Author Topic: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.  (Read 8975 times)

The Mobile Mustachian

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Hello everyone,

My wife and I are planning on having children about 3 years from now. We're fully funding our 401Ks and IRAs and we're starting to think down the road to college related expenses for our child (assuming we have 1). We live in PA, so we can pretty much pick any plan in the nation and still get the state tax deduction. The approach I am thinking of taking seems pretty straightforward and I'd appreciate your feedback.

We have 21 years approximately (3 + 18) until the funds will be needed. Currently in-state tuition is about $20,000 per year give or take a couple thousand.

Assumptions:
  • 4% rate of inflation for tuition
  • 8.5% average market return per year

In 21 years, the average cost for a four year college education using the 4% inflation figure is $182,000. Using an average 8.5% market return, this means that we should put $33,000 in the 'stache to pay for this future expense. We could drop this into the account now by claiming future year contributions.

What are your thoughts on this approach? What other considerations would you recommend? I'd also be very interested in your thoughts on which 529 plan to choose -- at present I am looking at the 529 Vanguard plan based in Nevada. Thanks for your time.

Gin1984

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #1 on: September 07, 2014, 04:12:27 PM »
Overall state tuition is increasing more than 4%.  Private colleges are increasing at a slower rate, but of course they already cost more.  I'd check what your state is increasing, over the last 5 years or so.

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #2 on: September 07, 2014, 04:38:37 PM »
That front-loading strategy makes sense to me.  I looked at our current 529's for our kids. 

The older two kids have $17k in each of their 529's.  We want to have enough to fund 4 years of tuition.  $17k in 11 years (the midpoint of when the money is needed) will be $44k at a 9% rate of return. 

Tuition costs of $8,200/yr x 4 = $32,800 will be $53,000 in 11 years (at 4.5% tuition inflation rate).  We will be just a little short in the 529's. The rest will come from our portfolio. 

4.5% tuition rate of inflation is maybe a tad optimistic for in state tuition. 

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #3 on: September 07, 2014, 05:05:18 PM »
Front loading is a terrific idea. You can place up to 5 years contribution limits in at one time.

In terms of providers, if you want to go straight low cost vanguard, NY has the best plan.

If you want a mix of vanguard and DFA funds and good international options utah is the best. (My choice)

One final tip. I think it makes sense to be very aggressive with your asset allocation within your 529, because if you don't got your goal your kids will still have other options for paying for college. (Ie unlike failed retirement savings, no one is at risk for eating dog food under a bridge if the market collapses.

Good luck.

AZ

sandandsun

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #4 on: September 07, 2014, 05:34:34 PM »
Would definitely go this route and front load if you can swing it... But to echo what others have said, tuition has been increasing more than 4 percent a year... Although, I think this will slow a little (I think it might average 5-6 percent a year which is lower than the 7-8 percent many states have seen lately).  Reason: state support for public institutions has declined rapidly in recent years with the recession... Schools simply increased tuition to cover the gap.  Although I dont think most of that state funding is coming back any time soon, it also doesn't leave a lot to cut going forward...  I'd look for tuition to increase closer to inflation rate than it has over the last decade...
« Last Edit: September 07, 2014, 05:36:48 PM by sandandsun »

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #5 on: September 08, 2014, 03:52:33 AM »
When you guys say "Front Load it" can you be more specific. Im in Wisconsin and have 4 kids. I put what I thought was the max 3k per kid in a year and get the state deduction.  Is there a way I can put more in that makes sense? My/Our income exceeds limits on most programs that have restrictions but we are 2 years or less away from total Fire.  Having 2 in High School the oldest I started putting on the payroll for 12-15 hours a week since he can make around 6k a year and only have to pay FICA and am just banking. I have some catch up to do as I have only about 25k per kid in account which 2 will be going to college in 3/4 years respectively then I have a 4 year gap for the next two.  The mistake was made years ago when i obviously thought I was just always going to make the money to pay for things but those days are gone. I want to play some catch up to help as much as I can but not by ruining our retirement.

Thanks,

FrugalSpendthrift

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #6 on: September 08, 2014, 07:15:33 AM »
When you guys say "Front Load it" can you be more specific. Im in Wisconsin and have 4 kids. I put what I thought was the max 3k per kid in a year and get the state deduction.  Is there a way I can put more in that makes sense?
Check with your state's program on the real maximum's.  The $3k may be the limit on how much you can deduct from your taxes, not how much you can contribute.  You have to consider gift taxes when you make really large contributions, but they have a carry forward option, so that you can make five years worth of gifts at one time and still avoid the gift tax.


AllChoptUp

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #7 on: September 08, 2014, 08:16:14 AM »
Front loading is a great idea, we did that with a gift from grandparents.  We chose Utah's program based on reviews; Utah was consistently at the top of ranked lists or in the top 3.  So far it's doing quite well :)


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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #8 on: September 08, 2014, 09:14:40 AM »
When you guys say "Front Load it" can you be more specific. Im in Wisconsin and have 4 kids. I put what I thought was the max 3k per kid in a year and get the state deduction.  Is there a way I can put more in that makes sense? My/Our income exceeds limits on most programs that have restrictions but we are 2 years or less away from total Fire.  Having 2 in High School the oldest I started putting on the payroll for 12-15 hours a week since he can make around 6k a year and only have to pay FICA and am just banking. I have some catch up to do as I have only about 25k per kid in account which 2 will be going to college in 3/4 years respectively then I have a 4 year gap for the next two.  The mistake was made years ago when i obviously thought I was just always going to make the money to pay for things but those days are gone. I want to play some catch up to help as much as I can but not by ruining our retirement.

Thanks,

There are two issues when it comes to 529 contributions.

The first is the state tax deduction. This is state specific and sometimes takes the form of a tax credit or tax deduction. In some states you can contribute a bunch and carry forward your tax deduction into future years.

In some states you must contribute to your own states 529 and in some states you may contribute to any 529 and still get the tax deduction.

So the take-home is that for state tax purposes you must check with your individual state to see what is available to you.

The second issue a 529 contributions is that they are subject to the gift tax. Each year you can contribute a certain amount to each family member without incurring gift taxes. For 2014 I believe it's about $15,000. This forms the effective ceiling up to Which it makes sense to contribute to 529's and beyond which it probably doesn't from a tax perspective.

This is where frontloading comes in. You are allowed to contribute up to five times gift taxes into a 529 account(So about $75,000) and not pay the gift tax, as long as you do not contribute to the 529 or gift further money for the next five years.

The advantage is that you get an additional 4 years of tax free compounding on the full amount of money that you would've contributed over the subsequent 4 years.

This is a great benefit if you've already fully funded your retirement accounts, and you're sure that you will have qualified expenses such as college to spend the money on eventually.
« Last Edit: September 08, 2014, 09:18:27 AM by milesdividendmd »

SomedayStache

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #9 on: September 08, 2014, 02:36:36 PM »
You need to add two more very important items to your 'Assumptions' list
  • that you will have children
  • that said child will need your money to pay for college

What happens if you never have kids?  I'm also going to throw a personal anecdote out there and give the example of myself and my two brothers:
  • Myself: National Merit Scholar status meant I got lots of scholarships.  Then I went and got married at 19 making myself eligible for federal grants on top of that.  My parent's didn't pay a dime for my education. (Of course I chose to make my path harder...but that's not relevant).
  • Brother 1: Has mild autism, tried community college but couldn't hack it.  No further college costs.
  • Brother 2: Was born severely disabled and college was never an option.

In all of these cases large amounts of money in a 529 would have been wasted.  (Since 529s didn't exist 30 years ago that was never an actual possibility).

Before you say my example is way too specific and not relevant there is also my husband's family.  There were four children there, but only 1 went to college.  College isn't for everyone and it doesn't need to be. 

I have 3 healthy kids and would be reluctant to 'fully-fund' a 529 for all of them.  If I had that amount of money I'd probably do some in a 529 and then earmark the rest as 'kid's education' but keep it somewhere more flexible.

milesdividendmd

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The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #10 on: September 08, 2014, 03:29:07 PM »
Those are all excellent points.

But I will make some counter arguments.

If you have two college educated parents and three healthy children, The odds are that at least one of the kids will go on to  some form of higher education. 529 accounts are freely transferable within family members.

Also in your case if you had received a national merit scholarship you would've been eligible to withdraw the 529 without the 10% penalty on earnings because of the scholarship exception, So no harm would've been done if your parents had invested in a 529.

In addition your siblings with disabilities would also be eligible for a waiving of the 10% Early withdrawl penalty.

So in most cases if you've  maxed out Tax  sheltered retirement savings, it is good to at least take advantage of the state tax break portion of the 529 savings plan.

AZ
« Last Edit: September 09, 2014, 09:20:19 AM by milesdividendmd »

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #11 on: September 09, 2014, 05:23:05 AM »
When you guys say "Front Load it" can you be more specific. Im in Wisconsin and have 4 kids. I put what I thought was the max 3k per kid in a year and get the state deduction.  Is there a way I can put more in that makes sense? My/Our income exceeds limits on most programs that have restrictions but we are 2 years or less away from total Fire.  Having 2 in High School the oldest I started putting on the payroll for 12-15 hours a week since he can make around 6k a year and only have to pay FICA and am just banking. I have some catch up to do as I have only about 25k per kid in account which 2 will be going to college in 3/4 years respectively then I have a 4 year gap for the next two.  The mistake was made years ago when i obviously thought I was just always going to make the money to pay for things but those days are gone. I want to play some catch up to help as much as I can but not by ruining our retirement.

Thanks,

There are two issues when it comes to 529 contributions.

The first is the state tax deduction. This is state specific and sometimes takes the form of a tax credit or tax deduction. In some states you can contribute a bunch and carry forward your tax deduction into future years.

In some states you must contribute to your own states 529 and in some states you may contribute to any 529 and still get the tax deduction.

So the take-home is that for state tax purposes you must check with your individual state to see what is available to you.

The second issue a 529 contributions is that they are subject to the gift tax. Each year you can contribute a certain amount to each family member without incurring gift taxes. For 2014 I believe it's about $15,000. This forms the effective ceiling up to Which it makes sense to contribute to 529's and beyond which it probably doesn't from a tax perspective.

This is where frontloading comes in. You are allowed to contribute up to five times gift taxes into a 529 account(So about $75,000) and not pay the gift tax, as long as you do not contribute to the 529 or gift further money for the next five years.

The advantage is that you get an additional 4 years of tax free compounding on the full amount of money that you would've contributed over the subsequent 4 years.

This is a great benefit if you've already fully funded your retirement accounts, and you're sure that you will have qualified expenses such as college to spend the money on eventually.
When you guys say "Front Load it" can you be more specific. Im in Wisconsin and have 4 kids. I put what I thought was the max 3k per kid in a year and get the state deduction.  Is there a way I can put more in that makes sense?
Check with your state's program on the real maximum's.  The $3k may be the limit on how much you can deduct from your taxes, not how much you can contribute.  You have to consider gift taxes when you make really large contributions, but they have a carry forward option, so that you can make five years worth of gifts at one time and still avoid the gift tax.




Thanks, I will check more into this.

teen persuasion

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #12 on: September 09, 2014, 09:26:28 AM »
When you guys say "Front Load it" can you be more specific. Im in Wisconsin and have 4 kids. I put what I thought was the max 3k per kid in a year and get the state deduction.  Is there a way I can put more in that makes sense? My/Our income exceeds limits on most programs that have restrictions but we are 2 years or less away from total Fire.  Having 2 in High School the oldest I started putting on the payroll for 12-15 hours a week since he can make around 6k a year and only have to pay FICA and am just banking. I have some catch up to do as I have only about 25k per kid in account which 2 will be going to college in 3/4 years respectively then I have a 4 year gap for the next two.  The mistake was made years ago when i obviously thought I was just always going to make the money to pay for things but those days are gone. I want to play some catch up to help as much as I can but not by ruining our retirement.

Thanks,

Might be derailing the thread a bit, but have you considered having your child open a Roth and funding that?  Funds in retirement accounts aren't included in assets on the FAFSA, but could be withdrawn if you they need.  I believe that YOU could also fund the Roth for them, as long as the child actually has earnings.

SomedayStache

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #13 on: September 09, 2014, 11:01:52 AM »
I didn't know there were waivers for withdrawing money from a 529 without paying the penalty.  Thanks Milesdividend, I will investigate that more.

sandandsun

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #14 on: September 09, 2014, 11:11:00 AM »
As long as you have a scholarship you can withdraw the same amount from 529 penalty free...  and, of course, you can withdraw to cover educational-related expenses (laptops, books, living expenses) - not just tuition and fees...

Gin1984

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #15 on: September 09, 2014, 11:39:35 AM »
As long as you have a scholarship you can withdraw the same amount from 529 penalty free...  and, of course, you can withdraw to cover educational-related expenses (laptops, books, living expenses) - not just tuition and fees...

AND if you child is going to school at least half-time and living at home, you can pay yourself a set amount to cover their "room and board." It's likely our kids will go CUNY for at least a little while, and we're setting aside money in the 529 just for that. If you look up your university's "cost of living at home" under their expected cost of attendance, you can pay yourself that amount from the 529 every year, tax free, if your child lives with you while going to school. For most of the NYC public universities, that amount is around $2,000/annum.
Where did you get that from?!

sandandsun

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #16 on: September 09, 2014, 11:51:20 AM »
Schools calculate room and board expenses for all students- even those who are commuting... I don't know about 'paying yourself' in practice (not sure what type of documentation you have to submit to withdraw living expenses), but it is certainly feasible as the cost of living is included in financial aid packaging.  Some schools include transportation costs as well...  there are a whole lot of 'ed-related expenses' that you wouldn't think about :)

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #17 on: September 09, 2014, 01:34:24 PM »
GoCurryCracker had a GREAT article on this exact question just yesterday.

http://www.gocurrycracker.com/is-college-worth-it-with-future-tuition-predictions/

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #18 on: September 09, 2014, 02:01:10 PM »
FYI for those looking at 529's and worried about the penalty on withdrawal if your kids don't use the funds.  The penalty only applies to earnings, not the principal.  So withdrawing $10,000 of unused funds that consists of $5000 principal and $5000 earnings would only have a $500 penalty (10% of $5000) and you'd owe tax on the $5000 earnings when it's withdrawn.   


msilenus

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #19 on: September 09, 2014, 02:05:38 PM »
A lot depends on your marginal tax rate.  Mine is very high.  About 45%.  When I ran the numbers, I discovered that if I had to choose between accidentally undercontributing by $1 to my 529s and overcontributing by $2 and paying a penalty, I was better off with the penalty.  (That's not to say that it's better to overcontribute than exactly-contribute --it's not. But you don't know how much you'll need, so you it's wise to figure out how to lead your target.)  If your rate is high, then there's huge value on reducing your taxable asset surface.

Then I went into looking into ways to use that $2 of overcontribution.  Turns out, you can point the money at yourself and enroll in a community college.  Then you can use the money to pay your own living expenses, up to what the CC says is allowed for financial aid purposes.  I'm pretty sure my wife could do this as well.  I suspect, there's at least $50k or so of space in my 529 plans that I can blur into overlapping with my tax-advantaged retirement space, because retirement and education both involve living.

There might be other tricks you can use.  Review the IRS pubs yourself, but as I read them, it looks like they only care if a qualified education expense existed, not what the money was used for.  So if you have nephews in college without 529s of their own, there's no good reason why they or their parents should object to you pointing some of that money at them and withdrawing it tax and penalty free.

Finally, I think that pointing any surplus money at grandkids is the best kind of legacy you can leave.  People are living so long that inheritances arrive too late to change anyone's lives.  If you want to do something for your kids and grandkids with your money, best to do it while you're alive (if you plan on living long), and best to take advantage of any tax incentives Uncle Sam is prepared to offer.

Net-net: when I realized how much I might actually benefit from having surplus money in a 529, I changed my balance targets.  Instead of shooting for saving for 4 years of public schools assuming in-state tuition and optimistic tuition inflation assumptions, I'm basing my targets on something closer to private school tuition.  If that's too much, then great: on to a very good spectrum of "Plan B" options.  If it's just right or too little, then I'll be glad as hell I was more aggressive!

I do recommend checking out that gocurrycracker link.  The analysis is excellent.

P.S. Note on using a Roth for college: this really screws with financial aid.  It produces income on next year's FAFSA form.  The way the aid calculations work, it's better to have assets in a 529 than income from a Roth.  529 withdrawals are not counted as income for financial aid purposes.

msilenus

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #20 on: September 09, 2014, 03:54:33 PM »
FYI for those looking at 529's and worried about the penalty on withdrawal if your kids don't use the funds.  The penalty only applies to earnings, not the principal.  So withdrawing $10,000 of unused funds that consists of $5000 principal and $5000 earnings would only have a $500 penalty (10% of $5000) and you'd owe tax on the $5000 earnings when it's withdrawn.

This turns out to be not as big a deal as you might think.  Your cost-basis isn't adjusted for inflation, and OP's time frame is something like 20 years.  So when projecting the proportion of the account that is basis, you need to use nominal (not real) returns over a very long period of time.  My napkins suggests we're talking about  basis somewhere in the 10%-15% range.

Gin1984

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #21 on: September 09, 2014, 06:23:26 PM »
A lot depends on your marginal tax rate.  Mine is very high.  About 45%.  When I ran the numbers, I discovered that if I had to choose between accidentally undercontributing by $1 to my 529s and overcontributing by $2 and paying a penalty, I was better off with the penalty.  (That's not to say that it's better to overcontribute than exactly-contribute --it's not. But you don't know how much you'll need, so you it's wise to figure out how to lead your target.)  If your rate is high, then there's huge value on reducing your taxable asset surface.

Then I went into looking into ways to use that $2 of overcontribution.  Turns out, you can point the money at yourself and enroll in a community college.  Then you can use the money to pay your own living expenses, up to what the CC says is allowed for financial aid purposes.  I'm pretty sure my wife could do this as well.  I suspect, there's at least $50k or so of space in my 529 plans that I can blur into overlapping with my tax-advantaged retirement space, because retirement and education both involve living.

There might be other tricks you can use.  Review the IRS pubs yourself, but as I read them, it looks like they only care if a qualified education expense existed, not what the money was used for.  So if you have nephews in college without 529s of their own, there's no good reason why they or their parents should object to you pointing some of that money at them and withdrawing it tax and penalty free.

Finally, I think that pointing any surplus money at grandkids is the best kind of legacy you can leave.  People are living so long that inheritances arrive too late to change anyone's lives.  If you want to do something for your kids and grandkids with your money, best to do it while you're alive (if you plan on living long), and best to take advantage of any tax incentives Uncle Sam is prepared to offer.

Net-net: when I realized how much I might actually benefit from having surplus money in a 529, I changed my balance targets.  Instead of shooting for saving for 4 years of public schools assuming in-state tuition and optimistic tuition inflation assumptions, I'm basing my targets on something closer to private school tuition.  If that's too much, then great: on to a very good spectrum of "Plan B" options.  If it's just right or too little, then I'll be glad as hell I was more aggressive!

I do recommend checking out that gocurrycracker link.  The analysis is excellent.

P.S. Note on using a Roth for college: this really screws with financial aid.  It produces income on next year's FAFSA form.  The way the aid calculations work, it's better to have assets in a 529 than income from a Roth.  529 withdrawals are not counted as income for financial aid purposes.

According to my financial aid department (which I admit was not the best), pulling money from a Roth is not income.  Nor, am I sure where you would even put that on the FASFA.

msilenus

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #22 on: September 09, 2014, 06:29:54 PM »
Quote
A good type of asset to own when applying for financial aid is a retirement account such as an IRA or 401(k). These qualified retirement accounts, whether owned by you or by your child, are not counted at all in determining EFC for purposes of federal financial aid. Be careful, however, about taking money out of your IRA (or any retirement account) to pay for college. Though the tax law now permits penalty-free withdrawals from a traditional or Roth IRA to pay for qualified college costs, doing so could jeopardize financial aid in the following year. The entire withdrawal, principal and earnings, counts as income on the following year's aid application.

http://www.savingforcollege.com/financial_aid_basics/financial_aid_and_your_savings.php

See also: http://www.kiplinger.com/article/college/T042-C001-S001-how-roth-iras-affect-financial-aid-eligibility.html, and others.

Gin1984

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #23 on: September 10, 2014, 06:30:34 AM »
Quote
A good type of asset to own when applying for financial aid is a retirement account such as an IRA or 401(k). These qualified retirement accounts, whether owned by you or by your child, are not counted at all in determining EFC for purposes of federal financial aid. Be careful, however, about taking money out of your IRA (or any retirement account) to pay for college. Though the tax law now permits penalty-free withdrawals from a traditional or Roth IRA to pay for qualified college costs, doing so could jeopardize financial aid in the following year. The entire withdrawal, principal and earnings, counts as income on the following year's aid application.

http://www.savingforcollege.com/financial_aid_basics/financial_aid_and_your_savings.php

See also: http://www.kiplinger.com/article/college/T042-C001-S001-how-roth-iras-affect-financial-aid-eligibility.html, and others.
I still can't see where a Roth would be written about, though I do know that the traditional would, to affect your financial aid, at least for the FAFSA.

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Re: The Set-and-Forget 529 Approach? Fully fund it now and let it ride.
« Reply #24 on: September 10, 2014, 02:36:29 PM »
FYI for those looking at 529's and worried about the penalty on withdrawal if your kids don't use the funds.  The penalty only applies to earnings, not the principal.  So withdrawing $10,000 of unused funds that consists of $5000 principal and $5000 earnings would only have a $500 penalty (10% of $5000) and you'd owe tax on the $5000 earnings when it's withdrawn.

This turns out to be not as big a deal as you might think.  Your cost-basis isn't adjusted for inflation, and OP's time frame is something like 20 years.  So when projecting the proportion of the account that is basis, you need to use nominal (not real) returns over a very long period of time.  My napkins suggests we're talking about  basis somewhere in the 10%-15% range.

True enough.  I was thinking for those close to college spending time, they can max out at least enough to get the state tax benefit (if any) and then maybe pay a penalty later (or maybe not) on a small amount of gains.  For OP, dodging a 10% penalty on a small amount of basis wouldn't matter very much.

 

Wow, a phone plan for fifteen bucks!