Author Topic: Am I crazy for going with a taxable over a 529  (Read 1120 times)

pnw_guy

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Am I crazy for going with a taxable over a 529
« on: July 19, 2021, 09:11:52 AM »
Hi all, we have a daughter that's just over a year old and so far, we've been building some savings for her in a taxable brokerage account. Recently, I've been wondering whether we should also invest in a 529 plan. Here are some details about our situation:

Income: High earners
In state with 529 tax benefit: No
Taxable brokerage account allocation: 70% US Total Stock Market, 30% Total International Stock Market
Time to college: Approximately 17 years
Children: 1 (and we don't plan to have any more kids)

The reason why we opened a taxable brokerage account for her instead of a 529 in the first place is flexibility. We suspect our daughter go to college but you never know I guess. And since we are already highly educated as a couple (i.e., we won't be using it on ourselves) and we don't plan on having other kids (i.e., we won't be using the account on other kids), she's the main person we'd be wanting to use the 529 plan for and it would be painful if it didn't get used for educational expenses and we had to pay a penalty.

The other thing is that I'm considering that our daughter might be like me and want FIRE. If I was an 18 year old and had the option between money for school vs. taking low interest loans and having flexible money I could start using towards FIRE, I'd take the latter. In other words, I'd arbitrage the difference between market returns in a taxable account and the interest rate on my student loans. I know this strategy assumes low interest rate loans from the Federal Government (instead of private loans).

So, am I crazy for going with a taxable brokerage account? Or should I open a 529 too?

Any thoughts would be appreciated.

FINate

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Re: Am I crazy for going with a taxable over a 529
« Reply #1 on: July 19, 2021, 09:57:38 AM »
Not crazy. A brokerage account is indeed the most flexible option, which is why many go this route. Nothing wrong with this.

Something to consider, however, if you expect to remain high income in the future: Funds in a 529 grow tax free and withdrawals aren't taxed if used for qualified expenses. For our kids we made max gift contributions ($30k since married filing jointly) their first 2 years to get initial balances to $60k. That was about 10 years go. Since then they have more than doubled in value, and should continue to grow, albeit more slowly as the allocation becomes more conservative as college approaches. So for us, two years of contributions for each kid, and now we consider college more or less fully funded -- i.e. it's the maximum amount we feel is reasonable shell out.
« Last Edit: July 19, 2021, 10:36:28 AM by FINate »

EvenSteven

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Re: Am I crazy for going with a taxable over a 529
« Reply #2 on: July 19, 2021, 10:53:21 AM »
No, you're not crazy. If you end up paying for a portion of your kid's education, you will end up a little bit behind with a taxable over a 529. If you do not end up paying for education you will end up a little ahead.

We get a state tax deduction, so we are using one. I figure it is more likely than not that we will be paying for some part of our kids education. It won't be the end of the world if we end up paying a modest penalty on a modest amount of money, though. And it can always be used for grand kids or other family members that we might choose to help out.

charis

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Re: Am I crazy for going with a taxable over a 529
« Reply #3 on: July 19, 2021, 11:02:28 AM »
Not crazy. A brokerage account is indeed the most flexible option, which is why many go this route. Nothing wrong with this.

Something to consider, however, if you expect to remain high income in the future: Funds in a 529 grow tax free and withdrawals aren't taxed if used for qualified expenses. For our kids we made max gift contributions ($30k since married filing jointly) their first 2 years to get initial balances to $60k. That was about 10 years go. Since then they have more than doubled in value, and should continue to grow, albeit more slowly as the allocation becomes more conservative as college approaches. So for us, two years of contributions for each kid, and now we consider college more or less fully funded -- i.e. it's the maximum amount we feel is reasonable shell out.

What do you mean by max contribution? I didn't know there was one.

reeshau

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Re: Am I crazy for going with a taxable over a 529
« Reply #4 on: July 19, 2021, 11:21:55 AM »
Agreed, not crazy.  Even though I chose the opposite, funding a 529 for our only child.

Flexibility is the big point in favor of your decision, no doubt.

Considerations for you:
When you do pay for college, the funds you take out will add to your capital gains, unlike a 529.  As high earners, that means you will be increasing your income and paying capital gains taxes.  That might be a problem now, but it is also a prime candidate for tax increases currently, so it threatens to be worse.  Keep an eye on it.

If you were to gift the money to your daughter at 18, perhaps to avoid the point above, you need to deal with the paperwork around avoiding a gift tax / impact to your estate planning.  And while that is just paperwork at the moment, it is also a prime target of tax discussions at the federal level.  Also, your daughter's assets will have a higher expected contribution than your own, so this could impact any financial aid she might otherwise get.

I funded our son's 529 in 5 years, to the level to fund a state college.  For me, it was nice to have "mission accomplished," and not have to have a looming worry.  If he gets a full ride or chooses another path, I won't feel bad at all either helping out a niece or nephew, having some "for fun" education ourselves, perhaps in history, philosophy, or lit, or just withdrawing at a 10% penalty when It's surplus.  I would celebrate the win.

Good luck on your adventure as parents!

FINate

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Re: Am I crazy for going with a taxable over a 529
« Reply #5 on: July 19, 2021, 12:00:39 PM »
Not crazy. A brokerage account is indeed the most flexible option, which is why many go this route. Nothing wrong with this.

Something to consider, however, if you expect to remain high income in the future: Funds in a 529 grow tax free and withdrawals aren't taxed if used for qualified expenses. For our kids we made max gift contributions ($30k since married filing jointly) their first 2 years to get initial balances to $60k. That was about 10 years go. Since then they have more than doubled in value, and should continue to grow, albeit more slowly as the allocation becomes more conservative as college approaches. So for us, two years of contributions for each kid, and now we consider college more or less fully funded -- i.e. it's the maximum amount we feel is reasonable shell out.

What do you mean by max contribution? I didn't know there was one.

There are no annual max contribution limits to a 529, though there is a lifetime aggregate limit. But you run into gift tax issues if any one person contributes over 15k per year (more for a 5 year election).

seattlecyclone

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Re: Am I crazy for going with a taxable over a 529
« Reply #6 on: July 19, 2021, 12:05:44 PM »
Crazy? No. Suboptimal? Maybe. Depends if your kid goes to college or not.

charis

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Re: Am I crazy for going with a taxable over a 529
« Reply #7 on: July 19, 2021, 01:56:24 PM »
I'm hoping our AGI will still be low enough at that time our kids will qualify for free statue tuition, and it should be because I'd like to be part-time by then anyway.  But we are covering our bases by contributing to 529s only up to the  max tax deductible amount (10k/yr).  The rest goes taxable. Maybe you can split the baby.

seattlecyclone

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Re: Am I crazy for going with a taxable over a 529
« Reply #8 on: July 19, 2021, 02:16:59 PM »
Maybe you can split the baby.

Please don't attempt this.

Paul der Krake

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Re: Am I crazy for going with a taxable over a 529
« Reply #9 on: July 19, 2021, 02:31:34 PM »
Re: what if my child doesn't go to college?

I couldn't find good stats on the subject because most studies focus on kids whose parents did not go to college, nobody seems to be worried about the other way around. But I think it's fair to assume that the odds of your daughter not even starting some sort of higher education curriculum with not one but two highly educated parents are really, really low.

That being said, your decision is not even eyebrow raising, let alone crazy. Flexibility is valuable and having a pile of money that can only be used for one purpose is the opposite of flexibility.





StarBright

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Re: Am I crazy for going with a taxable over a 529
« Reply #10 on: July 19, 2021, 03:37:00 PM »

Agree not crazy! And also - we actually plan on using our Roth IRAs IF we need to dig into savings for college. You can withdraw for a child's education penalty free.

It might not be the most optimal choice, but it gives lots of flexibility and we have enough uncertainty about one of ours going to college, and the possibility of free tuition through DH's employer if the kids do decide on  college, that flexibility was pretty important to us.


PDXTabs

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Re: Am I crazy for going with a taxable over a 529
« Reply #11 on: July 19, 2021, 03:46:22 PM »
It's not crazy, but it is sub-optimal if you need to pay for college. In particular there is the Kiddie Tax to think about.

But it gives you tons of flexibility if they don't need that money for college. For example, maybe they don't go to college and you just gift them shares that they use to pay for a down payment on a house.
« Last Edit: July 19, 2021, 05:36:04 PM by PDXTabs »

secondcor521

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Re: Am I crazy for going with a taxable over a 529
« Reply #12 on: July 19, 2021, 05:18:31 PM »
I'm guessing you're in WA state since you said there is no state tax benefit, plus your user name and the fact that OR and ID both have state 529 tax benefits on contributions.

I contributed to 529s for my three kids, but my situation was different from yours - ID has better tax benefits for 529 contributions, I have three kids, and I expected all three to go to college.

Some thoughts:

If the taxable account is in your daughter's name, then the prior comments about both kiddie tax and the adverse impact on financial aid are considerations to take into account.

If it's in your name, then you'll have taxes along the way and capital gains if you sell to pay college.  The capital gains is probably going to be high, since you say you're both educated, so in 18 years you're likely to be in a pretty high capital gains bracket - at least 15% and maybe 20% and possibly even 23.8% (NIIT).

I think you're overestimating those low interest college loans.  First, the low interest loans are only for the student, not for the parent, and they are limited in size - I think about $5K or $6K annually.  Second, the interest rates may not be low in 17 years.  Third, and most importantly, those student loans typically have a significant origination fee of 4% or more.  OTOH, the interest paid might be a tax deduction then.  I think it still is currently, although there may be limitations.  At any rate, I don't think you're going to be getting much interest arbitrage as you are hoping for after all is said and done.

I think you're overestimating the 529 penalty.  If your kid gets scholarships (a likelihood), then you only owe income tax, and only on the earnings portion of any nonqualified withdrawal.  And NQ withdrawals are reported on the student's return, so if you remove the excess over time while they're in school, they may not even owe any taxes or penalties at all.  I've made a variety of non-qualified withdrawals from my kids' 529s over the past several years (I ended up overfunding) totaling in the very low five figures, and so far have paid $0 in taxes and $0 in penalties.  Plus I'm able to watch and adjust as my kids' plans change and am aiming for zero or only a bit left when they're done - although if you only have one child this is admittedly harder to do.

Finally, if you're both highly educated, there's a decent chance that your kid will not only go to undergrad but might possibly go to grad school.  529s can be used for grad school as well.  Oh, and 529s can be used for private K-12 tuition up to $10K per year, if that's something your kid might do.

Don't forget the AOTC and the LLC, which are useful to coordinate as part of your overall arsenal.

pnw_guy

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Re: Am I crazy for going with a taxable over a 529
« Reply #13 on: July 19, 2021, 08:48:56 PM »
OP here.

This thread is chocked full of thoughtful advice and perspectives. Thank you all.

A couple of good points have really stood out to me:
  • Putting some of the money in a 529 plan. I don't know why I didn't consider doing more of this sooner. I myself contribute to a traditional 401K, Roth 401K, and taxable brokerage account to create flexibility in the future. I should have sooner considered creating a similar level of flexibility for our daughter's accounts.
  • The fact that - statistically speaking - she's very very likely to go to college. Having highly educated parents is definitely a predictor for college attendance, so there's definitely an outsized probability that she'll attend and we won't have to pay any penalties. Given what I do for a living, not thinking of the conditional probability of attending college (I was thinking of the unconditional probability) is pretty embarrassing.

Happy to put together a different and more targeted post to solicit this advice, but any thoughts on what 529 plans are best for out of state residents? I suspect it will come down to which ones have Vanguard funds with low ER's but happy to hear any suggestions.

secondcor521

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Re: Am I crazy for going with a taxable over a 529
« Reply #14 on: July 19, 2021, 09:54:36 PM »
^ Two resources:

1.  Vanguard has https://investor.vanguard.com/529-plan/finda529/map.html

2.  Also check out savingforcollege.com for ratings of plans.  I think they rate plans both for state residents and out-of-state folks.

pnw_guy

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Re: Am I crazy for going with a taxable over a 529
« Reply #15 on: July 24, 2021, 04:02:56 PM »
^ Two resources:

1.  Vanguard has https://investor.vanguard.com/529-plan/finda529/map.html

2.  Also check out savingforcollege.com for ratings of plans.  I think they rate plans both for state residents and out-of-state folks.

After reading through these options, it seems like lots of the state plans offer Vanguard funds with higher expense ratios. My question is why anybody would buy a 529 plan via one of the various states that offer them  - the plans in Ohio and New York look good - instead of going direct to the source and going with Vanguard. Again, this is coming from the perspective of an out of state resident.

Just unsure what I'm missing...

seattlecyclone

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Re: Am I crazy for going with a taxable over a 529
« Reply #16 on: July 24, 2021, 05:58:30 PM »
When I was looking at starting an account a few years ago the California plan (and maybe the New York plan) had index investments available for a couple basis points less than the Vanguard (Nevada) plan. No idea whether that's still the case. I decided it was worth paying a couple extra dollars in expense ratios to go with the Vanguard-branded plan and avoid setting up an account with yet another financial institution.

pnw_guy

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Re: Am I crazy for going with a taxable over a 529
« Reply #17 on: July 24, 2021, 08:22:34 PM »
When I was looking at starting an account a few years ago the California plan (and maybe the New York plan) had index investments available for a couple basis points less than the Vanguard (Nevada) plan. No idea whether that's still the case. I decided it was worth paying a couple extra dollars in expense ratios to go with the Vanguard-branded plan and avoid setting up an account with yet another financial institution.

Thanks for the reply. This is exactly how I'm leaning at the moment.

ender

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Re: Am I crazy for going with a taxable over a 529
« Reply #18 on: July 25, 2021, 09:03:30 AM »
I actually really dislike how inconsistently beneficial 529s are.

My current state lets my wife and I deduct $3k total.

Where I lived before was $3k or so per parent per beneficiary. Meh.