Author Topic: Mega Backdoor Roth for College savings?  (Read 4181 times)

MM_MG

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Mega Backdoor Roth for College savings?
« on: November 25, 2015, 10:03:29 AM »
Sorry if this has been covered. I did search, but found little.

We were thinking about doing 529 accounts for our kids next year , however after reading about the Mega Backdoor Roth I think that might be the better way to go.  I checked and my company's plan allows for 1) after-tax contributions, 2) company match on the after-tax contributions, and 3)in-service distributions twice a year.

Current thinking:
Front load my 401K to the $18K limit in Jan/Feb and then contribute as much as I can to the 401K plan with a minimum of 6% to get the company match each pay period. After  6-8 months do the first conversion from the 401K plan to a Roth IRA and then at the end of the year do a second conversion.

Background:
His 401K annually maxed at $18K
His/Her Roth IRA annually maxed at $11K-via backdoor roth
HSA will be fully funded in 2016 (first year doing HSA)
We plan to put $12K+ into our other taxable account at Vanguard in 2016
We have already fully funded our kids' pre-paid in-state tuition plan (4 years)
Live in a state with no state income tax

Rational:
Using the Roth IRA to save provides greater flexibility than a 529 account. 
Allows for additional 20K+ annual contributions to a Roth IRA, the contributions of which can be withdrawn any time.
We can use the funds for our retirement or to pay for our kids' education.

Thoughts? 

TL;DR:  Is using a mega backdoor roth a good vehicle for college savings (vs say a 529)?

 


MrMoogle

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Re: Mega Backdoor Roth for College savings?
« Reply #1 on: November 25, 2015, 10:11:41 AM »
I don't know enough about 529s.  But I do want to mention one point.

But with the Roth IRA, you would only be able to pull out contributions tax free, where with the 529, you could use interest too.  This might be perfectly fine, you can use the interest for retirement, just realize it's a hybrid solution.

MM_MG

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Re: Mega Backdoor Roth for College savings?
« Reply #2 on: November 25, 2015, 11:17:28 AM »
Thanks MrMoogle.  I do understand that.  There is also differences between how the Roth IRA and 529 would be counted toward any financial aide applications (e.g. FAFSA).  Of course planning for something that will take place in 10-15 years and may change is always risky. 

MM_MG

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Re: Mega Backdoor Roth for College savings?
« Reply #3 on: November 26, 2015, 09:26:37 AM »
I asked a Mustachian…but they didn't respond.  :(  LOL!


madamwitty

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Re: Mega Backdoor Roth for College savings?
« Reply #4 on: November 26, 2015, 04:37:13 PM »
Will you will be retired or not when you kids go to colleg? Do you expect to be eligible for financial aid? Are you committing to pay the entire cost regardless of what school the kids attend? Can your pre-paid in state tuition plan be cashed out for use at an out-of-state college?

Personally, I am planning to RE and burn down my taxable accounts prior to the college years. We'll be highly eligible for financial aid (at least under the current rules.) So if I already had a fully funded in-state tuition plan, I would think that would already be enough to cover my EFC anywhere. In that case, it doesn't sound like you need to save any more in a 529 plan.

Regardless, I'd put as much as possible into the Backdoor Roth. Good for helping you RE and does give flexibility for paying for college. I'm not particularly familiar with the mechanics so I can't evaluate your plan for timing. It sounds like you are generally aware of the FAFSA implications of tapping a Roth (i.e. counting as parental "income" on the following year's FAFSA.)

If you're planning to RE before your kids go to college, I'd be interested in hearing your plan for funding living expenses before and during the college years.

(If you're interested, my thinking about living expenses during college is discussed here: http://forum.mrmoneymustache.com/ask-a-mustachian/fafsa-and-roth-pipeline-income-alternatives/)

MM_MG

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Re: Mega Backdoor Roth for College savings?
« Reply #5 on: November 26, 2015, 06:23:59 PM »
Will you will be retired or not when you kids go to colleg?

First, thanks for the reply.  Very much appreciated.   Interesting question.  Kid #1 will be entering college the same year we expect to hit what I consider my low-end FI number.  More than likely we'll keep working while the kids are in school, but perhaps part time, but certainly at a point where we can up and go visit them whenever we want.

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Do you expect to be eligible for financial aid?
  I haven't researched income level cutoffs yet, but if we are both working, I doubt it.  At the risk of sounding like every other overly proud parent…we have pretty smart kids and both the wife and I played college sports, so we hope they have a shot at some sort of merit based aide (either academic or athletic or both).   

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Are you committing to pay the entire cost regardless of what school the kids attend?
We like to think this is open for discussion, but most likely we'll end up paying for it.  We should hopefully be in a position to cash flow the expense if we have to.  I still have some student loans (2% interest) and even though I do not plan to pay mine off any time soon, I do not want to see our kids saddled with any debt when they are starting out.

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Can your pre-paid in state tuition plan be cashed out for use at an out-of-state college?
  Yes.  The equivalent amount can be used anywhere.

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Personally, I am planning to RE and burn down my taxable accounts prior to the college years. We'll be highly eligible for financial aid (at least under the current rules.) So if I already had a fully funded in-state tuition plan, I would think that would already be enough to cover my EFC anywhere. In that case, it doesn't sound like you need to save any more in a 529 plan.
If they go in state, tuition is covered 100%.  Of course, that leaves fees, books, room and board etc. 

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Regardless, I'd put as much as possible into the Backdoor Roth. Good for helping you RE and does give flexibility for paying for college. I'm not particularly familiar with the mechanics so I can't evaluate your plan for timing. It sounds like you are generally aware of the FAFSA implications of tapping a Roth (i.e. counting as parental "income" on the following year's FAFSA.)
The flexibility is what attracts me to this approach.  If we need the money for school it is there, if not it just lets us RE-arlier, if we want to.   I need to do more research on using the funds and the implications on financial aide.   The simple approach seems to be to take out student loans for the first 3 years (assuming they are interest deferred) and then use the original contribution/conversion amount to the Roth IRA to pay off the loans in year 3 or 4, and to pay for year 4 school.  But I'm not sure if that will work or not.   Luckily I have some time to figure it out.  LOL!   

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If you're planning to RE before your kids go to college, I'd be interested in hearing your plan for funding living expenses before and during the college years.
  No plan as of yet, but the longer I work, the more attractive that becomes.  We just aren't ready to make the plunge yet. 

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(If you're interested, my thinking about living expenses during college is discussed here: http://forum.mrmoneymustache.com/ask-a-mustachian/fafsa-and-roth-pipeline-income-alternatives/)

Very much interested.  I will spend some time looking at the info in that link.   Thanks again.  Glad to know at least on mustachian doesn't think it is a crazy plan.  :)

madamwitty

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Re: Mega Backdoor Roth for College savings?
« Reply #6 on: November 26, 2015, 09:46:28 PM »
I would suggest running some numbers to see how much (need-based) financial aid you could get if you are working vs. not. Even if you are still working or have a lot of taxable investments, you may still be eligible for financial aid at some of the more expensive colleges.

The tax advantaged space in an IRA is limited, and precious for the early retiree. Definitely put what you can there. In my mind, the question is whether you should contribute to a 529 vs. taxable investments. Long story short: You'll have to run your own numbers, but here are some things to think about.

In thinking about whether to contribute to a 529 plan, I would break it down to three scenarios:

If you are in >15% tax bracket and not expecting any (need-based) financial aid, you are probably not FIREd and can cash-flow college - so probably a taxable account wins here.

If you are in 15% tax bracket (or less) and not expecting any (need-based) financial aid, taxable investment wins hands-down because neither earnings nor long-term capital gains are taxed...but a taxable account can be used for other purposes without penalty.

If you are in 15% tax bracket (or less) and expecting some (need-based) financial aid, a 529 can be good because distributions in the amount spent on education expenses does not count as income on the next year's FAFSA (whereas Roth distributions and capital gains do count as income, albeit untaxed.) Above the FAFSA income exclusion amount, marginal rates of 22% - 47% are assessed against income for purposes of calculating EFC. In my own case (10 years of FAFSA), I think it makes sense to have some 529 money to prevent a snowball of increasing EFC year after year. BUT! Don't save too much in the 529. If you have some taxable investments available without much in the way of capital gains, you could probably sell some without too much impact to FAFSA.

Hope this helps!