How many 529 plans should I have?

[MomofFour]

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.

Jim, here are a few answers to the questions you asked:

1) I would love to pay for most of my kids' college tuition. Maybe not all, but at least the majority of it.
2) Seems a little early to tell...
3) I am 33, my DH 38. Our mortgage is paid off, we invest 25% of his pay to 401k, maxed out our Roth's the last few years.
Currently our annual income is only around 50k, that will increase once our youngest starts school and I will work more.
Our state does offer an income tax credit for 529 contributions to our state's plan.

Thanks so much to everyone for the great responses!

[MomofFour]

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.

That is a great point, I will have to look into it.

[jIM_Ohio]

Jim, here are a few answers to the questions you asked:

1) I would love to pay for most of my kids' college tuition. Maybe not all, but at least the majority of it.
2) Seems a little early to tell...
3) I am 33, my DH 38. Our mortgage is paid off, we invest 25% of his pay to 401k, maxed out our Roth's the last few years.
Currently our annual income is only around 50k, that will increase once our youngest starts school and I will work more.
Our state does offer an income tax credit for 529 contributions to our state's plan.

Thanks so much to everyone for the great responses!

I applaud how much you can do on such a low income. When you work will your AGI be above 110k? This is cutoff for some of the tax credits?

I would create two pools of money- the 529 pool and the taxable account pool. The current 529 state tax deductions probably do not save you much (a 2% tax on 50k is $1000, so if you live in a state where the tax is low, you don't have much state tax you need to reduce...

And you could easily get around $1700-$2000 back per kid per YEAR in federal taxes if you have some monies in taxable accounts. If you use 529s and nothing else you are missing some significant benefits (IMO).

I would suggest 1 529 account, keep account in oldest child's name and only contribute enough to get max state tax deduction. I would then have a taxable account I would invest in T-bills (treasury bonds) or similar conservative investments. Keep the 529 in an investment with a time horizon suitable for youngest child.

When child 1 goes to college use the taxable account money to point where you maximize the federal tax benefits, then fund the rest with the 529 plan. Then move 529 plan into name of second oldest child. Keep the investment in a risk relative to youngest though.

Repeat this 2 more times. By the time your 4th kid is ready, the investment within the 529 should be in a conservative investment.

[Like2Plan]

MomofFour,
In which state are you a resident?

[Like2Plan]

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.

The big trick: you start saving for your kids college when you are young. But, your child goes off to college when you are at your peak earning years--and that is when the tax formula is applied. My point is you can not count on qualifying for these tax credits as part of your strategy because in 20 years you could make too much money (not that this is a bad thing. .) But, you end up paying more for college than if you had your money in a 529 plan.

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).

Actually, Jim it is difficult to find a loophole in this case-especially if the parents are funding 100% of the education (which for some is the goal).

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.

I agree about getting the financial house in order, but money that is taken from an IRA or 401K is money that can not be made up in the future. You have a maximum contribution each year. If you take past years' contributions and put it towards college expenses, you have a hole in your retirement account that can not be restored.

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.

Again, if you withdraw from your IRA in order to fund college for a year, it could have a significant impact to your AGI--especially if you have more than 1 child in college at the same time and you are on the cusp of not qualifying for some of the education tax credits. Contrast that with the 529 plan tax free on the earnings for state and federal if used for a qualified expense.

[MomofFour]

MomofFour,
In which state are you a resident?

We live in Indiana.

[jIM_Ohio]

L2P-

AGI can be manipulated in many situations to get it under the 110k or 160k for the credits or deductions.

If a person is making more than those amounts 529s are an EXCELLENT option because they offer a tax deduction at state level which lowers the tax burden now.

If a person follows my plan from start to finish, they would have excess in the 401k/IRAs which could be used to fund college without penalty. There is "hit or miss" with market performance in some cases... but the concept of using IRAs for education expenses is not a new one.

The best case for anyone in 25% tax bracket is to maximize all deductions which save them 25% NOW. 401ks, IRAs, HSAs would be the top of that list. Until each of those deductions is maximized (to lower AGI), 529s should not even be considered.

If a person had 10-15 years to plan for the college expenses, my point of view is that 10-15 years should pay the mortgage in full, then borrow or pay cash for college later.

Two reasons:
Paid off house means financial house is in better order than most.
The student loans could be in students name, not parents name (even if parents pay the loans).

[Like2Plan]

We live in Indiana.

It looks like your state has a tax credit of 20% of the contributions up to a maximum of $1,000 per year (with a $5,000 contribution). This is an excellant benefit.
From the frequently asked questions:
"Are there any special tax benefits for Indiana taxpayers?
Yes. If you are an Indiana taxpayer (resident or non-resident, married, or individual), you are eligible for a state income tax credit of 20% of contributions to a CollegeChoice 529 account, up to $1,000 credit per year. This credit may be subject to recapture from the account owner (not the contributor) in certain circumstances, such as rollover to another state's 529 plan or non-qualified withdrawal. "


Link to FAQ


There can only be one account owner and one beneficiary for a 529 account. For this reason, I think it makes it cleaner to have 4 accounts, one for each child. With the ages of your children, there will be times that you will have more than one child in college at the same time drawing funds from the 529 accounts, so a change in beneficiaries would not work in that case.

[jIM_Ohio]

I agree with L2P that the additional credit from state makes the Indiana 529 quite appealing. Makes up for no federal deduction, IMO.

Without the tax credit the tax benefit of a 529 is not very much.

[Like2Plan]

L2P-

AGI can be manipulated in many situations to get it under the 110k or 160k for the credits or deductions.

Only to a limited extent.

If a person is making more than those amounts 529s are an EXCELLENT option because they offer a tax deduction at state level which lowers the tax burden now.

Agreed.

If a person follows my plan from start to finish, they would have excess in the 401k/IRAs which could be used to fund college without penalty. There is "hit or miss" with market performance in some cases... but the concept of using IRAs for education expenses is not a new one.

I can't agree with you on this one. I believe the 401K/IRAs should be left alone. They are for retirement. 401K plans do not permit withdraws for this purpose without a penalty. You can get a hardship withdraw, but it is not penalty free either and you have to prove hardship. Here are some links: Should I Use My 401(K) To Fund My Child's College Education?
Paying for college with your 401(k)
You can get a loan on your 401k, but it is limited to your contribution amount or 50,000 whichever is less (and you have to pay interest on it and if you lose your job and don't pay it back, it is considered a distribution on which you pay the 10% penalty and taxes).
Even if you don't pay 10% penalty, you do incur a penalty if you are putting money into the account when your nominal tax rate is lower and pull it out when it is higher--added to the damage, your withdraw will add to your AGI potentially pushing youself into a higher tax bracket and possibly even having to pay the lovely "AMT" on top of everything else. I believe this should be done as a last resort. Funding college this way is certainly possible, but it will make college funding more expensive than it needs to be.

The best case for anyone in 25% tax bracket is to maximize all deductions which save them 25% NOW. 401ks, IRAs, HSAs would be the top of that list. Until each of those deductions is maximized (to lower AGI), 529s should not even be considered.

If a person had 10-15 years to plan for the college expenses, my point of view is that 10-15 years should pay the mortgage in full, then borrow or pay cash for college later.

I've found it is more of an emotional decision whether a parent is going to fund the college. But... if someone has decided they are going to pay for 100% of their child's college--no matter what, then the plan should be how to come up with the money at the least expense. Cash flow could be a problem even if you have the mortgage paid off in full. There are a lot a variables here, but it makes no sense to me to pay off a mortgage at 4.5% int rate only to get to the point where college money is needed and have to pay a premium to borrow money with a higher percentage interest rate and throwing away tax incentives along the way.

Two reasons:
Paid off house means financial house is in better order than most.
The student loans could be in students name, not parents name (even if parents pay the loans).

Even with the house paid off, it could lead to cash flow shortages. Student loans may not be possible (the student might not qualify) leading to parental loans (PLUS loans) which can come with a very high interest rate.

[jIM_Ohio]

If a person follows my plan from start to finish, they would have excess in the 401k/IRAs which could be used to fund college without penalty. There is "hit or miss" with market performance in some cases... but the concept of using IRAs for education expenses is not a new one.

I can't agree with you on this one. I believe the 401K/IRAs should be left alone. They are for retirement. 401K plans do not permit withdraws for this purpose without a penalty. You can get a hardship withdraw, but it is not penalty free either and you have to prove hardship. Here are some links: Should I Use My 401(K) To Fund My Child's College Education?
Paying for college with your 401(k)
You can get a loan on your 401k, but it is limited to your contribution amount or 50,000 whichever is less (and you have to pay interest on it and if you lose your job and don't pay it back, it is considered a distribution on which you pay the 10% penalty and taxes).
Even if you don't pay 10% penalty, you do incur a penalty if you are putting money into the account when your nominal tax rate is lower and pull it out when it is higher--added to the damage, your withdraw will add to your AGI potentially pushing youself into a higher tax bracket and possibly even having to pay the lovely "AMT" on top of everything else. I believe this should be done as a last resort. Funding college this way is certainly possible, but it will make college funding more expensive than it needs to be.

I am not advocating a 401k loan for college funding.
If a person is thinking "8k in my 401k now and 3k into 529 now", I would advise them to do 11k into 401k now (get that big fed deduction). If they need access to that money for college I would advise them to roll the 401k over to an IRA and tap the IRA (penalty free). This assumes that even with a 100k withdraw the retirement plan is on track.

The best case for anyone in 25% tax bracket is to maximize all deductions which save them 25% NOW. 401ks, IRAs, HSAs would be the top of that list. Until each of those deductions is maximized (to lower AGI), 529s should not even be considered.

If a person had 10-15 years to plan for the college expenses, my point of view is that 10-15 years should pay the mortgage in full, then borrow or pay cash for college later.

I've found it is more of an emotional decision whether a parent is going to fund the college. But... if someone has decided they are going to pay for 100% of their child's college--no matter what, then the plan should be how to come up with the money at the least expense. Cash flow could be a problem even if you have the mortgage paid off in full. There are a lot a variables here, but it makes no sense to me to pay off a mortgage at 4.5% int rate only to get to the point where college money is needed and have to pay a premium to borrow money with a higher percentage interest rate and throwing away tax incentives along the way.

This is a good topic to debate-
pay down a 4.5% mortgage to be able to pay cash for college. HMMM.

I assume from an earlier post in your situation you have a low mortgage payment (maybe $800/mo) and were comparing this to a 20k/year tuition bill for college (10k per year discrepency).

I would also assume in this case that the 529 plan is invested in around a 50-50 balanced fund (because college planning is a short/mid term expense, I could not think of someone subjecting too much to equities). I would also assume with such a low mortgage payment there is little tax incentive for the mortgage interest.

It is personal choice. My advice to parents is always get their own situation in order before funding higher education for kids/ That means paid off mortgage. I have not spoken once to a person with a paid off mortgage suggest they regretted paying it off sooner.

Quote:
Two reasons:
Paid off house means financial house is in better order than most.
The student loans could be in students name, not parents name (even if parents pay the loans).

Even with the house paid off, it could lead to cash flow shortages. Student loans may not be possible (the student might not qualify) leading to parental loans (PLUS loans) which can come with a very high interest rate

I agree the mortgage payment might be less than the tuition payment. The reason a student would not qualify for loans would probably be parental income? In this case does mortgage equity get included on FAFSA? Does 401k/IRA? Does 529? I think mortgage equity would count LESS than 529. I don't know for sure though...

If parental income or assets were too high to qualify for loans and family could still not fund college, they have bigger financial issues (living below means). If a family making more than 110k suggested they could not
a) pay off mortgage
then
b) pay cash for education
I would challenge the college of choice is too expensive or they have another financial issue which was not included in the a) pay off mortgage portion of the plan (that is really "pay off al debts- cars, boats, house and credit cards" category).

[disneysteve]

I am not advocating a 401k loan for college funding.
If a person is thinking "8k in my 401k now and 3k into 529 now", I would advise them to do 11k into 401k now (get that big fed deduction). If they need access to that money for college I would advise them to roll the 401k over to an IRA and tap the IRA (penalty free). This assumes that even with a 100k withdraw the retirement plan is on track.

That doesn't work, Jim. You can only roll over a 401k to an IRA if you are no longer working at that job. If the parent is still employed there, he/she can't do a rollover.

[jIM_Ohio]

That doesn't work, Jim. You can only roll over a 401k to an IRA if you are no longer working at that job. If the parent is still employed there, he can't do a rollover.

I had a longer response to this above and removed it before I posted.

If I am advising someone 10-15 years out, I would not skip the additional 401k tax deduction because that person MIGHT have the same job in 15 years.

In 11 years my 401k has been changed 4 times, 2 of the times I could roll the current 401k into an IRA.

Assuming I am discussing with a person in 25% tax bracket, I would advise that until the 401k is maxed (16500), no 529 contribution should even be considered.

If we need the 401k money in 15 years, there are ways to get it. They may not be pretty if we have to access the money while it is "in" the 401k, but things could change in 15 years.

For example if a 35 yo person with a 5 yo kid came to me and said they wanted to put 6% of a 100k income into their 401k and 10k into a 529... I would counter this with
Put 16% into 401k (I just saved the person 2500 in taxes), get the Roth or traditional IRA maxed (5k per year), then have a mortgage paydown/payoff plan, and they probably could then put some into a 529.

As raises come in, whatever is squeezed from the 401k is put into a 529 (because a 10% raise means only 15% can be in 401k before it is maxed- so about every 3 years they lose a percent on 401k contribution). The raise means less (as % of income) is in the 401k. It does not mean less is saved. This assumes the original mortgage paydown plan is funded.

I would advise them to pay down the mortgage unless there were tax reasons to not do so. The mortgage paydown plan described above might be an actual payment to mortgage, or it might be an investment in an account which at maturity is used for mortgage payoff (tax reasons for keeping mortgage).

Assuming person had 401k maxed until the 5yo was a junior in HS, I would then look at situation and assume
a) their retirement plan was well on track from 15% type contributions to 401k, plus Roth deposits.
b) the mortgage payoff plan was complete
so they could
c) reduce 401k contributions to fund education from former 401k deposits
d) pay down mortgage with those funds, or pay college with the taxable account if that made more sense
e) use a small 529 account to fund some of the education costs too.

This is not a one size fits all approach.

[disneysteve]

Assuming I am discussing with a person in 25% tax bracket, I would advise that until the 401k is maxed (16500), no 529 contribution should even be considered.

What do you think about my situation? I'm in the 25% bracket. I don't have access to a 401k. I max a Roth for myself (5k) and for my wife (5k). She works part-time and 50% of her pay goes into her 401k (about $4,500 this year). All of that amounts to 11-12% of income. Another $2,400 goes into a taxable mutual fund earmarked for retirement, bringing us to 13-14% of income. That gets us pretty close to your standard advice of 15% to retirement (and we have other savings that at least make up the difference). With that said, do you think it is unreasonable for us to be contributing to a 529 for our daughter?

[jIM_Ohio]

What do you think about my situation? I'm in the 25% bracket. I don't have access to a 401k. I max a Roth for myself (5k) and for my wife (5k). She works part-time and 50% of her pay goes into her 401k (about $4,500 this year). All of that amounts to 11-12% of income. Another $2,400 goes into a taxable mutual fund earmarked for retirement, bringing us to 13-14% of income. That gets us pretty close to your standard advice of 15% to retirement (and we have other savings that at least make up the difference). With that said, do you think it is unreasonable for us to be contributing to a 529 for our daughter?

Depends on age and amount already in retirement accounts.

Here is my math (assuming you invest good enough to get a 9% return)

age 68 retirement need 25X expenses in retirement accounts
age 60 need 12.5X expenses in retirement accounts
age 52 need 6.25X expenses in retirement accounts
age 44 need 3X expenses in retirement accounts
age 36 need 1X expenses in retirement accounts

You might tell me age 68 is too late to retire (age 59 might be the goal) so it looks like this:

age 59 need 33X expenses in retirement accounts
age 51 need 16X expenses in retirement accounts
age 42 need 8X expenses in retirement accounts
age 33 need 4X expenses in retirement accounts

If I remember, I think you are in late 30's or early 40's-
do you have 3X your annual expenses saved for age 68 retirement, or have 8X expenses saved for age 59 retirement?

Even if you missed the age 59 "mark" for age 42, assuming you are projected to have 16X by age 51 you will be OK.

My advice would be bump up the taxable account contribution instread of 529, and consider using savings bonds for this to save on the taxes later (if your 529 holds any bonds, there really is no difference if the bonds are used to pay for education as to which account they are held in).

One other issue working in your favor (I think) is that your retirement taxes will be much less than most. More than half your deposits for retirement are in Roth accounts- so what might be a 4% withdraw rate (the age 68 table for me), you might be able to make same table work with 4.25% or even 5% because you will not have as much withdraw subject to taxes. Keep your Roths in high growth equities and put the bonds in wife's 401k and taxable account- and this will become even more true as time passes (Roth accounts might be 50% of the deposits and hold 75% of the assets for example- that would be a very tax efficient retirement).

If you use 5% on first table, the multiples would be 20X, 10X, 5X, 2.5X and 1X by same ages.