mortgage/college/retirement does our strategy make sense?

[jpg7n16]

529 plans can be used for room & board and supplies if the student is full time

Oh sweet well I was wrong on that bit. But the part about not tax-free for taxes is still true.

So that everyone else can see, here you go:

Special IRS Web Section Highlights Back-to-School Tax Breaks; Popular 529 Plans Expanded, New $2,500 College Credit Available

529 plan distributions are tax-free as long as they are used to pay qualified higher education expenses for a designated beneficiary. Qualified expenses include tuition, required fees, books, supplies, equipment and special needs services. For someone who is at least a half-time student, room and board also qualify.

Though there are still some limitations:

FinAid | Saving for College | Section 529 Plans

Room and board are included only for students who are enrolled at least half-time. Room and board expenses are limited to the actual school charges for students who live on campus in housing owned or operated by the school, and to the school's budget figure (as listed in the school's published cost of allowance figures) for students who live off campus but not at home. Room and board for students who live at home is not included.

There is no federal benefit for contributions, but there is a state benefit it many states.

I should know this by now - but as I'm in Texas, we have no state tax - so it always slips my mind!

[jIM_Ohio]

Ok, I'm back from the Magic Kingdom (unfortunately). First, congrats on being so close to being mortgage-free. That's great. I'm not entirely sure I agree with Jim's breakdown. If your husband's job will pay at least 66% of 40K (current value) for any college your kids attend, I'm not sure I would tie up money in a 529. You run a pretty significant risk of overfunding the accounts and having to pay a penalty to get the money back. It might be reasonable to open one 529 for kid #1 and if the money doesn't get used, change the beneficiary to kid #2 later. You should be able to cash flow college otherwise. Also, though Jim says $500/month to each Roth, it is actually $416.67/month with the current limit of $5,000/year. That's an extra $166/month available even after the Roths are maxed. So after maxing Roths, that gives you $166+750=$916/month free for savings.

The one thing that might alter my thinking is a state tax deduction for the 529 contributions. Personally, my state doesn't offer a deduction so it saves me nothing upfront to fund my daughter's 529. If your state lets you deduct 529 contributions, that might make them worthwhile, but I'd still be very careful not to put too much in due to the great benefit you already have to pay for college.

$350/mo for 48 months is $17,000 in 529 and this would be $4425 per year in 529 for tuition of 13k per year. I did not think that was oversaving. Employer pays 8800 and parents pay 4400 of the 13k tuition bill.

$250/mo for 84 months is $21,000 in 529, and this would be $5000 per year in 529 for tuition of $15,000 per year. Meaning pay 15k of tuition, employer pays 10k, parents pay 5k.

I agree only use the 529 if OP's state gives them a deduction.

[moneyunderyourfuton]

If abroad to a different school, you should save in 529 plan for the younger kid, and something short term for the older.

Why short term investments for the older, instead of a 529? Your mortgage will not be paid off for another 28 months - 2.33 years. At that time, you said the oldest will only have 4 years, which is a short term horizon. You'd be best advised to go with a money market account, CDs, short term treasuries, short term bonds, etc.

+1. Some 529 programs actually offer 529 CDs. If that's available to you, it is worth considering, as you get the safety of the CD plus the possibility of state tax deduction. Otherwise, I would say just go with a regular CD or another short-term safe investment, since you won't have that many years between contributing and your first kid going to college. Saving on state taxes is not that useful if your investment on a 529 drops dramatically and you don't have enough time to sit out and let it recoup.

[disneysteve]

If abroad to a different school, you should save in 529 plan for the younger kid, and something short term for the older.

Most, if not all, 529 plans offer a cash account for students close to, or already in, college. If there is a state tax deduction, it can make sense to funnel money through a 529 even if your kid is already in school. Put the money in sophomore year, for example, and take it out junior year. You'll get the deduction which will surely beat what you would have earned in a plain CD at your local bank.

[jIM_Ohio]

It's tough to know the value of a 529 for the OP because we do not know

1) What their present tax situation is (federal and state returns)
2) if their state has a deductable 529 option
3) what their marginal state tax bracket is

I understood that the OP would have 4 years of saving for 529 once mortgage was paid off, where as another post suggested the mortgage would not be paid off before kid 1 went to college- this should be clarified as well.

When the mortgage is paid off, we will have 4 years until kid #1 enters college and 7 years until kid #2 gets there. We are trying to decide if, once the mortgage is paid off, we should:
A. throw all of that mortgage money into retirement savings like Roths and other investments for both of us and then cash flow the college expenses
B. start a 529 for the kids with the money that was going to the mortgage
C. a combination of the two.
D. refinance to a ridiculously small mortgage payment and start saving more now

Originally Posted by jpg7n16
If abroad to a different school, you should save in 529 plan for the younger kid, and something short term for the older.

Why short term investments for the older, instead of a 529? Your mortgage will not be paid off for another 28 months - 2.33 years. At that time, you said the oldest will only have 4 years, which is a short term horizon. You'd be best advised to go with a money market account, CDs, short term treasuries, short term bonds, etc.

OP is in good shape- mortgage will be paid off in a short amount of time and that should not be delayed IMO. It is a goal OP set and would make them feel good and secure... so carry on with that plan.

How the money gets allocated once mortgage is paid off is up for much debate...

If you put $500/mo into a Roth, you can max it out in 10 months... so if you start this in June, consider $500/mo fron June-April maxed IRA out for June tax year, then May-March maxes out the next tax year, then April-January maxes out the next tax year... You might get one additional year of Roth contributions if you plan for "higher" than the $417/mo Steve mentioned.

529 plan for kid 1 or not-
this 529 with 4 years until college, and 4 years of college has an 8 year time horizon.
if you have a state tax rate of X% and can get a CD at a bank of Y%
if X%>Y% do a 529
if Y%>X% then use the CD, skip the 529
if the CD is in the 529, then Y%>X% can still be in 529

Hopefully you followed that

529 plan for kid 2- 7 years until college plus 4 years of college, this money has an 11 year time horizon. You might use equities for first 3-5 years, but by year 6 I would expect this account is 80% cash and bonds (and mostly cash).

[frugalgirl]

It's tough to know the value of a 529 for the OP because we do not know

1) What their present tax situation is (federal and state returns)
2) if their state has a deductable 529 option
3) what their marginal state tax bracket is

I understood that the OP would have 4 years of saving for 529 once mortgage was paid off, where as another post suggested the mortgage would not be paid off before kid 1 went to college- this should be clarified as well.

In hopes of getting even more analysis, here's the info requested above:

1) With federal deductions, we fall into the 25% tax bracket. We are squarely in the middle of it. We live in PA, so we are taxed at a flat 3.2% regardless of income.
2) Here's what it says on the Kiplinger site regarding PA's 529 tax status:

Contributions to any Pennsylvania or non-Pennsylvania 529 plan of up to $13,000 per beneficiary in 2009 are deductible in computing Pennsylvania taxable income. Spouses filing jointly must each have at least $13,000 in income to claim the maximum $26,000 per-beneficiary deduction. Rollovers from another 529 plan or from qualified U.S. savings bonds are not eligible for the deduction.

3) Again, we get taxed at 3.2% in PA regardless of income.

To clarity, the mortgage will be paid off in 28 months. After that, we will have 4 years to save for child #1 and seven years to save for child #2. Kids are currently in 4th and 7th grades.

I am still digesting all of your posts. Keep it coming!
Thanks!

[frugalgirl]

$350/mo for 48 months is $17,000 in 529 and this would be $4425 per year in 529 for tuition of 13k per year. I did not think that was oversaving. Employer pays 8800 and parents pay 4400 of the 13k tuition bill.

$250/mo for 84 months is $21,000 in 529, and this would be $5000 per year in 529 for tuition of $15,000 per year. Meaning pay 15k of tuition, employer pays 10k, parents pay 5k.

I am not sure, but I think you may be misinterpreting the way the benefit works as I may have explained it poorly. The university (school x) will pay 66% of it's tuition (currently $40,000) to go to school y. So, if they go to Penn State (a school y) whose tuition is around $14,000/year, 66% of $40,000 will cover the whole amount. We will be responsible for paying taxes on the $14,000 worth of benefits that we are receiving plus room and board so we have to save for that in the appropriate investment. The 529 would most likely only be needed for room and board and books - it would be an extraordinary situation in which we would agree to send the kids to a school that costs more than 66% of school x's tuition.

Hope this helps.

[disneysteve]

Contributions to any Pennsylvania or non-Pennsylvania 529 plan of up to $13,000 per beneficiary in 2009 are deductible in computing Pennsylvania taxable income.

we get taxed at 3.2% in PA regardless of income.

That's a great deal. You get the state tax deduction regardless of which 529 plan you choose. That's particularly good since PA doesn't have one of the top-rated plans.

To continue on Jim's last post, you aren't going to outperform in a CD outside of the 529. In the 529, not only do you get the 3.2% deduction but you also get whatever the money earns in the plan. Even if it earns only 1% (which is tax-free remember), the total with the deduction is really 4.2%. You can't beat that.

[jIM_Ohio]

I am not sure, but I think you may be misinterpreting the way the benefit works as I may have explained it poorly. The university (school x) will pay 66% of it's tuition (currently $40,000) to go to school y. So, if they go to Penn State (a school y) whose tuition is around $14,000/year, 66% of $40,000 will cover the whole amount. We will be responsible for paying taxes on the $14,000 worth of benefits that we are receiving plus room and board so we have to save for that in the appropriate investment. The 529 would most likely only be needed for room and board and books - it would be an extraordinary situation in which we would agree to send the kids to a school that costs more than 66% of school x's tuition.

Hope this helps.

Better explanation and better understanding by me
thank you

Does benefit work whether you go to a state school (like Penn State) or a private school (I think Drexel is private)?

Is tuition at both schools going to be under 40k for both kids? Any schools being considered which are more than 40k? You NEED to make this decision within 3 years IMO. You don't NEED to know now, but this is the 300k question IMO.

How much is room and board budget? Meaning can you look around and find estimated room and board costs and then plan to put that in 529?

[jIM_Ohio]

In hopes of getting even more analysis, here's the info requested above:

1) With federal deductions, we fall into the 25% tax bracket. We are squarely in the middle of it. We live in PA, so we are taxed at a flat 3.2% regardless of income.
2) Here's what it says on the Kiplinger site regarding PA's 529 tax status:

Contributions to any Pennsylvania or non-Pennsylvania 529 plan of up to $13,000 per beneficiary in 2009 are deductible in computing Pennsylvania taxable income. Spouses filing jointly must each have at least $13,000 in income to claim the maximum $26,000 per-beneficiary deduction. Rollovers from another 529 plan or from qualified U.S. savings bonds are not eligible for the deduction.

3) Again, we get taxed at 3.2% in PA regardless of income.

To clarity, the mortgage will be paid off in 28 months. After that, we will have 4 years to save for child #1 and seven years to save for child #2. Kids are currently in 4th and 7th grades.

I am still digesting all of your posts. Keep it coming!
Thanks!

If you can get a 3.2% state tax deduction, compare that to a 3.2% return on CDs when you contribute for oldest child in 3 years. CDs now do not return 3.2% in most cases.

[disneysteve]

If you can get a 3.2% state tax deduction, compare that to a 3.2% return on CDs when you contribute for oldest child in 3 years. CDs now do not return 3.2% in most cases.

Not only that, but the money in the 529 will earn something, even if it is less than an outside CD. Plus, the earnings in the 529 won't be taxed upon withdrawal while the outside CD earnings will be taxed.

[frugalgirl]

Better explanation and better understanding by me
thank you

Does benefit work whether you go to a state school (like Penn State) or a private school (I think Drexel is private)?

Is tuition at both schools going to be under 40k for both kids? Any schools being considered which are more than 40k? You NEED to make this decision within 3 years IMO. You don't NEED to know now, but this is the 300k question IMO.

How much is room and board budget? Meaning can you look around and find estimated room and board costs and then plan to put that in 529?

Thanks for all of the suggestions, analysis and points to get answers to.

Answers, which you may have intended for me just to think about, I have answered below in case you are hoping for answers:

The benefit works for any school, in any state, public or private. There are probably some restrictions along the lines of being accredited.

It is easy to find info on room and board. I have done this for Penn State and Carnegie Mellon to compare the costs of a state school in a rural area vs. an expensive private school in an urban setting. Costs are in the $8k to $11 k range for most schools in 2010. I can estimate what we will need when he starts in 2016. I am using a 5% inflation rate over time which seemed to be the rate of increase. The totals range from $46k to $59k for the 4 years (2016-2019).

I have been assuming that we will not need any money for tuition. The $40,000 tuition at school x is one of the most expensive in the country and has been keeping pace with tuition at the other really expensive schools, so I doubt the kids will go over the benefit limit wherever they choose to go. Also, because most of the really expensive schools give some scholarship aid to a majority of students, I am assuming that my kids will fall into that majority. If my child got into an elite school with a stellar reputation (e.g. Harvard/Stanford) or wanted to study something that required a very specific educational program to succeed, then maybe we'd consider spending the extra cash. I think this likelihood is small. However, I wouldn't know this answer until he was a junior or senior in high school.

I can still use all of the information from everyone's posts to conclude:
1) It is a good idea to look further into the 529 to fund room and board. The investment choices should be conservative as they need to be available on a rather short term basis for older child.
2) Use the 529 if other investment options yield less than the state tax rate of 3.2% (plus expected tax savings on growth and considering the tax liability of alternate investment choices like CDs).
3) The old mortgage payment should/can be split into college savings and retirement savings portions.

Thanks for all of the detailed thinking.

[jIM_Ohio]

I can still use all of the information from everyone's posts to conclude:
1) It is a good idea to look further into the 529 to fund room and board. The investment choices should be conservative as they need to be available on a rather short term basis for older child.
2) Use the 529 if other investment options yield less than the state tax rate of 3.2% (plus expected tax savings on growth and considering the tax liability of alternate investment choices like CDs).
3) The old mortgage payment should/can be split into college savings and retirement savings portions.

Thanks for all of the detailed thinking.

You do well answering questions directly and quickly.

1) use the 529s for the room and board. You get a state tax deduction on contributions, and my conservative outlines before still fell under your "guesses" for room and board 7-13 years from now. I see no reason to NOT do the 529s for each kid (meaning do the 529's, I see no downside).

$350/mo for oldest
$250/mo for youngest
$150/mo into general taxable account
plus $1000/mo for Roths for both spouses.

Keep in mind when oldest goes to school you will have
about 17-20k in 529 plan for that kid
plus $7200 in taxable accounts
plus $350/mo (which is $4200/year) available for other school costs. For example lab fees or similar might not be on tuition bill, and 529's may or may not cover those "specific" costs. You also have to think about computer for kid which complies with school requirements and similar.

4 years later when their sibling starts, the $150/mo should have replenished the taxable savings, plus their own 529, plus the $350+$250/mo cash flow ($7200/year) for same expenses.

Conservative choices for kid 1, consider maybe 25% equities in 529 for kid 2- use the 529 for the tax deduction, and try to have options inside the 529 keep pace with CPI inflation (which has "nothing" to do with education inflation).

2) If a CD inside the 529 earns 2%, then your return will be the state tax deduction once plus the 2% per year the CD returns. The 529 is a good deal because the 2% would be taxed if in another account not in the 529.

3) My suggestion was
$350/mo for kid 1 529 (oldest)
$250/mo for kid 2 529 (youngest)
$150/mo taxable
$1000/mo for Roths (depending on what month mortgage is paid off, you may need to change these numbers- my goal is max Roths EVERY year even if you pay off mortgage in November and have only 5 months to contribute for that tax year, so keep $1000/mo for Roth contributions on radar, and if you max out Roth, you can divert the additional monies to the taxable account.

[frugalgirl]

You do well answering questions directly and quickly.

1) use the 529s for the room and board. You get a state tax deduction on contributions, and my conservative outlines before still fell under your "guesses" for room and board 7-13 years from now. I see no reason to NOT do the 529s for each kid (meaning do the 529's, I see no downside).

$350/mo for oldest
$250/mo for youngest
$150/mo into general taxable account
plus $1000/mo for Roths for both spouses.

Keep in mind when oldest goes to school you will have
about 17-20k in 529 plan for that kid
plus $7200 in taxable accounts
plus $350/mo (which is $4200/year) available for other school costs. For example lab fees or similar might not be on tuition bill, and 529's may or may not cover those "specific" costs. You also have to think about computer for kid which complies with school requirements and similar.

4 years later when their sibling starts, the $150/mo should have replenished the taxable savings, plus their own 529, plus the $350+$250/mo cash flow ($7200/year) for same expenses.

Conservative choices for kid 1, consider maybe 25% equities in 529 for kid 2- use the 529 for the tax deduction, and try to have options inside the 529 keep pace with CPI inflation (which has "nothing" to do with education inflation).

2) If a CD inside the 529 earns 2%, then your return will be the state tax deduction once plus the 2% per year the CD returns. The 529 is a good deal because the 2% would be taxed if in another account not in the 529.

3) My suggestion was
$350/mo for kid 1 529 (oldest)
$250/mo for kid 2 529 (youngest)
$150/mo taxable
$1000/mo for Roths (depending on what month mortgage is paid off, you may need to change these numbers- my goal is max Roths EVERY year even if you pay off mortgage in November and have only 5 months to contribute for that tax year, so keep $1000/mo for Roth contributions on radar, and if you max out Roth, you can divert the additional monies to the taxable account.

Jim,

Are you thinking that it is best to underfund the 529 a bit to get more into the Roths and then cash flow more during college by reducing the Roth contribution during those years?

Here's what I mean:

Child 1 starts college in fall 2016 - so need to fund years 2016-2019
Assumptions: money put into his 529 starting in fall 2012 earns 2%
Room and board for his college is 9k in 2010 and rises 5% per year
He needs 4 years of room and board
We start saving $525/month in fall 2012 continuing through 2019
Results:
He will need $52,000 total for 4 years of room and board
He will have $26,000 in his 529
We will have $25,200 in "cash" that accumulates during the 4 years he's in college that was going to the 529 prior to the start of college ($525/month = $6300/yr)
This puts us about even.

Child 2 starts college in 2019 - so need to fund years 2019-2022
Assumptions: money put into his 529 starting in fall 2012 earns 3%
Room and board for his college is 9k in 2010 and rises 5% per year
He needs 4 years of room and board
We start saving $425/month in fall 2012
Results:
He will need $60,000 total for room and board
He will have $39,000 in his 529
We will have $20,400 in "cash" that was going to the 529 prior to the start of college ($425/month = $5100/year)
That puts us about even for him.

Summary;
From 2012 through spring of 2019 until first child graduates:
Child 1 529 or cash flow = $525/month
Child 2 529 or cash flow = $425/month
Roths = $1750(available from old mortgage payment)-$525-$425 = $800/month
From 2019 - 2022 when only child 2 is in college:
Child 2 cash flow of $425/month
Roths = $1000/month
Other savings = $325/month

I guess the things to consider that could cause "trouble" are:
1) either child decides to live at home leading to over funding of the 529s. Other issues that could lead to over funding like interest rate fluctuations or incorrect assumptions about room and board costs should be easily compensated for by adjusting our contribution level as we go forward
OR
2) need extra cash on hand to pay tuition benefit taxes. This can be solved by decreasing Roth contributions.

I guess the discussion now turns to whether or not it is best to first max out the Roths upfront starting in 2012 as you've suggested and then use some of that Roth contribution money later if/when it is needed during college.

Thoughts?

[jIM_Ohio]

I would max roths before putting extra into a 529.

If the 40k benefit is taxed, that means in 25% bracket you owe 10k in taxes.
If this is a problem, that is about $800/mo less cash flow, and make sure you adjust withholdings so you don't owe a tax penalty April 15.

Do you or your husband get raises each year? Will cash flow be higher in 4 years because of only mortgage payoff, or will other monies be available?

If the $1750 is the only money available... I will rethink my advice.

$800/mo the first 48 months should be put into a taxable account for the taxes on the 40k benefit (times 4 years- right?).
I would also put $800/mo into Roths
Then put $150/mo those first 48 mos into the 529 for oldest child ($7200 total)


My math has $7200 without interest in 529 for oldest, plus enough in taxable account to cover taxes on the 40k benefit and Roth is fully funded. You projected a 52k need for this.

Over the 4 years oldest is in college, the $950/mo accounts for $45k of new money. 45k plus 9k in the 529 should cover the expenses for kid 1.

The big question is how much of the 40k taxable did kid 1 use (because if tuition was 40k, 10k is spent on taxes per year, if tuition was 15k, then 15k was spent on taxes over 4 years and 25k was left for kid 2.

Kid 2 has 2k from above, then 45k of new money for the 4 years they are in school (are your kids 4 years apart?- I assumed this) for a total of 47k. You projected the need to be 60k so there is 13k of gap, plus possible taxes owed on the tuition benefit I have not accounted for.

Based on this, you need to decide the following:

*Do you agree prioritizing Roth over 529 makes sense?
*Can you project tuition costs- 10k per year out of pocket for tax vs 3k out of pocket per year for tax makes a BIG difference.
*How much do you value the 529 tax deduction?