Another 529 help thread...

[I'm a red panda]

So I'm expecting my first take home baby this March. Assuming she makes it home, we need to figure out how to pay for college!
I was lucky enough that my college fund was never spent, so the immediate plan is to put all my savings bonds (as they reach maturity, since many still have pretty good interest rates) into an account for her; plus all the birthday and Christmas gifts etc.

I've read a few times that 529s aren't necessarily the way to go, and just using a taxable investment account is reasonable.  Since my college was paid for by a booming stock market, with the "set aside" money untouched, I can understand that...

But I'm just so confused by all the investment stuff. I'd seriously dig a hole in the backyard and put money there if I thought it wouldn't get stolen...  My husband and I have well funded (though not quite maxed, we are getting there) 403b/401k; we each have a Roth IRA, and we contribute to a taxable fund where we hold Vanguard index funds.  But mostly, I don't do anything with these accounts because I don't really know what I'm doing...

I've also heard that it is often beneficial to use a different state's 529.  How do I figure this out? Which state is the best?
Iowa does allow contributions to be tax deductible from your state income taxes, so how do I know if the Iowa plan is better than the other states plan keeping this in mind?

I kind of understand why people pay advisors... I have no freaking idea what I'm doing here!

[khangaroo]

Congratulations on the baby and welcome to parenthood!!

I'm no expert but I'll give you insight of what I've done for my 7 year old daughter.

I maximize $2,000 each year in an ESA because it gives you the most options in terms of investment options. I just stick the money in a total market index fund. This should be the minimum IMO.

I then contribute whatever I can into the Oregon 529 plan; similar to Iowa, Oregon lets you deduct contributions up to $2,310. To separate the plans between states would take some research and Googling. You have to determine if the return of the funds offered by a different state plan will beat the income tax deduction you'll receive. I haven't done the research myself but I'm sure there are many websites that have done it. I'm very happy with the Oregon 529 as they offer a US Equity index option and a fixed income/money market option. I'm not trying to hit a home run so I think both of those will provide a nice and reliable return for a college fund.

I don't know why people would tell you to invest in a taxable account against a 529 as the investment grows tax-free. And if the Iowa 529 has terrible investment options (high fees, bad returns, limited choices, etc.,) then I would go with a different state before I put the money in a taxable account. My $0.02.

Hope this helps! I was in the same boat and just researched as much as I could and this is the current strategy that I'm pursuing.

[seattlecyclone]

I looked at the Iowa 529 plan, doesn't seem bad. It has various index funds with a 0.26% expense ratio, which isn't amazing, but it's only about 0.1% higher than the lowest-cost plans out there (such as California and Vanguard/Nevada). The state tax deduction will probably pay for the difference, but do the numbers to be sure.

I don't know why people would tell you to invest in a taxable account against a 529 as the investment grows tax-free.

The reasoning here would be that we don't know what the future will hold. Maybe your kid will earn a huge scholarship and won't need the money. Maybe they decide they want to learn a trade instead of going to college. Maybe they join the Army and get the GI bill to pay for their education. Maybe a populist revolt causes state governments to give more funding to colleges so tuition won't be as high as you're expecting.

With a taxable account you pay the same relatively low capital gains tax on the earnings whether you use the money for college or not. With a 529 account, you pay no tax on the gains if the money is used for college, but you pay tax at regular income rates (plus 10% in many cases) on the gains if the money is not used for college.

Take the likelihood of not needing the money for college, multiply it by (your expected retirement tax bracket + 10%) and compare that to your expected retirement capital gains bracket. If the first percentage is lower, go with a 529. Else go with taxable. We did start a 529 for our son, but every family is different.

Do max out the retirement accounts first. For one thing, IRAs have a favorable provision where you don't pay early withdrawal taxes on money taken out for education, so you do get some tax benefits if you need that money for school. For another thing, you can always make your kid take out loans for education if necessary; not so for your own retirement.

[Gin1984]

I looked at the Iowa 529 plan, doesn't seem bad. It has various index funds with a 0.26% expense ratio, which isn't amazing, but it's only about 0.1% higher than the lowest-cost plans out there (such as California and Vanguard/Nevada). The state tax deduction will probably pay for the difference, but do the numbers to be sure.

I don't know why people would tell you to invest in a taxable account against a 529 as the investment grows tax-free.

The reasoning here would be that we don't know what the future will hold. Maybe your kid will earn a huge scholarship and won't need the money. Maybe they decide they want to learn a trade instead of going to college. Maybe they join the Army and get the GI bill to pay for their education. Maybe a populist revolt causes state governments to give more funding to colleges so tuition won't be as high as you're expecting.

With a taxable account you pay the same relatively low capital gains tax on the earnings whether you use the money for college or not. With a 529 account, you pay no tax on the gains if the money is used for college, but you pay tax at regular income rates (plus 10% in many cases) on the gains if the money is not used for college.

Take the likelihood of not needing the money for college, multiply it by (your expected retirement tax bracket + 10%) and compare that to your expected retirement capital gains bracket. If the first percentage is lower, go with a 529. Else go with taxable. We did start a 529 for our son, but every family is different.

Do max out the retirement accounts first. For one thing, IRAs have a favorable provision where you don't pay early withdrawal taxes on money taken out for education, so you do get some tax benefits if you need that money for school. For another thing, you can always make your kid take out loans for education if necessary; not so for your own retirement.

If your child earns a scholarship, you may remove the money without penalty, though it will be taxed as it would be if you cashed a fund in a taxable account. 

[seattlecyclone]

If your child earns a scholarship, you may remove the money without penalty, though it will be taxed as it would be if you cashed a fund in a taxable account. 

You're right that the 10% penalty doesn't apply in certain circumstances (if the student earns a scholarship, dies or becomes disabled, or a few other things). However the gain will be taxed as regular income, not as a capital gain. See Publication 970 for more information about this. Note that IRS publications generally refer to 529 plans as "Qualified Tuition Programs." They're the same thing.

[I'm a red panda]

False. You're right that the 10% penalty doesn't apply in certain circumstances (if the student earns a scholarship, dies or becomes disabled, or a few other things). However the gain will be taxed as regular income, not as a capital gain. See Publication 970 for more information about this. Note that IRS publications generally refer to 529 plans as "Qualified Tuition Programs." They're the same thing.

This is helpful to know. The "disabled" thing was a question I was just about to ask, so your link and post was very helpful- as the son we lost, had he lived, would have never been able to go through any education. So I was wondering what happens if it turns out college is not POSSIBLE.


I THINK we will probably go for the Iowa plan. My 403b will be maxed with another $1,000, so I just need to play with the percentages when/if I get a raise next year.

[little_brown_dog]

I like the 529 so far (only 1 year in though!)…we opened one up for our daughter with NY because our state doesn’t offer tax incentives outside the usual tax-advantaged growth. We chose NY due to low fees compared to other states. In fact, I looked at it because I remember a couple of people on here recommended looking into NY for 529s. Their site is extremely easy to use and navigate.

There are valid criticisms of the 529, but none so large as to deter us from opening one. The 10% penalty doesn’t really worry me, because given that we want and will hopefully have more than 1 kid, I suspect someone will use the money for qualified expenses. And worst case no one does, a 10% penalty while hefty isn’t really the end of the world.

In terms of saving, we have committed to saving a fixed amount that we know is substantial (but not big enough to impact our own retirement goals), and just plan on doing that amount every year unless circumstances change. I found this to be a far less stressful way of planning for college than trying to figure out how much I wanted them to end up with/how much they would need in 18 years. Kind of a set it and forget it mentality.

[I'm a red panda]

There are valid criticisms of the 529, but none so large as to deter us from opening one. The 10% penalty doesn’t really worry me, because given that we want and will hopefully have more than 1 kid, I suspect someone will use the money for qualified expenses. And worst case no one does, a 10% penalty while hefty isn’t really the end of the world.

Yeah, this is something that worries me, is that we will only have 1 (living) child. A bigger family just isn't going to happen for us.

I guess if that child isn't academically inclined and the money isn't all spent after an associates or bachelor's, I can give it to a nephew or niece for grad school (they are all older) or just go add another degree to my collection.  When it looked like we'd be childless we planned to split the money that had previously been earmarked as college fund to those kids anyway.  But with the cost of college having TOO much seems unlikely, so it will probably be okay even for just one kid.

[smella]

I also use the NY plan (nysaves.org) and I love it.  Very easy to use, very easy for friends and family to make online contributions, low fees, and my kid's account earned 8.5% from Dec 2015 to Dec 2016.

(We also happen to live in NY, so we get a deduction on state taxes for contributions up to $10k.)

[Paul der Krake]

There are valid criticisms of the 529, but none so large as to deter us from opening one. The 10% penalty doesn’t really worry me, because given that we want and will hopefully have more than 1 kid, I suspect someone will use the money for qualified expenses. And worst case no one does, a 10% penalty while hefty isn’t really the end of the world.

Yeah, this is something that worries me, is that we will only have 1 (living) child. A bigger family just isn't going to happen for us.

I guess if that child isn't academically inclined and the money isn't all spent after an associates or bachelor's, I can give it to a nephew or niece for grad school (they are all older) or just go add another degree to my collection.  When it looked like we'd be childless we planned to split the money that had previously been earmarked as college fund to those kids anyway.  But with the cost of college having TOO much seems unlikely, so it will probably be okay even for just one kid.

529 funds can be used on reasonable college expenses. My understanding is that it's totally acceptable to change the account beneficiary to be yourself or your spouse, enroll in a part-time classical arts study program in Athens and use the 529 funds to pay for tuition, a cozy greek apartment and some delicious Mediterranean food for a year or two.

[I'm a red panda]

There are valid criticisms of the 529, but none so large as to deter us from opening one. The 10% penalty doesn’t really worry me, because given that we want and will hopefully have more than 1 kid, I suspect someone will use the money for qualified expenses. And worst case no one does, a 10% penalty while hefty isn’t really the end of the world.

Yeah, this is something that worries me, is that we will only have 1 (living) child. A bigger family just isn't going to happen for us.

I guess if that child isn't academically inclined and the money isn't all spent after an associates or bachelor's, I can give it to a nephew or niece for grad school (they are all older) or just go add another degree to my collection.  When it looked like we'd be childless we planned to split the money that had previously been earmarked as college fund to those kids anyway.  But with the cost of college having TOO much seems unlikely, so it will probably be okay even for just one kid.

529 funds can be used on reasonable college expenses. My understanding is that it's totally acceptable to change the account beneficiary to be yourself or your spouse, enroll in a part-time classical arts study program in Athens and use the 529 funds to pay for tuition, a cozy greek apartment and some delicious Mediterranean food for a year or two.

I guess as long as it is an accepted school.  But I know at least quite a few Canadian schools are.  Interesting strategy :)

[Paul der Krake]

There are 327 eligible schools outside the US as of now. Some of them are counted multiple times because some universities like Oxford are technically a federation of individual schools.

http://www.savingforcollege.com/eligible_institutions/index.php?federal_school_code=&school=&state=FC&year=2016-2017&order_by=city&go=Submit&mode=search

They tend to be in English-speaking and first world countries, but that's still a decent selection.

[cheapass]

If your child earns a scholarship, you may remove the money without penalty, though it will be taxed as it would be if you cashed a fund in a taxable account. 

You're right that the 10% penalty doesn't apply in certain circumstances (if the student earns a scholarship, dies or becomes disabled, or a few other things). However the gain will be taxed as regular income, not as a capital gain. See Publication 970 for more information about this. Note that IRS publications generally refer to 529 plans as "Qualified Tuition Programs." They're the same thing.

If you wanted to withdraw the money for non-educational expenses couldn't you just transfer it to your child and have them withdraw a certain amount each year (below the minimum income for federal tax liability), so they wouldn't pay tax on it but instead only the 10% penalty? This would make it advantageous over a taxable account where you're paying 15-20% on earnings right?

[seattlecyclone]

If your child earns a scholarship, you may remove the money without penalty, though it will be taxed as it would be if you cashed a fund in a taxable account. 

You're right that the 10% penalty doesn't apply in certain circumstances (if the student earns a scholarship, dies or becomes disabled, or a few other things). However the gain will be taxed as regular income, not as a capital gain. See Publication 970 for more information about this. Note that IRS publications generally refer to 529 plans as "Qualified Tuition Programs." They're the same thing.

If you wanted to withdraw the money for non-educational expenses couldn't you just transfer it to your child and have them withdraw a certain amount each year (below the minimum income for federal tax liability), so they wouldn't pay tax on it but instead only the 10% penalty? This would make it advantageous over a taxable account where you're paying 15-20% on earnings right?

Two things:
1) When a 529 is owned by your kids instead of you, it counts as their asset instead of yours for the purpose of the FAFSA. Depending on your overall family situation, doing this transfer could cost you more in financial aid than it would save in taxes.
2) If you actually want your kid to get this money regardless of if they need it for school, and you expect them to not earn enough money to pay any tax otherwise, then go ahead and give the account to them. You're right that someone with no other income would pay less tax on it than someone with other income. If your plan is to avoid taxes by "giving" them the money so they can liquidate the funds at a low tax rate and then "give" you the money back, don't. These aren't real gifts and the IRS is not likely to look kindly on it.

[minority_finance_mo]

(We also happen to live in NY, so we get a deduction on state taxes for contributions up to $10k.)

I just signed up for a NY 529 myself - with NY's crazy income tax rates, the deduction more than did it for me. Do you know if the deduction applies to local taxes as well - or just NY State taxes?

[smella]

(We also happen to live in NY, so we get a deduction on state taxes for contributions up to $10k.)

I just signed up for a NY 529 myself - with NY's crazy income tax rates, the deduction more than did it for me. Do you know if the deduction applies to local taxes as well - or just NY State taxes?

Great question...I don't remember due to my infant-related sleep deprivation :).

[Mariposa]

(We also happen to live in NY, so we get a deduction on state taxes for contributions up to $10k.)

I just signed up for a NY 529 myself - with NY's crazy income tax rates, the deduction more than did it for me. Do you know if the deduction applies to local taxes as well - or just NY State taxes?

From our tax forms last year: looks like the deduction applies to both state and local taxes.

Also note that there is no rule for how long money has to be in the 529 account. If you have a child in college or graduate school, you can contribute $10,000 for a married couple, receive the deduction, and immediately withdraw the funds for qualified expenses.

[SeattleCPA]

A handful of useful comments from a 57-year-old who saved money for his daughters using uniform transfer to minors act accounts because Sec. 529 plans weren't available when girls were born.

Comment #1: Unless you amass a giant nest egg for college, kids won't pay any income taxes on their savings. That first $1K is taxed at 0%.. that next $1K is taxed at 10%. That kinda means you can have $50K in something like the Vanguard Total Stock Market Index fund and pay no tax. And you could have $100K in same fund and pay $100 a year. That's not very much...

Comment #2: There's probably a better than even chance your child or children won't do college or at least not the way a parent of a newborn imagines. You don't think this when you have a little one--maybe both mom and dad did college--but even from affluent college educated families apparently the statistics show that less than have of kids complete college. (I think the percentage is low forties... ) If a kid doesn't do college, you might not have minded paying a few dollars of tax in order to have flexibility about the funds you set aside.

Comment #3: There are ways to do college for free or at really low cost and if a family doesn't have a pile of money sitting in a Sec. 529 plan, maybe people are more likely to choose one of these other super economical options. One example: National Merit Scholars can go to pretty good colleges for free often. Another example: Online schools like Western Governors University can probably drop the entire cost of college to less than $20K for a motivated student.

[smella]

Comment #3: There are ways to do college for free or at really low cost and if a family doesn't have a pile of money sitting in a Sec. 529 plan, maybe people are more likely to choose one of these other super economical options. One example: National Merit Scholars can go to pretty good colleges for free often. Another example: Online schools like Western Governors University can probably drop the entire cost of college to less than $20K for a motivated student.

I got a large merit scholarship to an expensive private school, so was able to withdraw from my 529 without penalty under the scholarship exception.