OH 529 vs. Roth IRA - College Savings

[Flyingstache]

Hello everyone!

My wife & I are both 29yrs old & have been blessed with 2 wonderful boys under age 3! We both teach & coach in Ohio. My wife has taught for 8yrs & I am on year 4 after working in business for 4yrs.

We have no debt other than our house. We have about $70k in savings which is anticipating a down payment for a house (we would likely keep our current home to rent out) & buying a car (the one I am driving is on its last leg!). We have about $110k between an investment account with Vanguard (index fund), a traditional IRA & a Roth IRA that were rolled over from my business jobs.

We want to start thinking of college savings which leads to the question of using the 529 or the Roth IRA. We currently have 2 kids & hope to have 1-2 more if we are lucky enough. We do not plan on paying for all of our kids college but do want to help. Would love your advice or experiences about which option you think is best!

Thanks so much!

[seemsright]

I do not like how the 529 restricts how that money gets spent. So hubby and I did a hybrid method. He likes the 529 so we put money in a 529 till it got to a agreed amount then we switched to the Roth.

Our plan is to have it that way for now and once our kid goes to college we will switch back to the 529 to use it as through account to save the state taxes on the money.

Our kid also has a grandparent 529 and this was partly why we switched to the Roth because we do not want access money in 529. We only have one kid. With you having multiple kids our solution might not be the best for you.

[Flyingstache]

Thanks so much for the response!

The lack of flexibility with the $ in the 529 was something that caused hesitation for me as well. What did you use as criteria to determine the agreed upon amount?

Thanks again!

[achvfi]

My advise is to max out Roth and then if you still have money left out put it in 529.

[achvfi]

I dont have a fixed strategy on how much amount to save in 529s.

I am not a big fan of 529 plans. My plan is to max out all the tax advantage accounts and significant chunk in taxable before 529 plan investing.

529 makes sense if you plan to invest big chunk 10/15 years before you will need it and also to transfer money into them just before you need to spend (Of course, plan for yearly limits for state tax deductions)

[reeshau]

My advise is to max out Roth and then if you still have money left out put it in 529.

I favor putting college money in a 529, but I still echo this advice.  To quote two sayings:  "put on your own oxygen mask before you help others," and "people will loan you money for college, but they won't loan you money for your retirement."

Taking money out of a Roth has consequences, including that it can't be put back in.  And saving at $6,000 a year isn't exactly too much for retirement.  Planning to use that for college short-changes the additional compounding potential for your retirement.  Also, you aren't doing your kids a favor if you cut short your future to help them.  So make sure you have at least a rough idea of what you need for retirement, and make sure you have that covered.  Once your Roth is filled, then yes use the 529 as the additional tax-favored vehicle for the medium-term goal of funding education.  With some money in all buckets, your 47-year-old selves can decide how to deploy it, with all the extra information from experience and the looming retirement.  (Or, several years into early retirement!)

Our plan is to have it that way for now and once our kid goes to college we will switch back to the 529 to use it as through account to save the state taxes on the money.

Be careful with this advice--states may vary on their treatment.  Michigan, I know, gives your tax deduction on a net basis, so money in and out again right away does not get a tax deduction.  Check your state, specifically.

[ctuser1]

Please follow the investment order:
https://forum.mrmoneymustache.com/investor-alley/investment-order/

Roth should always come before 529. Once you have maxed HSA, Roth, regular 401k etc, only then should you go to 529 or taxable.

When the time for college comes, your child may be able to go to one of the cheaper in-state schools that you can potentially cashflow, or in an absolute pinch you can even withdraw the "contributions" from the Roth, and some money from HSA (depending on how you have kept receipts for medical expenses). Your child should also work through and pay for a part of it, and in the absolute worst case you can potentially get some student loans.

[seemsright]

My advise is to max out Roth and then if you still have money left out put it in 529.

I favor putting college money in a 529, but I still echo this advice.  To quote two sayings:  "put on your own oxygen mask before you help others," and "people will loan you money for college, but they won't loan you money for your retirement."

Taking money out of a Roth has consequences, including that it can't be put back in.  And saving at $6,000 a year isn't exactly too much for retirement.  Planning to use that for college short-changes the additional compounding potential for your retirement.  Also, you aren't doing your kids a favor if you cut short your future to help them.  So make sure you have at least a rough idea of what you need for retirement, and make sure you have that covered.  Once your Roth is filled, then yes use the 529 as the additional tax-favored vehicle for the medium-term goal of funding education.  With some money in all buckets, your 47-year-old selves can decide how to deploy it, with all the extra information from experience and the looming retirement.  (Or, several years into early retirement!)

Our plan is to have it that way for now and once our kid goes to college we will switch back to the 529 to use it as through account to save the state taxes on the money.

Be careful with this advice--states may vary on their treatment.  Michigan, I know, gives your tax deduction on a net basis, so money in and out again right away does not get a tax deduction.  Check your state, specifically.

Thanks for schooling me. I did not realize that other state 529 has rules in through accounts. In OR we can literally put money in the 529 and then turn around and pay the school expenses. And in turn save the 9% on the money.

I agree make sure you understand all of the rules and fine details.

[cincystache]

I wouldn't put much into 529s... We are in the 12% tax bracket so dividends and long term cap gains are also tax free in our taxable brokerage acct. I definitely wouldn't put any in until you are maxing out all your retirement/HSA accounts first and only if you're still above 80k or higher after all your deductions. You didn't say how much $ you make but if you can get below the income limit where LT cap gains and dividends are taxed at 0% (80k or below) 529's make no sense assuming you're investing the bulk in stock index funds.

For example, assuming you both max out your 403b (39,000) HSA (7,000) Traditional IRA(if eligible) (12,000) + standard deduction 24,800 you could gross ~138,000 and still pay 0% tax on index funds in your brokerage.

However, I did open a 529 for each of our kids to allow grandparents and other family to contribute to their college funds for birthdays, holidays etc. They contribute directly to the account instead of to me and therefore know it is going to education and not our other household expenses. I like 529's for that sort of thing, they are better for high income/high contributors putting lots of money in upfront IMO

[secondcor521]

cincystache's analysis above ignores any state income tax benefit to 529 contributions, which, if considered, can tilt the analysis in favor of 529s over ordinary taxable accounts.

I have three college age kids, and have saved for their college in a mix of 529s and ESAs.  In my state, I get a state income tax deduction for the first $6,000 in annual contributions, which was effectively about a 7% gain at the time of the contribution.

I agree with the general consensus that you should prioritize your retirement savings over kids' college.  In my case I knew I would not be willing to retire if I had not covered my kids' college costs, so I worried more about optimizing for taxes than I did strictly worrying about the ordering of retirement vs. college savings.

I will point out some things about the 529 that have worked out well for me:

1.  I can easily move money between my three kids' 529 accounts with (essentially) zero tax consequences.  My kids have taken time off from college to work, have switched schools, have gotten and lost scholarships, have gotten financial aid, and have just in general changed plans quite a bit.  Being able to move money around as their plans change has been quite helpful.

2.  If you use the funds for qualified expenses, there are zero taxes.  And if you use the funds for non-qualified expenses, then only the portion used for non-qualified expenses is taxed, and even further, only the portion of those non-qualified expenses that were gains are taxed, and only then when you take the money out.  Oh, plus a 10% penalty on those non-qualified earnings.

3.  You can avoid the 10% penalty on the qualified earnings if your kid has gotten scholarships.  All three of my kids have gotten enough in scholarships where I can avoid the 10% penalty on any non-qualified withdrawals.

[lhamo]

Under current rules I believe money in Roth's is not counted on the FAFSA, and may also not be counted in the CSS (the financial aid form most private schools use). So maxing the Roths will likely be better for financial aid purposes.

[reeshau]

Under current rules I believe money in Roth's is not counted on the FAFSA, and may also not be counted in the CSS (the financial aid form most private schools use). So maxing the Roths will likely be better for financial aid purposes.

Roth balances aren't reported as assets, but distributions (even tax-free distributions of contributions) are reported as income.

https://www.savingforcollege.com/article/how-do-distributions-from-a-roth-ira-affect-the-fafsa

[seattlecyclone]

If you are planning to use retirement accounts to pay for college expenses, you may also want to consider a traditional IRA. While IRA withdrawals to pay for college are often exempt from the 10% early withdrawal tax, that is not the same as making them a qualified distribution. This difference is important for Roth IRAs: early distributions of your earnings are subject to income tax at your regular rate. The promise of tax-free growth only comes true if you're able to leave the money in until retirement age.

If you think your Roth principal (that you can withdraw for free at any time and for any reason) will be enough to pay for college and any other early retirement expenses you may wish to pay out of that account, the Roth can be a good option. If you're going to need to spend beyond your contributions, a traditional IRA might give you a bit more flexibility in this area.

We do have 529s for our kids. We put in $10k for each shortly after they were born. Further contributions have just been from the grandparents giving a bit of cash here and there. I don't really want this money to grow past what we expect to spend on college, nor do I expect it to. If it does I'll consider this a very good problem to have, and a very good sign for what the rest of our portfolio must be worth at that time. We did always max out the retirement accounts first though.

[secondcor521]

Under current rules I believe money in Roth's is not counted on the FAFSA, and may also not be counted in the CSS (the financial aid form most private schools use). So maxing the Roths will likely be better for financial aid purposes.

You are correct that retirement accounts (401(k), IRAs, etc.) are not counted on the FAFSA.

However, retirement accounts, including Roths, are included on the CSS Profile.

529s held by the student or the parent are reported on the FAFSA as a parental asset and may be "FAFSA taxed" up to 5.64% of value depending on the rest of the FAFSA data entries.

Withdrawals from 529s are not reported as income on the FAFSA (another plus in favor of 529s).

Withdrawals from retirement accounts should be reported as income on the FAFSA for the applicable year.

[cincystache]

cincystache's analysis above ignores any state income tax benefit to 529 contributions, which, if considered, can tilt the analysis in favor of 529s over ordinary taxable accounts.

Good point @secondcor521 if you have high income and live in a high income tax state this can change the calculations. Thanks for pointing it out.

[NextTime]

I still struggle with how much to save for each child. Currently I only put in $50/per pay period for each child, so $1300/year. My mother has been generous and dumps I’m $1k-$2k/year.

Currently my 3rd grader has over $22k and the 4yo has over $13k. I feel pretty good right now.
But when I go through Fidelity’s retirement analysis on my 401k, it estimates needing around $225k to send both of them to state school. I’d like to pay for their entire undergrad, but that’s just ridiculous.

What do you all Shoot for?

[Flyingstache]

Thank you all for the great insights & advice!

A few things to help answer some questions & provide more information. My wife makes about $70k per year & I make about $60k. No debt other than the house (about $100k left on a 15yr mortgage for a house we bought 3yrs ago & is valued at $210k). We have about $70k in cash, $41k in a traditional IRA (former biz job rollover), $27k in a Roth IRA (for me - wife doesn't have one currently), & $57k in a Vanguard Index fund. We max out the HSA but we do not participate in a 403b or anything like that currently.

[cincystache]

I still struggle with how much to save for each child. Currently I only put in $50/per pay period for each child, so $1300/year. My mother has been generous and dumps I’m $1k-$2k/year.

Currently my 3rd grader has over $22k and the 4yo has over $13k. I feel pretty good right now.
But when I go through Fidelity’s retirement analysis on my 401k, it estimates needing around $225k to send both of them to state school. I’d like to pay for their entire undergrad, but that’s just ridiculous.

What do you all Shoot for?

225k probably includes room and board and a bunch of other stuff I would hope. It's too difficult to plan for with all the unknowns. College could cost anywhere between $0 and $200,000 depending on a multitude of factors. It's probably better to just have some set aside and a big pile of investments than can be used to help cash flow college if/when you need to. Not a bad idea to have the mortgage paid off by the time they go to college to free up additional cash flow.

[cincystache]

Thank you all for the great insights & advice!

A few things to help answer some questions & provide more information. My wife makes about $70k per year & I make about $60k. No debt other than the house (about $100k left on a 15yr mortgage for a house we bought 3yrs ago & is valued at $210k). We have about $70k in cash, $41k in a traditional IRA (former biz job rollover), $27k in a Roth IRA (for me - wife doesn't have one currently), & $57k in a Vanguard Index fund. We max out the HSA but we do not participate in a 403b or anything like that currently.

Well done... keep up the good work. Do you have access to a 403b or 401k? That could get your income down to where you aren't paying taxes on your dividends or cap gains. It seems like you're also pretty motivated to pay off the house... Why not sell some of your index funds and use some of your huge cash cushion and wipe out the mortgage? Then plow everything into investments and you'll be able to cash flow college by the time your kids are enrolling... I wouldn't mess with a 529 until you're maxing the HSA, both 403b's, both IRAs. If you're doing all that your taxable income will be low enough to hit the 0% dividends and capital gains rates so I'd still prefer a taxable account over a 529 even with the small state tax benefit. In ohio you can only deduct 4,000 per year per account so definitely don't put more than that into your 529 because there is no tax benefit beyond that level and you'd be no better off than in a taxable brokerage acct. Good luck

[Flyingstache]

Thanks so much for the response!

I didn't have a 403b set up because my school district did not mention that. I have since looked into it & I have access to a 403b through a vendor our school has partnered with. I haven't looked into it any further than that.

I had not considered selling any of the index funds as I had always planned to just buy & hold those funds (mostly because I read somewhere in Mr. Money Mustache that it was good to do that haha). I am frustrated with our excess cash but wasn't sure how much to keep since we are likely moving within 2-3 years to a larger house & were considering keeping the current house as a rental which would mean we wouldn't have the $ from the sale of that house to use as a downpayment for the next house.

I fully acknowledge I don't know much about taxes! Even your mention of hitting the 0% dividends and capital gains rates means nothing to me as I don't know what that really means or how it affects me! Sorry for my ignorance!

[caracarn]

Under current rules I believe money in Roth's is not counted on the FAFSA, and may also not be counted in the CSS (the financial aid form most private schools use). So maxing the Roths will likely be better for financial aid purposes.

As I had kids who decided to switch households during their college career so that we both (divorced parents) filed FAFSA.   What I found is that at this point in time little money is available through the FAFSA as compared to decades past.  There was literally a $500 improvement in what the FAFSA authorized (1 $500 Pell Grant) when the child filed at the household making $20K a year versus at the household making over $200K a year. 

Keep that in mind as you wrestle with this as the mental energy expended might result in a lot less of a difference than you hoped for.

[cincystache]

@Flyingstache glad to help. A few other thoughts...

On the 403b, just watch out for fees, as you know from vanguard you should only be paying 0.1% or lower on index funds. Some of these "vendors" sell high cost products knowing that most teachers (and people in general) don't pay attention or understand how fees work. You're smarter than that... so pay attention and in some cases if teachers bring this up to the administrators you can switch providers to vanguard or fidelity products and offer low-cost index funds. Your future self and all of your co-workers will (or at least should) thank you.

No issues with keeping the down payment set aside if you plan to keep your current house as a rental provided you've done the math and it makes sense. I don't own any rentals so I can't offer much perspective there.

There is nothing wrong with holding on to your index funds either but there are some fun things you can do if/when your income drops below about 105,000 (ie captial gain tax harvesting, MadFientist has a good article on this). No need to complicate though if you aren't interested, there are certainly more important things going on in your life. As I said, keep up the good work.

[Steeze]

I would only use a 529 after your 403b, HSA, and Roth’s are maxed for the year.

If you still have cash on the table after all that, 529 up to your state’s deductible amount then switch to a standard taxable account.

Even then, I wouldn’t 529 until you have 12+ months expenses in a taxable account and/or Roth principal as additional emergency funds.

Put on your own face mask first, then worry about the kids college fund. Worst case they take out loans and you help them make payments until they are on their feet. Doing that with a Roth, taxable account, rental income, or part time job is reasonable.

I am aiming for >50% of college costs in a 529. If I end up with more money than I need I will pay for the rest with my taxable account.