Using a 529 (self) to defer income/taxes?

[Reddleman]

Since I don't have any children, until recently I had no idea that you could actually set up a 529 plan for *yourself*!

My wife and I already max out all our possible contributions (457, 401k/403b, Roth IRA), but would like to have a place to stash more money and allow it to grow tax free.  I also am getting nearer to FIRE in the next few years, and am considering a career change that would probably result in going back for my doctorate.  So the spending of the 529 would be about 4-5 years away at this point.

1. Are there any disadvantages of doing this? 
2. If I do not end up using the money for education related expenses, I will have to pay a 10% penalty on withdrawals.  From what I understand, this would only apply on the gains.  What is the chance that this would be a bad idea given the 5-10 year eventual withdrawal window? 

[sokoloff]

If you withdraw for non-qualified expenses, you will pay taxes on the gains in addition to the 10% penalty on the gains. It's not that you get to engineer the total tax burden on the gains to be 10%.

[onlykelsey]

What state are you in? Some states give deductions, some don't, and some require that you use certain plans to get the deduction.

[Reddleman]

Great question.

I'm in NY, which allows few investment options, but they are all low-cost Vanguard (.15% total fee structure)!  They also allow up to $10k per year contributions for those filing jointly.  Also, although there are no federal tax benefits, NY does allow you to deduct the amount for state taxation.  This would effectively save me a few hundred dollars a year. 

So I'm thinking that the tax savings in NY, plus whatever tax-free growth I can expect in the next few years, to more than cover the 10% penalty on earnings.  So even if I don't end up using it for qualified educational expenses, it still works out in my favor.  Am I missing something here?

[onlykelsey]

Great question.

I'm in NY, which allows few investment options, but they are all low-cost Vanguard (.15% total fee structure)!  They also allow up to $10k per year contributions for those filing jointly.  Also, although there are no federal tax benefits, NY does allow you to deduct the amount for state taxation.  This would effectively save me a few hundred dollars a year. 

So I'm thinking that the tax savings in NY, plus whatever tax-free growth I can expect in the next few years, to more than cover the 10% penalty on earnings.  So even if I don't end up using it for qualified educational expenses, it still works out in my favor.  Am I missing something here?

I'm in NY, as well.  I don't think you're missing anything, but I'm an internet stranger.   Personally it sounds sort of complex if you don't plan on using it, but if chances are you'll at least take a few courses, I'd do it.

[seattlecyclone]

I wouldn't do this unless I actually planned to use the money on education. The extra tax rate you pay on the gains for non-qualified withdrawals compared to a regular brokerage account is pretty significant. It's not just the 10% penalty, you also need to add in the difference between your regular income tax bracket and capital gains rates.

[madamwitty]

What you’re missing: I think some states “recapture” the tax deduction if you don’t end up using the withdrawals for qualified expenses.

[onlykelsey]

What you’re missing: I think some states “recapture” the tax deduction if you don’t end up using the withdrawals for qualified expenses.

Ooh, you might be right.  I never looked in to that aspect of it: https://www.nysaves.org/home/why-ny-529-direct-plan/tax-benefits.html