New Child - Account Options

[Getmeouttahere]

Hello, my wife and I just had a little boy. We have some money from family to invest and I am leaning towards a 529 for him,  mostly because I couldn’t find anything comparable in regards to tax benefits. Am I missing anyother good investment account options or is the 529 the way to go? Obviously the goal would be for him to use this towards education, but if there are different types of accounts  that offer more flexibility in regards to how the funds are used that would be ideal.

[MDM]

Congratulations on the new baby!

You could also use a generic Uniform Gift to Minors Act account.

Other considerations might be that "you can borrow for college but not for retirement" and put on your own oxygen mask before assisting others.

[englishteacheralex]

I'm not an expert on this and I might be wrong.

Some states offer a tax break if you invest in a 529. Mine (Hawaii) does not. You can invest in any state's 529, so we picked New York because they have Vanguard funds.

We put a chunk of money in a 529 when our first was born, and my mother puts some money in the account sometimes. But we have stopped putting any new money in the account because we realized a couple of things:

1. There's no immediate tax advantage to us putting money into the account, since our state doesn't offer this. The tax advantage comes at the end if we take the money out for our kids' educations.

2. You can use the money for any family member's education, not just the one you opened the account for, so we only have one account despite having two kids. We figure we'll split the money between them.

3. You do have to use the money for some kind of tuition, which is sort of annoying in my opinion. If our kids get scholarships, we're allowed to take the equivalent money out of the 529 tax-free, but what if my kids don't want to go to college? Or are unable to go for some reason? I just don't like the money being earmarked only for education. I mean, you can get to it for whatever you want, but there's a penalty (10%? Can't remember) for using it for something other than education.

4. Because of the limitations, we decided to max out two Roth IRAs instead of putting new money into the 529. You can use the principle of a Roth IRA for anything without penalty, because it's after-tax money. And I think the growth can be used for education penalty free. Therefore...I just haven't been able to figure out why someone would open a 529 instead of a Roth IRA IF they didn't have the money to do both (we don't) AND there is no tax benefit in their state (there's not for us). I figure we'll use the Roth IRA for the kids' college if necessary and if not, hey, cool, extra retirement $$.

BTW, if I'm missing anything here in my analysis, please feel free to correct me!!

[Beach_Stache]

I think it all depends on the tax benefit.  In VA we get a tax benefit of up to $4k/account/child, so w/our 3 boys we have a separate account and all together about $10k/year, so we get to write that off in VA which gives us a decent return.  If your state doesn't offer a tax break then probably a Roth is best.

[Buffaloski Boris]

Congratulations!

It really depends on the state you live in.  If you are in a state that offers a STATE income tax deduction or credit for 529 contributions, it really is one of the better investment  vehicles out there. In my state, it's a generous STATE tax deduction.  So it's the equivalent of an instant 5%+ return on investment.  And then you earn whatever market returns you would get on the underlying investment.  The withdrawal options have also gotten a lot better.  You can now use the 529 accounts for private primary school as well as college or trade school.   

That state tax treatment though is really the big thing.  If your state doesn't offer special tax treatment, or if you live in a state without a state income tax, you're probably better off putting the money in a Roth or other tax advantaged account up to the maximums due to the 529 withdrawal restrictions.  See investment order topic at the top of investor alley.  Also, be cognizant of how 529 accounts are treated for financial aid purposes.   

[Catbert]

I would avoid a Uniform Gift to Minors account that someone suggested above.  It's certainly more flexible than a 529 since it can be used for things other than education.  But it becomes the minor's when  they turn 18 or 21 (depending on the state).  Maybe your cute little baby will be responsible at 18 and put the money toward education or save to start a business.  And maybe your 18 year old will desire a fast car or hookers and blow or day trading.  It will be there money and their decision!

A 529 is great if your state gives a tax deduction.  Even if not, it can be a good way for relatives to give money for education rather than plastic crap.

[Getmeouttahere]

Thanks all, I live in Michigan and will check into the tax benefits of a 529. If they are not existent or compelling, I will open a Roth for the kid.

[MDM]

Thanks all, I live in Michigan and will check into the tax benefits of a 529. If they are not existent or compelling, I will open a Roth for the kid.

If the case study spreadsheet is correct, you'll save the MI state tax rate of 4.25% on up to $10K/yr of 529 contributions, but the IRS gives no break on the contribution.

What do you have in mind for "a Roth for the kid"?

[erutio]

You can't open a Roth for the child unless they have earned income.
Some people get around this if they have their own small business or website.  They "hire" their baby as a baby model and pay them for pictures for their website.  What you pay the baby would have to stand up to scrutiny though, meaning has to approximate market rate.  Meaning you can't take one picture of the baby and have them charge a $6k fee to full up their Roth for the year.
Also, you would have to file taxes for the baby if they have a certain level of earned income.

One last thing, paying your child for chores cannot count as earned income.

[englishteacheralex]

Yeah--clarification; we have Roths for ourselves, not for our children, because only people with earned income can have Roths. But we can use the money for the kids if we want.

[reeshau]

Thanks all, I live in Michigan and will check into the tax benefits of a 529. If they are not existent or compelling, I will open a Roth for the kid.

Michigan, which created the original 529 account, will let you deduct $5,000 each for your wife and yourself.  It's one of the few tax deductions available for Michigan state income tax.

I'm an ex-Michigander, but still have my kid's 529 there.

https://www.misaves.com/plan/details.shtml#details-10

[Buffaloski Boris]

I should’ve clarified that the Roth would be for the parents UNLESS the kid has earned income. One thing to keep in mind, although it probably isn’t going to impact very much, is that 529 plans owned by parents are included in assets used in determining expected parental contributions for financial aid but retirement plans are not.

While I’m on a tangent, savings that the child has should be kept in their own Roth to the extent possible. That’s because savings in say a savings account are expected to be used by the child to fund their education for financial aid purposes but retirement savings are excluded. The child is expected to use a much larger portion of their assets to fund their education than parents are when determining financial aid. Since contributions to a Roth (but not earnings!) can be withdrawn without penalty at any time, why not shelter those funds? Again the big issue here though is Roth’s can only receive contributions to the extent of earned income. Which for kids usually isn’t much.