Author Topic: college savings strategy - 529 vs roth ira  (Read 2993 times)

andyInCT

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college savings strategy - 529 vs roth ira
« on: June 29, 2015, 08:21:56 PM »
I am trying to decide on a college savings strategy for kids 1 and 3 years old, for initially around $10k per year.  I'm considering the state 529, but leaning towards a pair of roth iras, via backdoor conversion, as the vehicle. 

For the 529 option, my state marginal tax rate is either 6 or 6.5%, depending on the year, and i can take a deduction on up to $10k per year.  However this benefit gets taxed on the subsequent year's federal return at a 33% marginal rate, so the state deduction has an effective value around 4%.  Additionally, my state's 529 plan is decent but not stellar when it comes to investment options and fees.  However, there is no recapture tax (or other fees as far as i can tell) on contributions later transferred out.  So i could presumably do periodic transfers out to a better plan out-of-state.

The Roth option would allow me to invest at lower cost with greater flexibility.  I understand Roth accounts are invisible to the fafsa as long as funds are not withdrawn.  So the plan would be to take out student or home equity loans to pay for school initially, then cash out the roth accounts after school to pay down debt.  I also appreciate the roth ira for its general flexibility, i.e., it doesn't have to go toward college if plans change.

Is the 529 really worth that tax deduction in the first year?  is there anything i'm missing?  thanks!


milesdividendmd

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Re: college savings strategy - 529 vs roth ira
« Reply #1 on: June 29, 2015, 09:30:03 PM »
I would fill your backdoor Roth for retirement prior to investing in a 529.

There are many ways to pay for college, and only a few to fund retirement.

Scandium

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Re: college savings strategy - 529 vs roth ira
« Reply #2 on: June 30, 2015, 08:30:37 AM »
The Roth options sounds interesting, but you'd be using up your own very limited Roth space to save for your kid's college? Unless they do baby-modeling or something and have income?

I just went with a new york 529. But since the only benefit is tax-free growth I have not put much in there yet.

Hmm. Say you put in $10k/year for 10 years. Grows to $170k;  $70k * 15% tax = $10.5k saved. And another $4k in state tax saved, at 6% Not bad I guess, but I'm not going to go crazy with it either.

johnny847

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Re: college savings strategy - 529 vs roth ira
« Reply #3 on: June 30, 2015, 08:43:59 AM »
You may want to jump on madamwitty's thread http://forum.mrmoneymustache.com/ask-a-mustachian/fafsa-and-roth-pipeline-income-alternatives/msg713836/#msg713836

That thread focuses more on figuring out how to minimize the EFC calculated by FAFSA, along with FIREing before paying for a kid's tuition and trying to use the Roth pipeline while kids are in college. So it's a bit of a different focus from your question. However, there's some good information there too.


Specifically for your question, just use your state's 529 first. As you said there's no recapture tax for contributions later transferred out, so just contribute, take the tax deduction, and then transfer it to a better 529, like that of (I think I've got these right off the top of my head) UT, NV, or NY.

Your Roth plan is not so great. As you say, they're invisible to FAFSA until the funds are withdrawn. Any funds withdrawn count as income on next year's FAFSA (though this works well if you're paying for the last year's tuition). However, more importantly, you're giving up very valuable Roth space for this. I don't think it's worth it.

Why do you say the 529 tax deduction is only for the first year? You can just claim the tax deduction every year you make a contribution.

Is your kid actually one yet? From a 3rd party website that I did not fact check against CT's laws (http://www.savingforcollege.com/529_plan_details/index.php?page=plan_details&plan_id=8)
Quote
Connecticut will provide $100 to families that open a 529 college savings account by their child's first birthday or within the first year after an adoption. Families that save an additional $150 in the first four years will receive a state match of $150, for a total of $250 in state funds.

Also
Quote
Contributions to a Connecticut 529 plan of up to $5,000 per year by an individual, and up to $10,000 per year by a married couple filing jointly, are deductible in computing Connecticut taxable income, with a five-year carryforward of excess contributions. Rollover contributions are not deductible. Contribution deadline is December 31 postmark if by mail, or final business day of the year if by electronic payment.
[Emphasis mine]

You could front load the CT 529 with up to $60k in on year if you wish and still get the full tax benefit in future years.

That website agrees with you, there's no recapture of the tax deduction if you roll over the funds to a different state's 529.

relena

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Re: college savings strategy - 529 vs roth ira
« Reply #4 on: July 01, 2015, 09:41:06 AM »
we liked the coverdells so we went with that in addition to 529s for our 2 kids.

coverdell:
https://en.wikipedia.org/wiki/Coverdell_Education_Savings_Account

KBecks2

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Re: college savings strategy - 529 vs roth ira
« Reply #5 on: July 05, 2015, 06:47:45 AM »
My kids have Coverdell + 529.  I hope that they will not need loans for college if we save well.  We will encourage affordable schools and apply for scholarships.