How many 529 plans should I have?

[MomofFour]

We have four kids, and we currently have one 529 plan.

Do you think we should just maintain the one we have, transferring money from it to the other kids in the future, or should we have accounts in place for each child?

Our kids are 8, 6, 3, and 1. We do have our current account in my oldest's name in an age based portofolio.

Thanks in advance for any responses!

[disneysteve]

I see a couple of problems with using just one account for 4 kids:

1. You have the money in an age-based portfolio which is timed to get more conservative as the 8-year-old approaches college age. That's fine, but likely isn't what you would choose for the 3 or 1-year-old kids.

2. How do you divide up the funds? Let's say child 1 gets to college and there is 50K in the account. How much of that does he get to use and how much gets left for children 2, 3 and 4? What if child 1 goes to grad school? What if child 1 goes to community college but child 2 goes to Ivy League? What if there's nothing left in the account after child 1?

[simpletron]

I see a couple of problems with using just one account for 4 kids:

1. You have the money in an age-based portfolio which is timed to get more conservative as the 8-year-old approaches college age. That's fine, but likely isn't what you would choose for the 3 or 1-year-old kids.

generally there are ways to adjust risk within the account. there is either different risk pathes for the age adjusted funds or just some funds that have set stock and bond percentages(100% stock, 80% stock and 20% bonds, 60/40, 100% cash and bonds). so if they want to I'm sure they could adjust the risk to meet their needs.

]
2. How do you divide up the funds? Let's say child 1 gets to college and there is 50K in the account. How much of that does he get to use and how much gets left for children 2, 3 and 4? What if child 1 goes to grad school? What if child 1 goes to community college but child 2 goes to Ivy League? What if there's nothing left in the account after child 1?

this is a problem no matter how many accounts you have. let's say you had 4 accounts with 12.5K, youngest goes to community and oldest went to ivy league, you can't take the extra from youngest to pay for oldest past tution cost.

fairness is always tricky thing with multiple kids. which is more fair, paying the total college cost for all the kids and nothing more, no matter what schools they go to or giving the same amount of money no matter what the school? in the first one, all kids are in the same spot at college graduation while the second puts them all at the same spot at the beginning of college, so both are fair in a sense.

if you answer that question with something similar to the first one then you should go with one account and try your darnness to make it last for all the kids. if you answer with the second you should go with four accounts and contribute fairly equal amounts to all accounts.

the only problem i see with one account is you could run into gift tax problem if you contribute more than 12K per year(i think thats the limit) or if you wanted to contribute more that what the plan allows.

remember you can always roll funds down to the next child, but can't really do the reverse with 529, so contributing more to older kids is not necessary unfair.

[jIM_Ohio]

We have four kids, and we currently have one 529 plan.

Do you think we should just maintain the one we have, transferring money from it to the other kids in the future, or should we have accounts in place for each child?

Our kids are 8, 6, 3, and 1. We do have our current account in my oldest's name in an age based portofolio.

Thanks in advance for any responses!

More info needed:
1) are you planning on paying 100% of tuition for all 4 kids?
2) any special needs/ or special talents for any of the kids?
3) What is overall financial plan (retirement, mortgage, parents age when kid 1 starts college and when kid 4 finishes college)?

I tend to side with use 529 deposits to pay down mortgage and achieve other short term financial goals, then capture the federal tax savings by paying for college outside the 529 plan (if you use 529 monies, you cannot get any federal tax savings on college education). Assuming 100% of expenses were paid with 529 monies.

More info is needed.

[disneysteve]

I tend to side with use 529 deposits to pay down mortgage and achieve other short term financial goals, then capture the federal tax savings by paying for college outside the 529 plan

Jim, I've read this before from you but I'm curious about one thing. What if you wouldn't have the mortgage paid off by the time the kid starts school? Then, you'd still have the same mortgage payment AND the college costs for which you'd have nothing saved. What do you do then? Take out a home equity loan?

[Joan.of.the.Arch]

I wonder if you need to take into consideration how the money would be inherited if you were to die before your children will have used this. All money goes to the child to whom the account is dedicated? I don't know, but it might be something to find out.

[disneysteve]

I wonder if you need to take into consideration how the money would be inherited if you were to die before your children will have used this. All money goes to the child to whom the account is dedicated?

That's an interesting question. Never thought about it. That could be another good reason to split the money up.

[jIM_Ohio]

Jim, I've read this before from you but I'm curious about one thing. What if you wouldn't have the mortgage paid off by the time the kid starts school? Then, you'd still have the same mortgage payment AND the college costs for which you'd have nothing saved. What do you do then? Take out a home equity loan?

Portions of my position are not well thought out/documented yet. Here goes what I think and know now:

The goal (from my standpoint) is to keep the overall taxes paid low (maximize after tax return). This would be true regardless of tax credits, 529 plans or similar in most cases (agree?).

Most 529 plans will exist for less than 18 years- so the value of compounding is minimal (most compounding happens at year 30-40 for investments). In addition there is nothing at federal tax code level which gives tax payer a benefit with a 529 plan, and these plans could take away the federal tax benefits which do exist for education.

Here are choices I would see a family having:

529 plan- pro- gives a state tax deduction. If a person contributes 5k per year and state tax rate is 5%, then a person is saving $250 per year in state taxes.

Over 18 years that is $4500.
con- 5% is a low deduction (IMO), and this removes the 90k invested from qualifying for any federal tax benefits. (if tuition over 4 years cost 120k, the other 30k would qualify for federal tax benefits). If the 529 funds 100% of college costs, a person loses the federal tax benefits.

IRA- money could be deducted if put into an IRA or 401k. Money can be withdrawn penalty free from an IRA for education needs. If a person contributes 5k into an IRA in 25% federal bracket and 5% state bracket, there is a $1250 tax savings NOW at federal level and $250 more at state level ($1500 in overall tax savings).

Taxable account- person pays $1250 in taxes at federal level, but could cash in the investment for any reason, and all reasons for monies use qualify for federal tax benefits- for example if 4 year tuition cost 120k, and 90k is in savings (30k loans), many deductions exist for the 120k of expenses:

2k (20% of 10K max tuition) for lifetime learning credit
$1650 (100% of first $1100 and 50% of next $1100 tuition) for Hope credit
4k tuition and fees deduction (really an adjustment)

Those are 2007 numbers- I could not find IRS pubs for 2009 numbers.

So for example putting the 5k per year in savings bonds would allow
a) the interest to be tax free (because used to pay for higher education)
b) the principal of the bond can be used to capture the federal deductions.


In addition some logic is used- if the 529 plan was an age based investment plan, it would hold government bonds (probably close to 70-80% within 3 years of college)- and the whole 529 account wrapper is not needed to shield the interest from taxation.

The 529 plan has penalties for early withdraw, for non education expenses and other restrictions. There are no such restrictions on purchasing savings bonds in a taxable account.

In addition I used 5k as my example ($400/month). Most people I know do not set that much aside. I could find $1000/year maybe, and at 4% state tax that saves me $40. Just not worth the $40 it saves me to get restrictions on how to use the money.

DS- if I remember your situation well enough, you missed the mortgage being paid off by X years.

What if wife's 401k was reduced to point where take home paid off the mortgage? If you needed $1000/month ($12000/year) to pay off mortgage and the 529 plan contribution is $200/month ($2400/year)... the extra $800 take home would cost you $2400 in taxes now (does this $9600 income push you into a higher tax bracket?).

The $2400 tax per year now get you:
1) a mortgage paid off faster
2) ability to pay cash for tuition
3) more financial flexibility (your mortgage payment is about $800/month, right?)- meaning you could invest $800/month more once tuition

In some ways it does not make TAX sense to pay the extra $2400 tax now to saving whatever tax later.
But it might make financial sense- less debt, possibly move you closer to financial independance sooner (lower expenses).

Remind me:
years to daughter going to college (I think 5)
interest rate on mortgage (I think 5.25%)
current mortgage balance and amount borrowed (I will need to calculate the ammortization table to figure this out).

My actual position would be
1) max out 401ks and access this for education if retirement is on track
2) pay off mortgage and fund college with mortgage payment (pay cash for college)
3) borrow money and let kid pay for college
4) fund 529s to get state tax deductions

[Like2Plan]

the only problem i see with one account is you could run into gift tax problem if you contribute more than 12K per year(i think thats the limit) or if you wanted to contribute more that what the plan allows.

simpletron
This is a good point. Also, if the state gives you a write off on a per account basis, then you could get a larger write off per year if you have 4 accounts. Example--my state has (up to) 2,000 per account write off per year. If I only have 1 account, it is just the (up to) 2,000. If I had 4 accounts to which I contributed 2,000 per year, I would get an 8,000 deduction.

[Like2Plan]

I tend to side with use 529 deposits to pay down mortgage and achieve other short term financial goals, then capture the federal tax savings by paying for college outside the 529 plan (if you use 529 monies, you cannot get any federal tax savings on college education). Assuming 100% of expenses were paid with 529 monies.

More info is needed.

Jim,
If used for a qualified college expense, 100% of the earnings on the 529 are federal and state tax free (this is in addition to the state tax write off on the contributions). We were extremely lucky to invest in a prepaid tuiton 529 plan for our DS. The payout so far has been over 2 times what we invested--this over a relatively short investment time horizon (4-6years). The gain all tax free.

Remember, in regards to taking a write off on your taxes on money invested outside a 529--the federal tax write offs (I'm thinking of the Hope and the Lifetime Learning adn the Tuition and Fees Tax Deduction) are income tested and not everyone qualifies for them.

[Like2Plan]

I wonder if you need to take into consideration how the money would be inherited if you were to die before your children will have used this. All money goes to the child to whom the account is dedicated? I don't know, but it might be something to find out.

Joan,
This is my understading as well. The transfer is considered a completed transfer. It could result in the money not being distributed in the way the OP had intended.

[jIM_Ohio]

Jim,
If used for a qualified college expense, 100% of the earnings on the 529 are federal and state tax free (this is in addition to the state tax write off on the contributions). We were extremely lucky to invest in a prepaid tuiton 529 plan for our DS. The payout so far has been over 2 times what we invested--this over a relatively short investment time horizon (4-6years). The gain all tax free.

Remember, in regards to taking a write off on your taxes on money invested outside a 529--the federal tax write offs (I'm thinking of the Hope and the Lifetime Learning adn the Tuition and Fees Tax Deduction) are income tested and not everyone qualifies for them.

Couple of points-

prepaid tuition plan would be different than "money invested in education". Prepaid tuition gets the ROR of "tuition increases" where as an investment plan gets the risk and return of the market.

To best of my knowledge these plans depend on the state and the custodian.

A few points I did not add to my post:

1) Student loans (and the tuition the loans pay for) qualifies for the federal deductions and credits. Meaning a person could pay down their mortgage or invest more in a retirement plan (while child is in HS), then borrow money and get the credits/deductions in the year the expense was incurred.
2) Tax issues are always specific to a given person- income phase outs is one issue, another might be to have the child (of a parent which has too much income) qualify for the credit/deduction based on other things (50% of own support).

More than one way to skin a cat.
"...but if you try any of them the humane society gets really upset".

[Like2Plan]

Couple of points-

prepaid tuition plan would be different than "money invested in education". Prepaid tuition gets the ROR of "tuition increases" where as an investment plan gets the risk and return of the market.

To best of my knowledge these plans depend on the state and the custodian.

Yes--it does depend on your state. But, it is money invested in education.

It is funny because the market had been behaving in a similar fashion to now (ie down-down -down each year for 3 years) While our regular 529 plan came through relatively unscathed--a small loss, we just didn't see the growth. It made the prepaid plan seem like a good hedge as one part of the overall education funding plan we had for DS

[Like2Plan]

Most 529 plans will exist for less than 18 years- so the value of compounding is minimal (most compounding happens at year 30-40 for investments). In addition there is nothing at federal tax code level which gives tax payer a benefit with a 529 plan, and these plans could take away the federal tax benefits which do exist for education.

Here are choices I would see a family having:

529 plan- pro- gives a state tax deduction. If a person contributes 5k per year and state tax rate is 5%, then a person is saving $250 per year in state taxes.
Over 18 years that is $4500.

Another PRO: Earnings are also federal and state tax free (if used for a qualified college expense)

con- 5% is a low deduction (IMO), and this removes the 90k invested from qualifying for any federal tax benefits. (if tuition over 4 years cost 120k, the other 30k would qualify for federal tax benefits). If the 529 funds 100% of college costs, a person loses the federal tax benefits.

Parents may not be able to qualify for the federal tax benefits anyway because they are income tested.

IRA- money could be deducted if put into an IRA or 401k. Money can be withdrawn penalty free from an IRA for education needs. If a person contributes 5k into an IRA in 25% federal bracket and 5% state bracket, there is a $1250 tax savings NOW at federal level and $250 more at state level ($1500 in overall tax savings).

If it is fully deductible, don't you have to pay taxes on entire amount that is withdrawn? Taken as a lump sum it could push you into a higher bracket.
Or, if it is a Roth--you wouldn't get the initial write off.
Still, if you access money you have saved for retirement--and you can't make up for that contribution in the future.

Taxable account- person pays $1250 in taxes at federal level, but could cash in the investment for any reason, and all reasons for monies use qualify for federal tax benefits- for example if 4 year tuition cost 120k, and 90k is in savings (30k loans), many deductions exist for the 120k of expenses:

The deductions are income tested, you may not qualify. The earnings are all taxed.

Those are 2007 numbers- I could not find IRS pubs for 2009 numbers.

So for example putting the 5k per year in savings bonds would allow
a) the interest to be tax free (because used to pay for higher education)
b) the principal of the bond can be used to capture the federal deductions.
In addition some logic is used- if the 529 plan was an age based investment plan, it would hold government bonds (probably close to 70-80% within 3 years of college)- and the whole 529 account wrapper is not needed to shield the interest from taxation.

The interest is only tax free if you meet certain conditions. I believe the bonds can only be used for tuition and fees (The costs of books or room and board are not qualified expenses), it has to be in the parent's name, the parent had to be at least 24 when the bond was purchased and finally--there is an income test. The interest rates have been very anemic lately. But, think about deferred interest over 18 years-- and you are in your high income earning years when your children go off to college. If you make too much money to get any write offs and you end up paying federal taxes on deferred interest accumulated over 18+ years.
If you put it in the child's name, the kiddie tax kicks in on the 18+ of deferred interest. If you are hoping for some financial aid (assuming the parents don't make too much money), the bonds will work against the child as they are expected to be contributed at a higher rate than the parents.

The 529 plan has penalties for early withdraw, for non education expenses and other restrictions. There are no such restrictions on purchasing savings bonds in a taxable account.

Penalties are on the earnings. If you have written off the contribution on the state taxes, you have to add the contribution back in on your state taxes.

My actual position would be
1) max out 401ks and access this for education if retirement is on track

I don't know if this is universal, but the rules for my 401K do not allow a withdraw for education expenses (without the normal penalty). A loan is allowed, but there is a $50,000 limit (which would not cover all the college expenses). Also, I would have to pay interest on the loan in this scenario.

2) pay off mortgage and fund college with mortgage payment (pay cash for college)

The amount of the mortgage payment may not be enough to cover expenses. (It wouldn't be in our case).

3) borrow money and let kid pay for college
4) fund 529s to get state tax deductions

[jIM_Ohio]

I try to steer people towards mortgage payoff before college funding. It is not a rule and there are reasons to make it work and there are other techniques which might be better in some situations.

The income tests for the credits is 110k (2007 tax code) for hope and lifetime learning and 160k for tuition and fees deduction.

If a person makes MORE than those numbers and needs help with college funding, they probably have access to other means for education funding OR could opt to have child find a way to provide half their support OR allow child to claim the credit (the dependency exemption would not be worth much to parents anyway).

--
I think we agree the parents need their own financial house in order before funding college. This is why I suggest using IRAs and 401ks for all investments until maxed.

If a mortgage is paid off, that is a good step towards financial house being in order. Especially if a person has a large mortgage payment.

The education provision in IRAs is to waive the 10 percent penalty, NOT waive the tax on withdraw. The IRA money is also removed from some FAFSA calculations if I remember as well. Get the tax deduction when available. If retirement is not on track, do not withdraw for education from IRAs or fund other plans (like 529s) to begin with.