Author Topic: 529 college savings plan vs. custodial acocunt  (Read 2206 times)

davef

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529 college savings plan vs. custodial acocunt
« on: July 05, 2016, 01:03:49 PM »
I am 34 Married, and we have a joint income that is around 100k/year. I do not plan on retiring early. In addition to my 9-5 job  I own my own business and plan to run that indefinitely. Currently I contribute 15% to 401k plus maxed Roth IRAs for the wife and I. 

We had our first son last month. I've looked into a Oregon 529 fund, I can do $4620 annually tax deductible. BUT there is a 10% penalty plus taxes if it is used for anything other than college. Would a Custodial account make more sense? How can I write that off?

Thank you in advance for your advice.

seattlecyclone

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Re: 529 college savings plan vs. custodial acocunt
« Reply #1 on: July 05, 2016, 01:28:53 PM »
A key difference here is that when you contribute to a 529 plan, the money is still yours. If your son doesn't need it for his education, you can do what you want with it. You can freely redesignate it for another relative's education (kid #2, grandchild, niece/nephew, even yourself) or withdraw it for your own non-educational purposes after paying the tax and penalty on the growth. Meanwhile just like an IRA any dividends and gains aren't taxed as long as the money remains in the account. Also it sounds like you get a tax break on your state taxes when you contribute to a 529 plan, so that's another point in its favor.

An interesting thing about the 529, supposing your kid doesn't need it, is that you can make withdrawals for room and board tax-free as long as the beneficiary is a half-time student. If you want to get that money out after your kid is done with school and you're retired, you could designate yourself as the beneficiary and sign up for a couple of classes at your local community college (French or pottery or something else you're interested in), just enough to put you at the half-time enrollment level. You can then take out the amount you spent on tuition plus some reasonable living expenses tax-free. Just an idea for a backup plan if you go the 529 route.

With a custodial (UTMA) account, the money isn't yours anymore. Once your son reaches the designated age in your state (usually 18 or 21), it's his to do with as he pleases. You have no legal right at that point to stop him from blowing it on a new car or whatever else he wants. While your son is still a minor, you have control over investment decisions, but any money you take out of the account needs to be used for his benefit, and can't be used for anything that you're legally required to pay for as a parent (food, clothing, shelter, medical care, etc.). You may expect you'll raise your son with a healthy respect for money and the wishes of his parents, but the fact of the matter is that you're taking a risk when you give money to your 18-year-old kid when he's still a baby who doesn't even have a real personality yet.

For the purpose of the FAFSA for college aid, assets belonging to the kid (such as an UTMA account) count more heavily toward the expected family contribution than assets belonging to the parent (such as a 529).

On the plus side, if you have appreciated stock you can transfer it to an UTMA and sell it under your child's name. A kid generally gets the first $2,100 of investment income per year taxed at their own rate (often 0%). Past that the income is taxed at the parent's rate. If you give stock directly, it retains its original cost basis, so this can be a way to harvest some capital gains at a lower rate. You could then take the money out for some discretionary child-related expense like summer camp or music lessons or braces, or let it compound for college.

catccc

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Re: 529 college savings plan vs. custodial acocunt
« Reply #2 on: July 05, 2016, 02:23:50 PM »
wow, thanks for that bit about being a half time student and room and board, seattle cyclone!  I didn't know you could do that!

seattlecyclone

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Re: 529 college savings plan vs. custodial acocunt
« Reply #3 on: July 05, 2016, 03:10:27 PM »
No problem. I haven't run this idea by a lawyer or anything, but it seems to check out. The IRS documentation about 529 plans clearly states that expenses for the beneficiary's room and board count as eligible education expenses for half-time students, that distributions for eligible education expenses don't count as taxable income, and that you can change the beneficiary to a relative (such as yourself) with no tax consequences. Add it all up and using the money on your own half-time community college tuition seems like a valid thing to do.

As a concrete example, the nearest community college to me says that a student must take six credits per quarter to be a half-time student. Tuition for six credits costs $616.50, and the room and board allowance for a quarter is $3,260. So I would pay $616.50 each quarter to take a couple of classes and also get the right to remove $3,876.50 from the 529 account tax-free. Not a bad deal if you want to take some classes anyway!

Samsam

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Re: 529 college savings plan vs. custodial acocunt
« Reply #4 on: July 05, 2016, 03:14:02 PM »
No problem. I haven't run this idea by a lawyer or anything, but it seems to check out. The IRS documentation about 529 plans clearly states that expenses for the beneficiary's room and board count as eligible education expenses for half-time students, that distributions for eligible education expenses don't count as taxable income, and that you can change the beneficiary to a relative (such as yourself) with no tax consequences. Add it all up and using the money on your own half-time community college tuition seems like a valid thing to do.

As a concrete example, the nearest community college to me says that a student must take six credits per quarter to be a half-time student. Tuition for six credits costs $616.50, and the room and board allowance for a quarter is $3,260. So I would pay $616.50 each quarter to take a couple of classes and also get the right to remove $3,876.50 from the 529 account tax-free. Not a bad deal if you want to take some classes anyway!

Wow, I did not realize this bit.  Thank you!

madamwitty

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Re: 529 college savings plan vs. custodial acocunt
« Reply #5 on: July 05, 2016, 04:05:02 PM »
I am intrigued by the 1/2 time community college idea. As another data point, a community college near me charges $306 tuition for a semester (half time=6 units), allowing $2,484 in room and board. A similar ratio to seattlecyclone's example above.

529 distributions are prorated between contributions and earnings. If, for example, your 529 plan has quadrupled in value over a couple decades and now 3/4 is earnings, then a payment of $306 to withdraw a total of $2790 is ~15%. It's like getting free tuition at community college if you were going to be withdrawing unused money in the 15% tax bracket anyway (E.g. kid gets a scholarship and you get to take out some money penalty free.)

seattlecyclone

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Re: 529 college savings plan vs. custodial acocunt
« Reply #6 on: July 05, 2016, 04:40:56 PM »
Note also that if you do the half-time community college thing, the tuition (but not the room and board) can be used for the Lifetime Learning Credit, which gives you back 20% of the first $10,000 of expenses. You can't double-dip on the tax credit and the 529 withdrawals, you have to pick one or the other. The credit probably would probably be more advantageous to many of us though.

davef

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Re: 529 college savings plan vs. custodial acocunt
« Reply #7 on: July 07, 2016, 11:04:11 AM »
I'd like to know more about custodial accounts. Can I write if off just like a 529 on my taxes each year I contribute?

seattlecyclone

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Re: 529 college savings plan vs. custodial acocunt
« Reply #8 on: July 07, 2016, 12:17:02 PM »
I'd like to know more about custodial accounts. Can I write if off just like a 529 on my taxes each year I contribute?

There's no federal tax write-off for contributions to either.

The 529 is kind of like a Roth IRA for college: you pay tax on the money before you put it in, once it's in there's no tax on the growth as long as you withdraw it for the right reasons.

An UTMA account is basically just a regular taxable brokerage account in your kid's name. Any dividends or capital gains will be subject to tax, though if you have less than ~$2,000 of these in a year (per kid) it's likely that you'll owe no tax on them. Combine this with the fact that gifts of appreciated assets to the account retain their existing cost basis, and you have the opportunity to harvest some capital gains tax-free on the condition that the money has to be used for kid-related stuff.

tonysemail

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Re: 529 college savings plan vs. custodial acocunt
« Reply #9 on: July 07, 2016, 12:24:22 PM »
you can also combine the two.
First, you can leverage the UTMA account to harvest capital gains.
Then request a distribution for the minor and put those funds in a custodial 529 account.
But FWIW, I think it's a big pain in the ass and it's easier to use the UTMA distributions for funding summer camps.