Assume all tax-deferred space is maxed out, no kids ever, period. So 529 will be used for retirement and never for qualified educational expenses.
Recently learned that 529 only gets the 10% penalty tax on the earnings. So it looks like:
- Contributions when withdrawn for non-qualified expenses get NO tax
- Dividends get NO tax, or more accurately that goes into earnings which is taxed
- Earnings when withdrawn for non-qualified expenses get 10% penalty tax + taxed as ordinary income(?).
Compare this to taxable:
- Contributions get NO tax
- Dividends get preferred (i.e. lower) tax treatment
- Earnings when withdrawn (i.e. sold) are taxed as LT-gains rate
It's probably a toss up to be honest, but 529 come with creditor/bankruptcy-protection. So why aren't people using 529 in lieu of taxable? Looks like 529 will be useful for tax-inefficient and high returns instruments like REITs.
Using 529 as a retirement account instead of taxable?
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Re: Using 529 as a retirement account instead of taxable?
How is it a toss up? Taxable account earnings are taxed upon withdrawal at a discount to your income tax rate (I.e. LTCG rate) while 529 earnings are taxed at your full income tax rate plus 10% penalty...
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Re: Using 529 as a retirement account instead of taxable?
Also the 529 will have program expenses beyond the fund's ER - say maybe 0.25% for a cheaper plan. But the 10% penalty on earnings and regular tax rates makes it unattractive already, doesn't it?
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Re: Using 529 as a retirement account instead of taxable?
You can retired and continue as a college student. Sell all you belonging and live in the dorm. Use 529 to pay room and board tax free. Actually, I was thinking study history major in one of the EU university (very low cost tuition). Learning new things is import for old age retiree.
Re: Using 529 as a retirement account instead of taxable?
This is NOT a toss-up, taxable is better in 99.999% of situations. In extreme situations with a long time horizon, it could make sense. The crucial part you don’t mention is that dividend income in taxable gets taxed at a preferred rate and adds to the tax-free basis while dividends in the 529 have taxes deferred, but are later taxed at a much higher rate (minimum 17 percentage points higher, under current tax law in the 22% bracket).
A back-of-the-napkin spreadsheet shows this becomes beneficial in the following extreme case:
- LTCG rate: 15%
- Income tax rate: 22%
- Dividend yield: 2%
- Expense + tax ratio of taxable vs expense ratio of 529: > +0.5 percentage points (e.g. 0.2% 529 expense, 0.7% taxable expense + tax cost)
- Time horizon: >50 years
I literally don’t see any plausible way this makes sense.