529 Plan vs Mega Backdoor Roth

[fred2017]

Hello Bogleheads,

My son is 3 years old and his 529 plan balance is ~50k.
Currently I am contributing $500 monthly and also may make extra deposits if I have extra free money.

My employer provides after-tax contribution option which can convert to Roth with in-plan conversion (mega backdoor Roth?).
Currently I have maxed out 401k, Roth IRA, also made some after-tax contribution (which is automatically converted into Roth) but much less than the limit (combination of pre-tax 401k, Roth, after-tax and employer contributions).

So my question is - since I have the opportunity to contribute more to the after-tax (and convert to Roth), shall I utilize this opportunity to contribute more rather than contributing to 529 plan (as 529 plan is less flexible than Roth)?

Thanks for advice !

[retiredjg]

Maybe.

Some plans will allow you to roll your in-plan Roth rollovers (IRRs) out to Roth IRA while still working for that employer. If your plan allows that (or if you changed employers before college money is needed) the Roth IRA could be used to supplement the 529.

It's hard to go wrong with Roth accounts. If you get a state benefit from the 529, you might want to continue that as well or do some of both.

[fred2017]

Maybe.

Some plans will allow you to roll your in-plan Roth rollovers (IRRs) out to Roth IRA while still working for that employer. If your plan allows that (or if you changed employers before college money is needed) the Roth IRA could be used to supplement the 529.

It's hard to go wrong with Roth accounts. If you get a state benefit from the 529, you might want to continue that as well or do some of both.

Thanks for the input.
- I am in CA and I don't believe there is state benefit from the 529
- While I assume that my plan does not allow to transfer to my Roth IRA while I am with the employer, 99% chance that I will change employment by the time my child goes to college. I need to check that if I leave the employer, if the plan allows to transfer the after-tax contribution portion to my Roth IRA.
Thanks again.

[Friend50]

50k is a lot to have in a 529 for a 3 year old. I’d stop or slow down contributions to that and just let it grow. If you have the option to put more into a Roth yes I’d do that. If you’re unsure maybe split $100 per month to the 529 and $400 to the Roth or whatever other split sounds good to you.

[JJMrk]

Hard to answer this without knowing what your goals and financial position are.

How much do you want in the 529 when he turns 18? Once you’ve determined that, work backward with a future value calculation and you can estimate how much you need to save every month. For me that number is 4-500/month assuming 5% real returns for each kid.

On the other hand- are you 50 with no retirement savings? You might choose to prioritize your own retirement since there are a lot of ways to pay for college but not as many to pay for retirement

[WL2034]

How are the investment options/fees for the MBDR? All things equal I’d prioritize the MBDR. CA has a very low cost 529, but I didn’t think there was a CA state tax break for 529 contributions. I’m not a CA resident, so I am not totally sure on that.

[Nohbdy]

I’m pretty sure there’s not much incentive for CA 529. Maybe like a hundred bucks from scholarshare iirc. I’d be doing Roth although I have no experience with MBDR.

[hedge_hog88]

There are many threads on here, and I am in a similar boat. If I have the means I would try to fund the 529 as quickly as possible to the current cost of 4-year in-state flagship U. For example, this would be about 160k in today's money for a UC. It is relatively safe(?) to assume the investment can keep up with the tuition/cost inflation for the reminder of the 529. This avoids overfunding the 529 in case the child decides to become a drummer. I would put the rest of my excess saving in the MBDR. So if the child decide to attend a fufu private school, I can cash flow the difference or withdraw from the retirement accounts. What do people think of this compromise?

Addedum: I just reread the OP, it is unclear how one got to 50K at 3yo by funding 500 monthly. So superfunding the 529 may not be feasible. I guess the spirit of my proposal is that one can do both 529 and MBDR. There's something to be said about assigning names to piles of money even if they are really the same pile.

[fred2017]

I’m pretty sure there’s not much incentive for CA 529. Maybe like a hundred bucks from scholarshare iirc. I’d be doing Roth although I have no experience with MBDR.

Yes, $100 promotion to open 529 account and that's it.

[fred2017]

There are many threads on here, and I am in a similar boat. If I have the means I would try to fund the 529 as quickly as possible to the current cost of 4-year in-state flagship U. For example, this would be about 160k in today's money for a UC. It is relatively safe(?) to assume the investment can keep up with the tuition/cost inflation for the reminder of the 529. This avoids overfunding the 529 in case the child decides to become a drummer. I would put the rest of my excess saving in the MBDR. So if the child decide to attend a fufu private school, I can cash flow the difference or withdraw from the retirement accounts. What do people think of this compromise?

Addedum: I just reread the OP, it is unclear how one got to 50K at 3yo by funding 500 monthly. So superfunding the 529 may not be feasible. I guess the spirit of my proposal is that one can do both 529 and MBDR. There's something to be said about assigning names to piles of money even if they are really the same pile.

I have the same thought. So probably I will switch to more contribution to MBDR. In case more money is needed for his college, I can use my Roth IRA to fund the remaining.

I set monthly $500 contribution, but I also made several one-time $5k- $10k contributions when I have the free money. From one my earlier post last year, it seems that my contribution at the time was behind by considering the college cost and the cost increase trend, so I made some extra contributions.

Thanks!

[fred2017]

How are the investment options/fees for the MBDR? All things equal I’d prioritize the MBDR. CA has a very low cost 529, but I didn’t think there was a CA state tax break for 529 contributions. I’m not a CA resident, so I am not totally sure on that.

MBDR has the same investment options as the 401k plan, I selected the low cost funds (at Fidelity) such as FXAIX FID 500 Index (0.02%) and FSPSX FID INTL Index (0.04%).

There are only 3 investment options for CA 529 Plan based on enrollment year - 2038/2039 Enrollment Portfolio Passive (0.07%) or 2038/2039 Enrollment Portfolio Active (0.37%) or 2038/2039 Enrollment Portfolio ESG (0.27%), and I just selected the passive one with lower cost.

[retiredjg]

I need to check that if I leave the employer, if the plan allows to transfer the after-tax contribution portion to my Roth IRA.
Thanks again.

Do check, but they really have little control over this. What they do control is whether you take a full distribution or a partial distribution. They can prohibit the partial distribution if they want.

In general, if you move on to a new job you would roll the pre-tax portion of your 401k to the next 401k and roll the Roth portion to Roth IRA.

[fred2017]

In general, if you move on to a new job you would roll the pre-tax portion of your 401k to the next 401k and roll the Roth portion to Roth IRA.

Yes, I did that for my prior employment - 401k to my current 401k at Fidelity and Roth 401k to my personal Roth IRA at Vanguard. (It was Roth 401K. Currently I did not contribute to Roth 401k, all maxed out to regular pre-tax 401k. But I made extra after-tax contribution which was converted to Roth (not sure what type of Roth) through in-plan conversion (assume this is called mega backdoor roth conversion).

[neilpilot]

Assuming you have ETFs/Stocks/MFs that have paper gains in a taxable account, consider setting up a UTMA custodial account. You can transfer appreciated assets into the UTMA and the basis transfers as well. Then, when you sell the appreciated assets in the UTMA, just transfer the UTMA cash balance to the 529.

We've done this with the grandchildren, and then every year we sell assets to generate gains just up to the limit of the Kiddy Tax ($2600 in 2024, $2700 in 2025). Your son is responsible for paying the tax on the gain. Just file IRS Form 8615 with your return, and so long as your son's total income is under the annual limit you don't need to pay tax on the gain.

[retiredjg]

In general, if you move on to a new job you would roll the pre-tax portion of your 401k to the next 401k and roll the Roth portion to Roth IRA.

Yes, I did that for my prior employment - 401k to my current 401k at Fidelity and Roth 401k to my personal Roth IRA at Vanguard. (It was Roth 401K. Currently I did not contribute to Roth 401k, all maxed out to regular pre-tax 401k. But I made extra after-tax contribution which was converted to Roth (not sure what type of Roth) through in-plan conversion (assume this is called mega backdoor roth conversion).

Yes, this is one of the versions of mega-backdoor Roth. The money is being held in a Roth 401k account (separate from if you made Roth contributions). When you leave this employer, you can roll this into your Roth IRA just like you did last time.

[fred2017]

Assuming you have ETFs/Stocks/MFs that have paper gains in a taxable account, consider setting up a UTMA custodial account. You can transfer appreciated assets into the UTMA and the basis transfers as well. Then, when you sell the appreciated assets in the UTMA, just transfer the UTMA cash balance to the 529.

We've done this with the grandchildren, and then every year we sell assets to generate gains just up to the limit of the Kiddy Tax ($2600 in 2024, $2700 in 2025). Your son is responsible for paying the tax on the gain. Just file IRS Form 8615 with your return, and so long as your son's total income is under the annual limit you don't need to pay tax on the gain.

Thank you for this information, which is new to me.
My old son is in college now, we did not save 529 for him, so we pay his tuition out of pocket, without any benefit claim due to income over the threshold.
Can I set a UTMA for him, transfer appreciated assets to the UTMA, and sell with gains to the limit of kiddy tax, then use the basis and gain to pay his tuition (and file form 8615 with my return)? But won't save much - $2700 x 15% (long-term gain rate) = $405 (not sure worth the effort )
Thanks.

[986racer]

Assuming you have ETFs/Stocks/MFs that have paper gains in a taxable account, consider setting up a UTMA custodial account. You can transfer appreciated assets into the UTMA and the basis transfers as well. Then, when you sell the appreciated assets in the UTMA, just transfer the UTMA cash balance to the 529.

We've done this with the grandchildren, and then every year we sell assets to generate gains just up to the limit of the Kiddy Tax ($2600 in 2024, $2700 in 2025). Your son is responsible for paying the tax on the gain. Just file IRS Form 8615 with your return, and so long as your son's total income is under the annual limit you don't need to pay tax on the gain.

Thank you for this information, which is new to me.
My old son is in college now, we did not save 529 for him, so we pay his tuition out of pocket, without any benefit claim due to income over the threshold.
Can I set a UTMA for him, transfer appreciated assets to the UTMA, and sell with gains to the limit of kiddy tax, then use the basis and gain to pay his tuition (and file form 8615 with my return)? But won't save much - $2700 x 15% (long-term gain rate) = $405 (not sure worth the effort )
Thanks.

Take a look at this thread : Back Door AOTC

[fred2017]

Take a look at this thread : Back Door AOTC

Thank you so much for the information. Read through few times and still had difficulty to understand clearly:

- Gift stocks to the student
- The student sell the stocks and pay the tuition, the LTCG will be taxed, filled with parents tax return
- Year 2024 as example, 1st $1300 is tax free, 2nd $1300 is taxed at 10%, over $2600 will be taxed at parents' tax rate (e.g. 24%)
- $19167 LTCG in your post as example, regular tax at 15% is $2875, with back door AOTC, tax = $1300*10% + ($19167-$2600)*0.24 - $2500 (AOTC credit) = $1606, which overall save $2875-$1606 = $1269

Is my understanding correct?

[neilpilot]

Take a look at this thread : Back Door AOTC

Thank you so much for the information. Read through few times and still had difficulty to understand clearly:

- Gift stocks to the student
- The student sell the stocks and pay the tuition, the LTCG will be taxed, filled with parents tax return
- Year 2024 as example, 1st $1300 is tax free, 2nd $1300 is taxed at 10%, over $2600 will be taxed at parents' tax rate (e.g. 24%)
- $19167 LTCG in your post as example, regular tax at 15% is $2875, with back door AOTC, tax = $1300*10% + ($19167-$2600)*0.24 - $2500 (AOTC credit) = $1606, which overall save $2875-$1606 = $1269

Is my understanding correct?

The $1300/$2600 limits were TY 2024. This year they’re $1350/$2700

[986racer]

Take a look at this thread : Back Door AOTC

Thank you so much for the information. Read through few times and still had difficulty to understand clearly:

- Gift stocks to the student
- The student sell the stocks and pay the tuition, the LTCG will be taxed, filled with parents tax return
- Year 2024 as example, 1st $1300 is tax free, 2nd $1300 is taxed at 10%, over $2600 will be taxed at parents' tax rate (e.g. 24%)
- $19167 LTCG in your post as example, regular tax at 15% is $2875, with back door AOTC, tax = $1300*10% + ($19167-$2600)*0.24 - $2500 (AOTC credit) = $1606, which overall save $2875-$1606 = $1269

Is my understanding correct?

First 1300 is tax free. Next 1300 is taxed at student’s LTCG rate (almost certainly 0)

The rest of LTCG is taxed at parent’s LTCG rate (either 15% or 20%). The 19167 number is used if your LTCG rate is 15%. The number should actually be 19267 for tax year 2024

So, 19267 - 2600 is 16667. 16667 * 15% is 2500. AOTC credit is 2500, and so the tax liability is zero

[fred2017]

Thank you for the explanation, so over $2600 ($2700 for 2025) is taxed at parents' LTCG rate, not their income rate, that would be even great.

So the student needs to have a account so you can gift to?

Thanks again !

[986racer]

First 1300 is tax free. Next 1300 is taxed at student’s LTCG rate (almost certainly 0)

The rest of LTCG is taxed at parent’s LTCG rate (either 15% or 20%). The 19167 number is used if your LTCG rate is 15%. The number should actually be 19267 for tax year 2024

So, 19267 - 2600 is 16667. 16667 * 15% is 2500. AOTC credit is 2500, and so the tax liability is zero

Thank you for the explanation, so over $2600 ($2700 for 2025) is taxed at parents' LTCG rate, not their income rate, that would be even great.

So the student needs to have a account so you can gift to?

By the way, I already have several thousands gain in my 529 plan for my 3-years old boy. Can I change the plan to my college son, so I can at least use that gain to pay his current tuition (then switch back to the younger one once his college is done?)

Thanks again !

After 2700, their LTCG sales are taxed at your LTCG rate and their STCG sales are taxed at your STCG rate.

For the 529, the easiest thing to do would be to open a new account at the same plan for your oldest son and then you can do a transfer of funds from the youngest son to the oldest

[cmr79]

...
By the way, I already have several thousands gain in my 529 plan for my 3-years old boy. Can I change the plan to my college son, so I can at least use that gain to pay his current tuition (then switch back to the younger one once his college is done?)
...

Yes, there shouldn't be any penalty for changing the beneficiary from one child to another.

[fred2017]

Thank you.

[cmr79]

Yes, there shouldn't be any penalty for changing the beneficiary from one child to another.

Suddenly I realize that my college son is going to submit financial aids application soon for next school year starting from this fall, will this change of 529 plan beneficiary impact this financial aids application?

As the parent/owner of the 529, the FAFSA would treat the account the same way for your older son's financial aid whether he is the beneficiary or your younger child is...the 529 is still considered your asset and will raise your EFC (expected family contribution) by 5.64% of the 529's balance either way. Other methods of determining EFCs (CSS or institution-specific) might vary from FAFSA, but generally they should be similar...this is to prevent people from trying to shield available assets by switching 529s to a younger child.

[fred2017]

As the parent/owner of the 529, the FAFSA would treat the account the same way for your older son's financial aid whether he is the beneficiary or your younger child is...the 529 is still considered your asset and will raise your EFC (expected family contribution) by 5.64% of the 529's balance either way. Other methods of determining EFCs (CSS or institution-specific) might vary from FAFSA, but generally they should be similar...this is to prevent people from trying to shield available assets by switching 529s to a younger child.

Thank you very much.