How many 529 plans should I have?

[disneysteve]

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?

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).

I'm 44. We're in the general ballpark with the current savings. Of course, we were much closer a year ago before the market tanked. I'd say 68 is too old and we can't likely afford 59 (though I'd love if we could). I'm hoping for 62 or so but that isn't carved in stone. We'll see how things go once the market starts having a positive return again.

Good point about the lower taxes in retirement from the Roths. Also good advice about doing the bonds in the 401k and the growth in the Roths. I actually need to sit down and juggle some allocation stuff. I plan to to that one of these cold winter weekends. As our number of accounts has grown, assets haven't necessarily accumulated in the best location and some repositioning is definitely in order.

Thanks.

[jIM_Ohio]

I'm 44. We're in the general ballpark with the current savings. Of course, we were much closer a year ago before the market tanked. I'd say 68 is too old and we can't likely afford 59 (though I'd love if we could). I'm hoping for 62 or so but that isn't carved in stone. We'll see how things go once the market starts having a positive return again.

Good point about the lower taxes in retirement from the Roths. Also good advice about doing the bonds in the 401k and the growth in the Roths. I actually need to sit down and juggle some allocation stuff. I plan to to that one of these cold winter weekends. As our number of accounts has grown, assets haven't necessarily accumulated in the best location and some repositioning is definitely in order.

Thanks.

Age 62 need 25 X
Age 53 need 12 X
Age 44 need 6 X
Age 35 need 3 X

If you had 3X at 35 but the market took away 6X this year, I would expect 12X to reappear 9 years later.

What is your state tax bracket (for the 529 deduction)?
How much is contributed to the 529?
How much do you expect to pay for college? dollar amount, not percent.

As I thought last night after posting, I would advise more 401k if possible, and look at other avenues like HSAs for more pre-tax savings. For example shift the taxable account to an HSA, and capture that tax savings with another investment too.

I assume NJ would have around a 3-6 percent state income tax, so deferring taxes now makes sense as much as possible (31 percent tax deferral now is a good move).

[disneysteve]

Jim, NJ is a lousy place to live as far as taxes are concerned. There is no deduction for 529 contributions (which is why we're not in the NJ state plan, we're in NY's). We currently put $300/month in. It has been lower and has been higher at other times in the past. I don't have a clear end-point in mind for college funding. It will really depend on where things stand overall at that point. Our situation is complicated (in a good way) by the fact that at age 18 our daughter will begin receiving annuity payments from an accident settlement when she was 6. She knows that she will be expected to use at least some of that money toward schooling and living expenses. That will buffer what is needed beyond that.

We can't contribute any more to the 401k (unless my wife works more hours). The max she is allowed is 50% of income. We wanted to do 100% but they wouldn't let her. I don't have a 401k.

HSAs in NJ suck basically. They are not cheaper than traditional plans which makes them worthless. There is no point to taking a high deductible and assuming more risk if you don't save money in premiums in the process. I'm hoping they change that one of these days.

As for the NJ income tax, it is tiered:
-- 1.4 percent on the first $20,000 of taxable income.
-- 1.75 percent on taxable income between $20,001 and $50,000.
-- 2.45 percent on taxable income between $50,001 and $70,000.
-- 3.5 percent on taxable income between $70,001 and $80,000.
-- 5.525 percent on taxable income between $80,001 and $150,000.

[jIM_Ohio]

Jim, NJ is a lousy place to live as far as taxes are concerned. There is no deduction for 529 contributions (which is why we're not in the NJ state plan, we're in NY's). We currently put $300/month in. It has been lower and has been higher at other times in the past. I don't have a clear end-point in mind for college funding. It will really depend on where things stand overall at that point. Our situation is complicated (in a good way) by the fact that at age 18 our daughter will begin receiving annuity payments from an accident settlement when she was 6. She knows that she will be expected to use at least some of that money toward schooling and living expenses. That will buffer what is needed beyond that.

We can't contribute any more to the 401k (unless my wife works more hours). The max she is allowed is 50% of income. We wanted to do 100% but they wouldn't let her. I don't have a 401k.

HSAs in NJ suck basically. They are not cheaper than traditional plans which makes them worthless. There is no point to taking a high deductible and assuming more risk if you don't save money in premiums in the process. I'm hoping they change that one of these days.

As for the NJ income tax, it is tiered:
-- 1.4 percent on the first $20,000 of taxable income.
-- 1.75 percent on taxable income between $20,001 and $50,000.
-- 2.45 percent on taxable income between $50,001 and $70,000.
-- 3.5 percent on taxable income between $70,001 and $80,000.
-- 5.525 percent on taxable income between $80,001 and $150,000.

All good info- why is the HSA a bad move? Mine has some fees too, but the tax savings more than makes up for $1-$6 in fees.

[disneysteve]

All good info- why is the HSA a bad move? Mine has some fees too, but the tax savings more than makes up for $1-$6 in fees.

As I understand it, and as our insurance broker has explained, in most states except NJ, HSA plans generally have a lower premium than a comparable traditional plan which makes up, in part, for the higher deductible. Here in NJ, however, the last time we checked, the HSA was actually more expensive than a comparable non-HSA plan. That means that not only would I have a much higher deductible, but I'd also be paying a higher premium. So the HSA wouldn't save us anything.

[Like2Plan]

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.

Jim,
You keep saying you can tap the IRA penalty free, but even though you are not assessed an additional 10% penalty, you are going to get a tax spanking if you do what you suggest. The only IRA that would be remotely penalty free would be the Roth (but you are giving up money that would grow tax free over time to be used for expenses in retirement)--and with that one you are not taking deductions along the way.

You are taking a tax class, have you modeled what would happen if you actually did this? Let's say you have a deductible IRA. Your plan is to siphon off money to pay for college. For argument sake, you are devoting 1/2 of the contribution to college--2,500 X 18 years). Each year, you get a tax break on the 2,500. Federal tax savings= ___ per year. Then, 18 years later, your child goes off to college (or in your case children ). Let's say the tuition and fees, room and board and books cost 20K. How much will you have to withdraw from your IRA to cover the 20K (assuming you are going to have to take out more to cover the taxes)? What will the tax consequences of adding this one big distribution in a single tax year? (Let's pick a household income of 109,000 which stays the same the entire time. Which, by the way is unlikely--most likely it will go up over time--even if you don't get any big promotions. ) Multiply this by 4 years. It also assumes that our tax rates are not going to change which is also unlikely.


The problems:
1. You are only allowed a finite contribution level--which you should devote to retirement. I believe the IRA contribution level is 5,000 now. Even if you devoted 100% of your retirement fund towards college, you might not have enough to cover it.
2. If you go the 401K route, currently your only option is a loan--up to 50K. That would not be a disasterous as a distribution, but 50K will most likely not be enough (and if you leave work without paying it back, you pay taxes on it because it is considered a distribtuion).

[Like2Plan]

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).

Jim,
EE Savings bonds bought currently have a permanent interest rate determined at the time they are issued. The current rate is 1.3%. I bonds, are currently .7% interest (permanently) plus the rate of inflation (determinded every 6months.) They cannot be redeemed within the first 12 months. If you redeem them between 1 and 5 years, there is a 3 month interest penalty.
The maximum you can purchase in one year (per SS number) is 5,000 per year.

Link to Treasury Direct Education Tax Exclusion

If you have any inkling that you are going to make more than the phase out amount of income, savings bonds are not a good idea for education. The reason, you are paying taxes on deferred interest over 18 years in 4 tax years (fewer years in DS case as his daughter will be off to school in a few years)AND, you will be at a higher income (and higher nominal tax rate) when you are paying taxes on the interest. And, you would be surprised at what can happen over a time horizon of 18 or so years. I would not be surprised if DisneySteve one day got an opportunity to set up his own practice and decided to take the opportunity and the challenge on. That could do all sorts of things to income--I wouldn't want DS to say, "I didn't see that one coming when I was setting up my daughters college funding plan..."

If end up getting phased out, you would have been much better off to have the savings in a regular savings account (vs savings bonds). The interest would have been taxed in the year it was earned (at a lower nominal tax rate), you would be free to move the money to where it earned the best interest and you would have no restrictions on getting to the money.

For 2007, the amount of your interest exclusion is phased out (gradually reduced) if your filing status is married filing jointly or qualifying widow(er) and your MAGI is between $98,400 and $128,400. You cannot exclude any of the interest if your MAGI is $128,400 or more.
source: IRS publication 970 Education Savings Bond Program

[Like2Plan]

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).

That is rather simplistic. There may be several good reasons for not tapping into assets--like tax consequences would be a good one. Market timing another (although one could argue that a parent should take this into account if planning to use shares in say GE to pay for college they should plan to do this several --or over several years prior to the child going off to college.) It also does not address that some areas have a higher cost of living than others.

I do not think paying off a mortgage is a bad thing. (Our mortgage was paid off a year ago. ) I just take issue with the timing. I do not think the mortgage has to be paid off before you start saving for college or before the child goes off to college. In our case, our mortgage payment would have covered about 60% of the cost of college. And the college wants 1/2 the money (fall term) by Aug 1st and the other half (spring term) by Dec 15th. ( This doesn't count the transportation costs, books and incidentals. ) The college does have an option to pay each month, but you pay a fee for this and it is over a shorter time frame (I think it is 10 months).

I think the most important objective is to have the cash available to pay the college expenses when the time comes--(if the parent has his/her heart set on paying for college). Then, you don't have any cash flow problems, you don't have to apply for any loans and you don't even have to fill out the FAFSA forms and you are beholding to no one.


Here are some links to some good information:
Saving for College


link to financial aid. org

link to financial aid. org loan statistics

College Savings Checklist

[disneysteve]

I bonds, are currently .7% interest (permanently) plus the rate of inflation (determinded every 6months.) They cannot be redeemed within the first 12 months. If you redeem them between 1 and 5 years, there is a 3 month interest penalty.

FYI - It is possible to cut that 3-month penalty down to a 1-month penalty. In fact, if you check last month's issue of Kiplinger's, you'll find they published a letter that I wrote explaining how to do that.

One beneficial loophole with I bonds is the way in which interest is paid. You get interest for an entire month regardless of when in the month you actually purchase or redeem the bond. If you buy on December 1, you get interest for the full month of December. If you buy on December 31, you also get interest for the full month of December.

Buy your bond at the very end of the month. Redeem your bond at the very beginning of the month. You will then get interest for 2 more months than you actually owned the bond. If redeeming in less than 5 years, you'll lose 3 month's interest but really will only be losing 1 month's interest that way.

[Like2Plan]

FYI - It is possible to cut that 3-month penalty down to a 1-month penalty. In fact, if you check last month's issue of Kiplinger's, you'll find they published a letter that I wrote explaining how to do that.

One beneficial loophole with I bonds is the way in which interest is paid. You get interest for an entire month regardless of when in the month you actually purchase or redeem the bond. If you buy on December 1, you get interest for the full month of December. If you buy on December 31, you also get interest for the full month of December.

Buy your bond at the very end of the month. Redeem your bond at the very beginning of the month. You will then get interest for 2 more months than you actually owned the bond. If redeeming in less than 5 years, you'll lose 3 month's interest but really will only be losing 1 month's interest that way.

DisneySteve,
That is interesting, but a bigger issue is if it turns out you can't take the write off which is only good for for tuition and fees (room and board and books are not a qualified expense), you will end up paying taxes on deferred interest accumulated over several years.

If this happens, you would have been better off getting a higher interest paid in a regular account without having your money tied up.

At a minimum, you have tied your money up for 12 months--and if redeemed before 5 years you have lost 1 months worth of interest. And, in your case isn't your DD headed off to college in about 5 or 6 years?

[disneysteve]

L2P, I wasn't commenting on I-bonds appropriateness for college. I was just interjecting a little factoid about avoiding the 3-month penalty.

And yes, our DD will be college bound in 2014.

[jIM_Ohio]

Jim,
You keep saying you can tap the IRA penalty free, but even though you are not assessed an additional 10% penalty, you are going to get a tax spanking if you do what you suggest. The only IRA that would be remotely penalty free would be the Roth (but you are giving up money that would grow tax free over time to be used for expenses in retirement)--and with that one you are not taking deductions along the way.

You are taking a tax class, have you modeled what would happen if you actually did this? Let's say you have a deductible IRA. Your plan is to siphon off money to pay for college. For argument sake, you are devoting 1/2 of the contribution to college--2,500 X 18 years). Each year, you get a tax break on the 2,500. Federal tax savings= ___ per year. Then, 18 years later, your child goes off to college (or in your case children ). Let's say the tuition and fees, room and board and books cost 20K. How much will you have to withdraw from your IRA to cover the 20K (assuming you are going to have to take out more to cover the taxes)? What will the tax consequences of adding this one big distribution in a single tax year? (Let's pick a household income of 109,000 which stays the same the entire time. Which, by the way is unlikely--most likely it will go up over time--even if you don't get any big promotions. ) Multiply this by 4 years. It also assumes that our tax rates are not going to change which is also unlikely.


The problems:
1. You are only allowed a finite contribution level--which you should devote to retirement. I believe the IRA contribution level is 5,000 now. Even if you devoted 100% of your retirement fund towards college, you might not have enough to cover it.
2. If you go the 401K route, currently your only option is a loan--up to 50K. That would not be a disasterous as a distribution, but 50K will most likely not be enough (and if you leave work without paying it back, you pay taxes on it because it is considered a distribtuion).

You are equating "penalty free" with "tax free". Taxes would be paid on IRA withdraws for education, penalites would not.

The IRS asseses taxes on distributions from a traditional IRA up to point where contributions were deductable. IRS will asses penalities if distribution was not qualified.

If the distribution is before age 59.5 there is possibility of a 10 percent penalty. This penalty is waive with certain qualifiations. 72t, first house and education expenses are all exceptions- there are more.

My point is to save taxes early unless taxpayer knows they are in the 15 percent tax bracket. Retirement accounts (401k, Roth) should be maxed before considering education expenses. HSA's maxed too, if available.

The federal tax deductions now are more important in most cases than smaller state tax deductions on college savings.

I have stated my position on 401ks- I am NOT suggesting a 401k loan for college savings. I would advise maxing 401ks until kids Junior year of HS, then scaling back 401k contributions to fund college (with cash) before using a 529.

[jIM_Ohio]

Couple of additional tax issues with the bonds:

If bonds are in child's name, file a tax return for them the first year interest was paid on the bonds. You will owe no taxes (based on std deduction). This tells the IRS you are claiming the interest each year, and the sum of the interest is not enough to be taxed.

I believe more than one type of bond is interest free for education, check with treasury direct for the types (I-bonds an EE bonds come to mind).

[jIM_Ohio]

My whole stance on retirement before education is based on risk-reward, tax savings and having financial house in order.

risk-reward:
If you are saving for college, your investment risk is generally short or mid term. You have 14-18 years to save, which suggests no more than 60 percent equities to start with (maybe 70??) and would transition to 10-20 percent equities within 4-6 years before education starts.

Implying the compounding is going to be missed (not enough risk can be taken).
If the money is added to retirement accounts, which have a slightly longer time horizon, risk can be mitigated more (there are more assets), so adding more monies to this benefits the investor for both retirement and the education needs.

tax savings: The small state tax deductions on college plans cannot beat the federal tax savings on retirement plans in most situations.

financial house in order- if a person plans to payoff mortgage
with a 14-18 year time horizon, they can allocate $400-$2000 extra per month to get the loan paid off. If they get a raise 2 years later put that raise into the 529, the mortgage will still be paid off on time, an some money will also be in the college plan too.

[Like2Plan]

You are equating "penalty free" with "tax free". Taxes would be paid on IRA withdraws for education, penalites would not.

Jim,
I am NOT equating "penalty free" with "tax free". All I ask is that you do some modeling based on the parameters given above. Give me some numbers.

I AM suggesting that if you are reaching into those deductible funds that you have been accumulating over the years, you are going to pay MORE in taxes when you pull them out to pay those college expenses than if you had not been taking the deduction all along. Also, I would not be surprised to see tax rates go up for most folks... Govt bailing everyone out is going to need some more cold hard cash, eh?

BTW, have they covered AMT in your tax class, yet?