirement fun.
Last edited by bc3x on Sat Sep 04, 2010 4:28 pm, edited 1 time in total.
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livesoft
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Post by livesoft » Sat Sep 04, 2010 10:23 am

The 529 plan is considered the owner's assets. It would be unwise to have the child as the owner. Parental assets are used up at a lower rate than child's assets in federal financial aid formulas.

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Post by bc3x » Sat Sep 04, 2010 10:50 am

Should have written "even if" instead of "despite the fact that".

From NYS 529 brochure, page 14:
Image
Last edited by bc3x on Sat Sep 04, 2010 4:30 pm, edited 1 time in total.
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Post by 5oclocksomewhere » Sat Sep 04, 2010 12:47 pm

livesoft wrote:Do NOT contribute to a 529 plan until your retirement account contributions are maximized each year.

According to the federal formulas, a 529 plan does count against potential financial aid, while retirement accounts do not count.


I'm sort of in the same boat as Bru but max out 401K, and my 2 kids are 7 and 9 years old. Should I make sure I contribute to non-deductible IRA's (5K for me and 5K for spouse) before doing a 529?

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Post by livesoft » Sat Sep 04, 2010 1:00 pm

Only if you immediately convert the non-deductible traditional IRA to a Roth IRA.

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Post by letsgobobby » Sat Sep 04, 2010 1:15 pm

5oclocksomewhere wrote:
livesoft wrote:Do NOT contribute to a 529 plan until your retirement account contributions are maximized each year.

According to the federal formulas, a 529 plan does count against potential financial aid, while retirement accounts do not count.


I'm sort of in the same boat as Bru but max out 401K, and my 2 kids are 7 and 9 years old. Should I make sure I contribute to non-deductible IRA's (5K for me and 5K for spouse) before doing a 529?


if you're unsure if you can afford to fund both, then you should fund a non-deductible IRA (and convert to Roth as livesoft pointed out) first. It is much more flexible, as it will have tax-free withdrawals of principal for life. It's the old adage that your children can borrow for college if they need to, while no one will lend to you for retirement.

Ideally you would fund both.

Another question to ask yourself is whether you should be funding a non-deductible IRA (and converting to Roth) before maxing out your 401k. The answer depends on your employer match, the investment choices available to you in the 401k, your marginal tax rate, and other personal factors.

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us savings bonds

Post by greenspam » Sat Sep 04, 2010 1:19 pm

how about maxing out US savings bonds; can later be used tax-free for kid's education (oops -- only if your AGI is within limits) and if not, a good 'emergency' fund.
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Abciximab
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Post by Abciximab » Sat Sep 04, 2010 1:19 pm

I'd have to agree that investing for retirement is the priority. Kids can always borrow money for college, but you can't borrow money to fund your retirement.
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Post by 555 » Sat Sep 04, 2010 1:41 pm

Question: What's the effect on FAFSA if parents withdraw from a Roth during the child's college years?

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Post by livesoft » Sat Sep 04, 2010 1:52 pm

If you withdraw Roth contributions, then there is no taxable income. So I would say no effect.

You should also be aware that there's the FAFSA, then there's what colleges will do. Private colleges do not have to follow the FAFSA if they don't want to. Thus, there is the CSS profile as well.

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Post by bc3x » Sat Sep 04, 2010 2:45 pm

The Free Application for Federal Student Aid (FAFSA) online application form has this section for parental information.

Image

If further probing leads to the disclosure of Roth withdrawals for higher education expenses, one would guess that less aid would be available.
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Post by Bob's not my name » Sat Sep 04, 2010 3:38 pm

bc3x makes an excellent point about Roth withdrawals. However, aid is all based on the prior year's income and current assets, so these issues can be managed carefully to maximize aid potential (viz., in this example, by holding Roth withdrawals until after base year 4 -- the calendar year that straddles sophomore and junior years -- and after the last FAFSA is submitted). Sumutka wrote an excellent (if dense) article on such strategies; it is perhaps dated now, but worth Googling up for illustration purposes (you'll find a link by searching this forum, too).

The OP sounds like an unlikely aid candidate, but I don't think the aid system will endure in its current form for sixteen years. It was already changed radically a few years ago when Harvard, followed quickly by others, decided to start redistributing wealth to the middle class as well as the working class and poor (sorry, upper middle class, you're still screwed). The government also continues to dabble in the issue, resulting in the current profusion of overlapping and mutually exclusive tax breaks, most of which benefit those who already get aid. Because all the rules will change, parents with young children need to diversify their bets. Roths do have excellent flexibility characteristics, as other posters have pointed out, and they should probably be part of any college financing strategy.

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Post by livesoft » Sat Sep 04, 2010 3:47 pm

In any event I don't think a Roth withdrawal will count any more against you than money in a 529 plan.

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Post by 555 » Sat Sep 04, 2010 4:31 pm

Wait? Roth doesn't count as assets, but withdrawals from it may count as income apparently. 529 plan does count as (parental) assets. But surely when you withdraw from it (for qualified expenses), that doesn't count as income.

livesoft wrote:In any event I don't think a Roth withdrawal will count any more against you than money in a 529 plan.

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Re: 529 or retirement accounts

Post by Opponent Process » Sat Sep 04, 2010 4:54 pm

bru wrote:I've been debating whether or not to open a 529 plan for my 27 month old son.


what colleges are he considering?
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Re: 529 or retirement accounts

Post by bru » Tue Sep 07, 2010 9:55 am

Opponent Process wrote:
bru wrote:I've been debating whether or not to open a 529 plan for my 27 month old son.


what colleges are he considering?


Tongue in cheek I hope. Actually in my confusion about all of this I got his age wrong, he is almost 29 months (big difference I know). Based on his current behavior he may grow up to be a stuntperson so all of this may be moot but if he does decide to pursue higher education his dad went to a state school, his mom went to a private college for undergrad and out of state for graduate school. Both of us are doing ok.

If it's up to me (and if I'm paying I guess it will be) he'll go to a community college for the gen ed stuff before moving to a university.

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