How many 529 plans should I have?

[disneysteve]

I would not be surprised to see tax rates go up for most folks.

I'd be extremely surprised if taxes DON'T go up. We've got historically low rates right now. That can't last, even before all this bailout nonsense started.

I know that you can't plan for what might possibly happen, but I do believe that my tax rate will be higher 10 or 15 years from now than it is today.

[jIM_Ohio]

AMT not covered- AMT is something which is calculated for every return (it is the law), you only pay it if it is higher than other techniques, I think.

My model does not fit your case- in the case you suggested a person set aside $2500/year*18 years=45000, so 56 percent of the tuition has been set aside. Without knowing the retirement account balance, I cannot tell you if they can withdraw anything for education.

What my model says is look at the retirement planner- my age/amount list for a given risk profile- is it on track or ahead? On track or behind- no education withdraw. Ahead- the amount which can be withdrawn is only the amount person is ahead.

In your example if total retirement accounts had 400k for age 60 and the retirement chart said the needed 600k at 60, no education withdraw allowed. If the retirement chart said 300k was needed at age 60, 100k could be withdrawn.

In your example the $2500 marked for education is invested the same way as the $2500 for retirement. Probably with an 80-20 or 70-30 risk profile, an this risk profile could be maintained even through years 1-4 of college. So an 8-9 percent return for 18 years could be assumed.

If $2500 was put into a 529, it might be 70-30 at 18 years away... by 10 years away probably 40-60 and by 4 years away close to 10-90 or 100 percent bonds/cash. Overall return for all 18 years would be less than 7 percent, probably closer to 4 percent.

The best case in your model is the 401k was maxed, an IRA was maxed, and mortgage is paid off.

So the 80k education expenses mentioned were covered with contributions (no compounding needed), so any compounding is helping the retirement plan, where as the principal is going to education.

80k/18=$4444 per year is for education... yet the $4444 is invested quite aggressively with rest of retirement allocation. Interest stays with retirement plan, the principal is moved to cash closer to college at a market high.

[jIM_Ohio]

Taxes will be going up. Meaning the paper tax rates increase. A person's taxes will only go up while working, IMO.

Two reasons immediately come to mind:

If LBYM is the method of budgeting, retirement will not need to cover what I term "handout taxes"- SS, medicare, maybe others, that alone is a 7.6 percent raise based on gross salary (double for self employed).

Second is some high tax states (like NY) give significant tax breaks/exemptions to retirees- so some taxes paid on income while working go away in retirement as well.

In general I think the US will continue with a tiered tax system for next 20-40 years and I also think 3/4 of americans will always be in lowest 2 of those brackets. The taxes going up will be on the top 1/4. Anyone raising taxes on the 3/4 will be accused of taxing the poor or middle class. Political suicide if you ask me.

[Like2Plan]

Jim,
Quite a detailed analysis as usual, but what I was curious about most was the tax liabilty--taking a tax write off over 18 years and then taking a large sum out. Simply put, my assertion is that you won't break even tax liabilty wise and that you will pay more in taxes when you take the sum out than the accumulated tax savings you have enjoyed while making the contributions.

[jIM_Ohio]

Jim,
Quite a detailed analysis as usual, but what I was curious about most was the tax liabilty--taking a tax write off over 18 years and then taking a large sum out. Simply put, my assertion is that you won't break even tax liabilty wise and that you will pay more in taxes when you take the sum out than the accumulated tax savings you have enjoyed while making the contributions.

Because we are dealing with taxes 18 years in the future, guessing at taxes paid would be full of assumptions or holes.

Assuming all accounts were maxed (401k-Roth-HSA) at an early point (say 10 years prior to educaton expenses getting incurred), and there was a plan to also have a taxable investment account, have a mortgage paid off, and still be working when college expenses were incurred the order of payment would be:

1) any college investment plans
2) cash from income
3) taxable accounts
4) retirement accounts

The IRA "exception" is not the leg I am leaning on from a financial planning perspective. It is worst case.

If 401k was maxed 18 years before college expenses were incurred ($16.5k for 2009) on a given income (say 100k), the 16.5 percent savings rate is established.

As the person gets raises, no guarantee the max keeps up with the raise, so the same 16.5 percent is now 14 percent into 401k and 2.5 percent for taxable account.

It would be the taxable account where college funding would come from. At that point the 2.5 percent could also be put into 529 if the retirement plan was on track.

[MomofFour]

[QUOTE=jIM_Ohio;198077]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.[/QUOTE



I have taken some time to re- read all the posts on this morning, and I have a couple of questions.

1. jIM- above you stated that "you could easily get around $1700-$2000 back per kid per YEAR in federal taxes if you have some monies in taxable accounts". What exactly do you mean by this?


2. To everyone- I still think that I need to put at least some of our college savings in 529's. Do you think I should try to put $5000 a year divided into four accounts for the kids?

That would give us the full amount of state tax benefit.

Would you be concerned about this being too much savings for college?

I know that may sound funny, but when I went to college, I received numerous scholarships including one for over 1/2 of my tuition. Then, there is always the chance that one or more of the kids may not go to college. ( I certainly hope not, but am being realistic. My husband and I tell the kids even now that they are expected to go to college, so hopefully they will.)

[jIM_Ohio]

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.

I have taken some time to re- read all the posts on this morning, and I have a couple of questions.

1. jIM- above you stated that "you could easily get around $1700-$2000 back per kid per YEAR in federal taxes if you have some monies in taxable accounts". What exactly do you mean by this?


2. To everyone- I still think that I need to put at least some of our college savings in 529's. Do you think I should try to put $5000 a year divided into four accounts for the kids?

That would give us the full amount of state tax benefit.

Would you be concerned about this being too much savings for college?

I know that may sound funny, but when I went to college, I received numerous scholarships including one for over 1/2 of my tuition. Then, there is always the chance that one or more of the kids may not go to college. ( I certainly hope not, but am being realistic. My husband and I tell the kids even now that they are expected to go to college, so hopefully they will.)

Sure-
see http://www.irs.gov/pub/irs-pdf/p970.pdf for specifics.

there are 3 primary tax incentives for education:
1) Tuition and fees deduction (really an adjustment)
2) Lifetime learning credit
3) Hope credit
There is a 4th secondary tax incentive and that is the deduction (really an adjustment) on student loan interest.

Basic review of taxes are
ALL INCOME-all adjustments= Adjusted Gross Income (AGI)
AGI is then reduced by deductions (std deduction or itemized deduction) to calculate TAXABLE INCOME.

Taxable income is looked up in tax table to calculate the tax you owe.

Credits are then subtracted from the tax you owe. For education credits (lifetime learning and hope), these credits cannot reduce tax below $0 (the credits are NON REFUNDABLE).


The tuition and fees deduction allows you to take up to 4k in qualifed expenses as an adjustment into income. Max AGI is 160 MFJ/80k single or HH.

This means if you make 50k in income, it would lower your income to 46k before calculating AGI. This might qualify you for EIC or other credits.

The lifetime learning credit allows you to deduct 20% of qualified expenses up to $10000 (so max benefit of $2k). Max AGI of 110 MFJ or 55k single or HH.

If you had $50k income and an AGI of 50k, you would calculate your tax owed ($7500 is a high guess). The credit would then lower this dollar for dollar ($7500-$2000=$5500). The lifetime learning credit is per return, so if you had 2 kids in college, each with a tuition of $10,000, you could only apply $10,000 of the expenses to your return.

For the hope credit, you get 100% of first $1100 in education expenses back, and 50% of the next $1100 back (total credit of $1650 for 2007). These limits have increased for 2008, I did not see the new limits when I looked at IRS site prior to posting. The hope credit can only be taken for a person in the first two years of education (I guess hope means they HOPE you finish the last 2 years without the credit).

Hope credit would work same way as lifetime learning. 50k of income calculated AGI to 50k, tax is calculated on 50k ($7500 is a high guess), then the $1650 is subtracted from the $7500. Max AGI of 110 MFJ or 55k single or HH.

Here is the tricky part with 4 kids. I am going to assume kids are each 3 years apart (aged 18-15-12-9 for this example). I will name the kids A-B-C-D

In 2009 use the lifetime learning for kid A (senior year of HS/freshman year of college) (max 2k benefit on 10k tuition)
In 2010 use the LL again. (max 2k benefit on 10k of tuition)
In 2011 use the Hope credit for A and lifetime learning for B (max benefit would be 2k LL on tax return, or 2k from B on LL and $1650 from A on Hope)
in 2012 use the LL for A (do not qualify for Hope in 3rd/4th year) and Hope for B (because this would be $3650 of benefit).
2012=A graduates and C starts school. Use Hope for B and LL for C ($3650). I assume B is a sophomore in the spring semester of this tax year.
2013 LL for B and Hope for C
and so on...

LL is better in general if you have more than $8300 of tuition. However with 2 kids in school and a max benefit on LL of 10k in tuition, you might choose to use the hope credit on one kid to get more money back.

Hope is per STUDENT and can be taken twice over a 3 year period covering 1st and 2nd years of higher education.

If you borrow money to pay for college, the loans qualify you for the credit (with some qualifications).
If you have scholarships, those DO NOT qualify you for the credit (unless you claim the scholarship as taxable income, but I would not think that would be wise).

If you have 3 kids in college at once, you would be able to use the hope twice on same return if you wanted.

You cannot claim more than one of the tax savings (tuition and fees deduction, hope, LL) for the same student for the same tax year, or claim two credits for the same expense. The pdf I linked above makes that very clear.

[noppenbd]

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).

Jim, are you saying that if you pay for 100% of college with 529 monies you can't take Hope or LL credit that year?

[jIM_Ohio]

Jim, are you saying that if you pay for 100% of college with 529 monies you can't take Hope or LL credit that year?

CORRECT to best of my understanding.

Scholarship money cannot apply to credits (money is not taxable as income unless you want it to be).
Student Loans can apply to credits (because the loans will be paid with after tax dollars)
529 monies are not taxed on withdraw- which would exempt them from being applied to credits at the federal level.

From IRS pub 970:

If you pay qualified education expenses with certain

tax-free funds, you cannot claim a credit for those education expenses that are not qualified.

Any other nontaxable (tax-free) payments

received as educational
assistance.

[Like2Plan]

CORRECT to best of my understanding.

Scholarship money cannot apply to credits (money is not taxable as income unless you want it to be).
Student Loans can apply to credits (because the loans will be paid with after tax dollars)
529 monies are not taxed on withdraw- which would exempt them from being applied to credits at the federal level.

Jim,
Actually, only the earnings are counted as a tax-free distribution on a 529 plan. Every year that you receive a distribution, you receive a 1099-Q which breaks down what the earnings are for a given distribution. If you look at ch8 (page 50) of the link you provided.
"Coordination with Hope and Lifetime Learning Credits
A Hope of lifetime learning credit (education credit) can be clained in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses are not used for both benefits. This means that after the beneficiary reduces tax-free educational assistance, he or she must further reduce them by the expenses taken into account in determining the credit. "

The example also includes a scholarship which makes it trickier to follow, but the QTP distribution was 3,700 of that 1,200 was tax free earnings. The parents took the Hope credit on their return and the child had some taxable income on her return after it was done...

[MomofFour]

To everyone- I still think that I need to put at least some of our college savings in 529's. Do you think I should try to put $5000 a year divided into four accounts for the kids?

That would give us the full amount of state tax benefit.

Would you be concerned about this being too much savings for college?

I know that may sound funny, but when I went to college, I received numerous scholarships including one for over 1/2 of my tuition. Then, there is always the chance that one or more of the kids may not go to college. ( I certainly hope not, but am being realistic. My husband and I tell the kids even now that they are expected to go to college, so hopefully they will.)

Just wanted to give this it's own space, I'm afraid it may have gotten lost in the big post I did before.

Any thoughts?

[jIM_Ohio]

Jim,
Actually, only the earnings are counted as a tax-free distribution on a 529 plan. Every year that you receive a distribution, you receive a 1099-Q which breaks down what the earnings are for a given distribution. If you look at ch8 (page 50) of the link you provided.
"Coordination with Hope and Lifetime Learning Credits
A Hope of lifetime learning credit (education credit) can be clained in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses are not used for both benefits. This means that after the beneficiary reduces tax-free educational assistance, he or she must further reduce them by the expenses taken into account in determining the credit. "

The example also includes a scholarship which makes it trickier to follow, but the QTP distribution was 3,700 of that 1,200 was tax free earnings. The parents took the Hope credit on their return and the child had some taxable income on her return after it was done...

Make sure you read the whole thing

A Hope or lifetime learning credit (education credit) can be
claimed in the same year the beneficiary takes a tax-free
distribution from a QTP, as long as the same expenses are not used for both benefits. This means that after the beneficiary
reduces qualified education expenses by tax-free
educational assistance, he or she must further reduce
them by the expenses taken into account in determining
the credit.

I interpret this as meaning the 529 withdraw reduces the amount of the credit you qualify for. I am not sure if your post suggests you think otherwise.

[noppenbd]

Make sure you read the whole thing



I interpret this as meaning the 529 withdraw reduces the amount of the credit you qualify for. I am not sure if your post suggests you think otherwise.

If you look at the example only the earnings portion of the 529 withdraw is considered a tax-free distribution. So the contributions that you withdraw would be eligible for Hope & LL credits. That is what the Pub 970 example shows. In theory someone could "double dip": get the state tax credit upon deposit and still pick up the federal Hope and/or LL credits upon withdrawal.

[jIM_Ohio]

If you look at the example only the earnings portion of the 529 withdraw is considered a tax-free distribution. So the contributions that you withdraw would be eligible for Hope & LL credits. That is what the Pub 970 example shows. In theory someone could "double dip": get the state tax credit upon deposit and still pick up the federal Hope and/or LL credits upon withdrawal.

I did not understand this to be true... if it is true I might change my stance on 529s. More to follow soon.

[Like2Plan]

To everyone- I still think that I need to put at least some of our college savings in 529's. Do you think I should try to put $5000 a year divided into four accounts for the kids?

That would give us the full amount of state tax benefit.

Would you be concerned about this being too much savings for college?

I know that may sound funny, but when I went to college, I received numerous scholarships including one for over 1/2 of my tuition. Then, there is always the chance that one or more of the kids may not go to college. ( I certainly hope not, but am being realistic. My husband and I tell the kids even now that they are expected to go to college, so hopefully they will.)
Just wanted to give this it's own space, I'm afraid it may have gotten lost in the big post I did before.

Any thoughts?

MomofFour,
You can go to a calculator which will tell you about how much 4 years of college will cost when your children go to college. I can look a couple up for you, if you would like. If your children get a scholarship, you can pull out the same amount from your 529 plan without incurring the 10% penalty on the earnings. You do pay taxes on the earnings. You could also change beneficiaries if there was money left over.

Let me tell you what happened in our case. Our goal was to cover 100% of our son's college. When we looked at an college expense calculator it was estimating 50k for 4 year in state public college and 100K for private. This was 20 years ago. College tuition costs outpaced inflation and these estimates were low. We are actually looking at around 75K for 4 years at an in state college. (This includes tuition and fees, room and board and books). DS is halfway through college.