529 Plan and Tax Sheltered Accounts for High Income Single Filers

[MissPeach]

I've been trying to figure out how to put as money as possible into tax advantaged accounts. Preferably pretax accounts like a 401K or HSA but I'm OK with putting a portion of my money in other tax advantaged accounts like a roth IRA if I can get the money out at some point without penalties (I've been reading about seasoning a Roth).

I basically have 2 questions:

1. If you invest in a 529 plan, from what I have read it seems to operate similar to a roth IRA except you have to use it for educational expenses. My state (CA) doesn't have any state tax advantages.

If I want to tap into this money at some point, is there a way to roll it over to another type of plan such as a roth IRA without taking the penalties? I'm debating which is better - to leave in a taxable account or start a 529. I have a child I would like to help at some point but I'm not sure how much since my parents have expressed interest in paying for college. I don't want to lose the money if I need it in FI, she decides not to go, my parents pay, etc. I also don't want to pay excessive fees or lost appreciate since it seems my state has limited funds to choose from.


2. Am I missing any other tax advantaged accounts I should look into? I am a single filer and my income is too high for an IRA of some sort. I'm maxing my 401K. I don't have access to a HSA. I'm saving about 60% of my income so I would love if I can either encourage it to grow tax free or put enough of it in tax deferred accounts to move down a tax bracket. I'm not seeing anything other than going for self employment and incorporating. Am I missing some options?

[ZMonet]

Sounds like you're already looking into and know about a back door Roth IRA and you should certainly do that.

My understanding on the 529 is that you can withdraw the money but will pay a 10% penalty for anything not used on educational expenses.  I think this is read broadly to include things like computers, books, etc.  You can also change the beneficiary if you want.  The 529 can be a good vehicle, but you're right to be concerned if you aren't going to use it to cover educational expenses. 

[okiedoke]

On 529s, you only pay taxes and the 10% penalty on the gains -- not what you contributed.  So, if you contributed 20k, and it grew to 30k, you'd pay ordinary income taxes and a 10% penalty on the 10k of growth. 

[chicagomeg]

On 529s, you only pay taxes and the 10% penalty on the gains -- not what you contributed.  So, if you contributed 20k, and it grew to 30k, you'd pay ordinary income taxes and a 10% penalty on the 10k of growth.

Also, if your child receives a scholarship, you can remove the amount of the scholarship from the 529 w/o paying the penalty (but still paying ordinary income taxes I believe).

[seattlecyclone]

The 529 money can really only be used for educational expenses. You can't roll it over to any other type of plan. What you can do is change the beneficiary. So if your parents generously pay for your kid's college education, you could pay it forward and use the 529 account to pay for your grandchild(ren)'s education. As others have said, you can also just take the money out at any time and pay your regular income tax rate plus a 10% penalty on any gains.

Am I missing any other tax advantaged accounts I should look into? I am a single filer and my income is too high for an IRA of some sort. I'm maxing my 401K. I don't have access to a HSA. I'm saving about 60% of my income so I would love if I can either encourage it to grow tax free or put enough of it in tax deferred accounts to move down a tax bracket. I'm not seeing anything other than going for self employment and incorporating. Am I missing some options?

Are you aware of the "back door Roth IRA"? This is where you contribute money to a traditional IRA post-tax (there's no income limit to this type of contribution) and then immediately roll it over to a Roth IRA. This really only works if you don't have a significant pre-tax IRA balance, because any Roth conversion is pro-rated between pre-tax and post-tax amounts.

[shuffler]

Additional tax-advantaged savings:  Your 401k plan may support after-tax contributions (beyond the 17.5k limit) that you can then roll-over into Roth.  I'm able to get Roth-style treatment for an extra $20k/yr this way.

https://forum.mrmoneymustache.com/ask-a-mustachian/401ks-iras-hsa-done-now-what/msg196277/#msg196277

[MissPeach]

Thanks for the suggestions so far.

I'm aware of the backdoor IRA but I'm not in a good position to use one right now. I have an IRA that is invested entirely in individual dividend stocks. I've made 30-600% on that portfolio for each stock so the gains would be expensive at my income bracket if I convert it now. I expect to be in a lower tax bracket when I FI since my expenses are low. I've thought about moving the money to my work 401K but I have two hesitations. First my 401K's best performing fund is only making 12% since inception (which is so much lower than I have done on my own) and fees are in the 1-2% range. Second is I bought a few stocks at all time lows and even though I'm making a profit, I'm being greedy since I think the stocks I bought within the last year still have much farther to climb. I figure this year at least I'll build my taxable account and can hopefully roll my IRA to a 401K in another year or two.

I wasn't aware the rules had changed in the after tax 401K contributions and you no longer have to pay the profits as earned income in the conversion. Does anyone have any good articles or sources explaining how the conversion needs to happen to keep it tax free and avoid earned income taxes, whether it can be done while working for the employer, whether IRAs have to be factored in, etc.? I haven't been able to find anything comprehensive on these questions. I also checked some other threads on here but I didn't see these questions being answered. I would prefer to do it as quickly as possible so the investment gains are minimal.

In my 401K there are no publicly traded funds. It's all high priced fund that were created for my company with very limited information other than fees, investment type (i.e., large cap, bond, etc.) and rates of return for certain time periods. My 401K provider does allow employees to manage their own funds in a brokerage style account for a $50 yearly fee. Has anyone worked out the math on this or have a good online calculator? I'm also trying to determine whether their fund fees are costing me more than $50 + vanguard's fees + commissions. All they provide me is funds in, out, and company match. It's not very transparent.

[PathtoFIRE]

I would also be interested in learning more about after-tax 401k contributions. My wife and I both have IRAs from previous rolled over 401/403s, which would need to be dealt with before making backdoor Roth contributions as well, and while my 401k and her TSP both accept transfers from tIRAs, I have a bit of a bias towards keeping those moneys in a Fidelity account. I have also been reading about solo/individual 401ks, and while neither of us has a personal business or contractor type work, I was wondering whether that type of account might be a good way to recharacterize the tIRAs, allow the flexibility to invest of investing outside our current 401k/TSP available funds, and get the benefit of having something in place for additional saving if we were to really seek out income outside of our jobs. Looking at the forms for starting a solo 401k at Fidelity (Vanguard does not accept rollovers or transfer into their accounts I believe), it looks like the only requirement that you have to make to show you have a business is give them your EIN, which you can get online through the IRS. I'm just wondering, since I couldn't find a detailed answer after a cursory google search, what the minimum requirements are to actually claim a sole proprietor business? Does selling a few things on Amazon count, and including that info with your EIN on your tax return? Maybe it's more hassle than it's worth if you don't have an actual "business", but I haven't seen anyone discuss using it for this type of purpose, so wanted to throw it out there for the OP and for anyone else to comment and maybe disabuse me. Thanks!

[shuffler]

I wasn't aware the rules had changed in the after tax 401K contributions and you no longer have to pay the profits as earned income in the conversion.

Still have to pay taxes on the growth, I believe.  I contribute my $20k and then immediately convert those funds to Roth.  So there (practically) isn't any growth.

whether it can be done while working for the employer

I'm still employed with my employer.

whether IRAs have to be factored in, etc.?

The process I described doesn't involve IRAs at all.  You put in after-tax 401k money, and then you convert it to Roth 401k money.  Still within the 401k plan, just with Roth-style tax treatment.  No IRAs were harmed in the process.

Does anyone have any good articles or sources ...?

The best thing to do is talk to your HR department and your 401k custodian.
My HR department was actually proactive about it.  They sent a mail along the lines of "Hey, you max our your 401k, so you might be interested in this ..."

Other than getting the info first-hand for your particular plan, there are other threads on this forum:
https://forum.mrmoneymustache.com/investor-alley/$10k-after-tax-into-401k-or-brokerage-account

... and the Bogleheads as well, with links in that thread:
http://www.bogleheads.org/forum/viewtopic.php?t=66208