529 Plans?

[Snowman99]

Hello All,

We have a 2 year old and another on the way, and our financial guy encouraged us to put whatever we have leftover after maxing our contributions to our 401k Plans and IRA Plan into 529 Accounts for our kids to pay for college.  For those of you unaware, 529 Plans are a mechanism in the United States where your earnings accumulate tax free, but you can only use distributions from the fund to pay for college educational expenses.  We live in Massachusetts, which provides an additional income tax deduction up to $2k (not much but we'll take it) for contributions to the fund.

The concept of tax free earnings and additional deductions sounds great, but here's the rub: you get whacked with a 10% penalty on the earnings, (in addition to whatever capital gains or income tax you owe) for any "nonqualified distribution," which is a distribution that is not used toward a college educational expense.  I believe the 529 Plan can also be used to pay for your kid's graduate school.

The only limit for contributions to a 529 Plan are that no contributions are allowed after the balance of the fund reaches $400k.

I have a 401k at work that will be maxed out this year  plus my wife and I will each be funding our Roth IRA's to the maximum contributions.  Whatever we have saved leftover will either be going into a taxable investment account, these 529 Plans, or a little bit of both.

The problem I have with the 529 Plan is that I have no idea what our children are going to want to do with their lives once they are 18.  Also, I have no idea what the state of the market for college education will be.  Going by current rates of inflation in this sector, the cost of college is predicted to be even more ridiculous than it is now (private school tuition is about $60k/year), with even State Universities reaching the level of $30k year when considering all the expenses.  Reading between the lines in the political winds, however, it looks like there will have to be some measure toward free college education in the near future.  There are already very low cost public options in our state (e.g. community college for two years, followed by going to UMass for the remaining two- you receive a UMass degree). 

To me, there are just so many variables to consider to justify putting money into the 529 Plan.  Further, this will essentially lock in funds that we would otherwise be using for early retirement.

I was wondering if anyone here had thoughts concerning these 529 Plans and whether they are a worthwhile consideration.  We would love to ensure that our children do not have to pay for school, and the tax benefits are always appreciated, but we also do not want to be foolish in tying up our money unnecessarily.

Would appreciate any thoughts on the matter.  Thanks.

[AlmstRtrd]

I agree with you that you never know what the college landscape will be like in all those years. Just wanted to add that in our case we put about 28K into 529s that grew to be 46K or so. This is just for one kid. We then stopped contributing because we were trying to maximize financial aid. Depending on how much you have in assets and what accounts they are in, that strategy may or may not make sense for you. What I'm getting at is that 529 assets cannot be hidden on either the FAFSA or the CSS forms. When colleges see funds set aside explicitly for a kid's education, they take that money right away.

And FWIW, we are also trying to make sure our daughter gets through at least her undergrad studies free of debt. The book Paying For College Without Going Broke was helpful. We started planning all this in earnest when our daughter was nine years old and the rules and expenses were a bit easier to predict.

The last thing I would add is that your kids themselves can help a lot by being good students. The total cost for our daughter's freshman year was roughly 58K. Breaking that down, it's about 15K in need-based aid, 21K for a merit scholarship, and we are paying 22K.

[Hargrove]

I recommended to someone just using a Roth IRA as the savings vehicle. I told them Roth because they had goals of buying a house, saving for college for kids, and saving for retirement, which are all long-term but two could be tax-heavy from a Traditional, one is up to chance if the kid actually goes to college. They're Mustachian by habit (AirBnB vacations, antipathy for Disney World type excursions, etc) but almost financially a blank slate, so I started them with a recommended 60/40 at Vanguard with a Roth IRA (60% VTSMX 40% VGTS). They didn't realize NON-earnings are free to withdraw, and earnings could be additionally withdrawn for the above mentioned expenses, which is a lot of flexibility if you want one answer for all those goals. Then if the kid doesn't go to college, you literally don't have to do anything.

[Scandium]

I put some into a 529 for our kids, but don't consider it that great of a deal. We don't get the state income tax deduction though, as our state's plan is high ER so went elsewhere. But if over ~15 years say we have gains/dividends of $10,000, that results in saving a whooping $1,500 in capital gains taxes.. Not a whole lot IMO. All for tying this money to college expenses only. (Though you can spend that on your own education in retirement for example. Take a class at community college and use 529 money to pay your mortgage.)

I'm sure your FA recommend this because it would give him/her more AUM to charge fee on.

[Secretly Saving]

We only utilize a 529 up to the tax benefit in our state. This pretty much guarantees that we wont be over funding them.  Everything else we save in retirement accounts and taxable accounts. 

[mizzourah2006]

The money can be transferred, so theoretically if your kid(s) don't use it all, when they have kids you could transfer the remaining money to them. That being said I am not putting a ton in each year, because I just don't see undergrad being the same as it is today 18-20 years from now. Many colleges are already blending MOOC and in-person right now. If 10k people are taking each class they don't really need to charge $1k/credit hour to make a lot of money.

[Snowman99]

Thanks for the comments everyone.  After reading a few I went off and did a little research about FAFSA and what colleges look at when determining financial aid.  It looks like the 529 Plan really isn't such a great deal when considering the financial aid aspect (something the financial guy did not tell me).  I was also counseled by a coworker who has four kids approaching college age about this. 

FAFSA does not consider the following parental assets when determining need:

1. Retirement Accounts;
2. Home equity;
3. Family owned business
4. Personal belongings like cars, furniture, etc.
5. Debt

FAFSA will consider the 529 plan as an asset in addition to any taxable investment accounts, bank accounts and cash on hand.  Some colleges use something called a CSS profile (or whatever it is called) that does consider home equity, etc., but these tend to be only the wicked expensive elite schools that I have no interest in paying for.

Accordingly, if you are just going to take the FAFSA into account, the best thing to do is to max out the retirement accounts (already happening) and applying the balance to your mortgage, or other debt if you have any. 

The retirement accounts are 100% stock index funds, so we can take whatever is left over and throw it at the mortgage and consider that our tax free "bond exposure" until paid off and then reassess.  Meanwhile we will fund only $2k/year on the 529 Plans to get our state deduction.

Thanks again everyone.  Very helpful.

[Car Jack]

Something else you can consider for FAFSA-only colleges (which is more than just public colleges....Wentworth, for example is FAFSA only):  Grandparent 529.  The strategy is that the grandparent 529 isn't seen at all for public OR private college.  Only use it for senior year.  Although FAFSA goes back to income 2 years ago, private colleges can do whatever they want.  With a son in private college in MA, I know that they use CSS for the first year and their own aid form after that which goes to previous year.

Something you could consider with the MA 529 plan, administered by Fidelity is to open a Fidelity 2% credit card and direct the rewards to go into the 529.  I did that for my son but since he's in college now, when the fall bill comes in, it's all coming out.  We have had zip for aid (the amount of income that gets your aid to zero is far lower than you'd expect) so won't even bother with FAFSA for his last couple of years.

Absolutely put the money in retirement accounts, pay off cars, get a HELOC to make equity in the house available and pay off the mortgage.  Something to remember about private colleges.....they don't restrict themselves to only looking at FAFSA type assets.  They DO ask about retirement accounts, primary home value, car value etc.  How they use them in calculations, I don't know, but they do ask.  They also ask if anyone else paid for college expenses last year.  For us, my mom directly paid some of these costs to the college.  The IRS allows payments directly to college and does not include that in the $14k gift allowance before eating into the lifetime gifting amount.

Indeed, the better grades the student gets, the more merit aid they can qualify for.  The caveat with that is if they get into a stretch school, they likely get zip for merit aid.  If they go to a lower ranked school, they'll get more aid.  Also, if they transfer, schools give zip for merit aid to transfer students (my son transferred and lost $11k a year by doing so).  That should be considered when thinking that 2 years of community college followed by 2 years of a 4 year school will save money.  It may not.

And do NOT under any circumstances fall for the "college financial planner" claim that they have a product that can protect your assets from being seen by FAFSA.  They'll sell you a whole life policy, collect their up front 8% and your money will be locked up until the kids are done with college.  We had one give talks at our town's schools and we nearly fell for the scam before I found Bogleheads and asked there.

[Morning Glory]

Something else you can consider for FAFSA-only colleges (which is more than just public colleges....Wentworth, for example is FAFSA only):  Grandparent 529.  The strategy is that the grandparent 529 isn't seen at all for public OR private college.  Only use it for senior year.  Although FAFSA goes back to income 2 years ago, private colleges can do whatever they want.  With a son in private college in MA, I know that they use CSS for the first year and their own aid form after that which goes to previous year.

Something you could consider with the MA 529 plan, administered by Fidelity is to open a Fidelity 2% credit card and direct the rewards to go into the 529.  I did that for my son but since he's in college now, when the fall bill comes in, it's all coming out.  We have had zip for aid (the amount of income that gets your aid to zero is far lower than you'd expect) so won't even bother with FAFSA for his last couple of years.

Absolutely put the money in retirement accounts, pay off cars, get a HELOC to make equity in the house available and pay off the mortgage.  Something to remember about private colleges.....they don't restrict themselves to only looking at FAFSA type assets.  They DO ask about retirement accounts, primary home value, car value etc.  How they use them in calculations, I don't know, but they do ask.  They also ask if anyone else paid for college expenses last year.  For us, my mom directly paid some of these costs to the college.  The IRS allows payments directly to college and does not include that in the $14k gift allowance before eating into the lifetime gifting amount.

Indeed, the better grades the student gets, the more merit aid they can qualify for.  The caveat with that is if they get into a stretch school, they likely get zip for merit aid.  If they go to a lower ranked school, they'll get more aid.  Also, if they transfer, schools give zip for merit aid to transfer students (my son transferred and lost $11k a year by doing so).  That should be considered when thinking that 2 years of community college followed by 2 years of a 4 year school will save money.  It may not.

And do NOT under any circumstances fall for the "college financial planner" claim that they have a product that can protect your assets from being seen by FAFSA.  They'll sell you a whole life policy, collect their up front 8% and your money will be locked up until the kids are done with college.  We had one give talks at our town's schools and we nearly fell for the scam before I found Bogleheads and asked there.

Agree with what you said about paying down debt and maximizing retirement accounts.

I did receive merit aid as a transfer student that covered about half of my tuition, so it is worth looking into. It depends on the school. Mine was a private nonprofit lib arts college with an excellent financial aid department and a large endowment.

It is also worth it to fill out the FAFSA no matter what your income level is. Some states have grants that kick in if you make slightly too much money to get the federal grants, and schools also use FAFSA to give out need based aid.  There was one year I made slightly too much to get the state grant so the school found me a private scholarship that was almost as much. You also need FAFSA to access subsidized loans.

The CC then transfer strategy is an excellent choice if your child will turn 22 prior to the transfer, so your income won't count at all. I had a good-ish job after CC, so I did a couple of "gap years" before finishing my degree so that I wouldn't have to report parents income (parents had debt problems and were unable to help with costs), also so that I could work and save to avoid loans. My school's sticker price was about 22k/year, of which I was only responsible for about 5k after merit and need based aid.

I did take some subsidized loans but had them paid off within a year after graduating. The main reason was that I had a stupid financed car so I used my savings /income to pay that off and took the school loans because the rate was 0% until 6 months after graduation. Looking back, I would be a lot richer if I had invested instead of paying off the loans, because this was right after the market crash in 2008.

My smartest decision was to buy a small house at age 20 (very LCOL area) so that I would not have to pay for the overpriced dorm and meal plan. I was able to sell it for a small profit just a few months before the housing crash

I later paid close to nothing for a Master's degree because of an employer tuition reimbursement program.

I am still debating whether or not to 529 for my son. He is 2 so I have some time to decide. I am in a better position financially than my parents have ever been. I see the child tax credits as "his", so I would like to set up some kind of account for him, just not sure whether to do 529 or taxable.