Using 529 as a retirement account instead of taxable?

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AndroAsc
Posts: 1119
Joined: Sat Nov 21, 2009 7:39 am

Using 529 as a retirement account instead of taxable?

Post by AndroAsc » Sat Oct 13, 2018 11:34 pm

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- Contributions when withdrawn for non-qualified expenses get NO tax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- Earnings when withdrawn for non-qualified expenses get 10% penalty tax + taxed as ordinary income(?).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- Earnings when withdrawn (i.e. sold) are taxed as LT-gains rate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.

HEDGEFUNDIE
Posts: 853
Joined: Sun Oct 22, 2017 2:06 pm

Re: Using 529 as a retirement account instead of taxable?

Post by HEDGEFUNDIE » Sun Oct 14, 2018 12:46 am

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...

typical.investor
Posts: 235
Joined: Mon Jun 11, 2018 3:17 am

Re: Using 529 as a retirement account instead of taxable?

Post by typical.investor » Sun Oct 14, 2018 1:00 am

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?

WhiteMaxima
Posts: 1387
Joined: Thu May 19, 2016 5:04 pm

Re: Using 529 as a retirement account instead of taxable?

Post by WhiteMaxima » Sun Oct 14, 2018 1:02 am

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.

MrBeaver
Posts: 228
Joined: Tue Nov 14, 2017 4:45 pm

Re: Using 529 as a retirement account instead of taxable?

Post by MrBeaver » Sun Oct 14, 2018 2:37 am

AndroAsc wrote:
Sat Oct 13, 2018 11:34 pm
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.
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
As one’s tax bracket rises, the 529 option gets worse because the tax delta between 529 and taxable increases. If tax bracket falls, the 529 option gets worse because tax drag of taxable is almost zero in the 12% income tax /0% LTCG bracket. If you seek tax inefficient investments in the 529 (REITS), the 529 expense ratio likely rises faster than the taxable tax drag because those are not common options in low fee 529s.

I literally don’t see any plausible way this makes sense.

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