529 college savings plans

[ERICOPOLY]

A couple of things I noticed tonight about 529 accounts which compound tax-deferred.

 

1)  you can set up a 529 plan for yourself as beneficiary, no matter how old you are (for your future education)

2)  later you can transfer the funds to another beneficiary's 529 plan (like in 30 years when you have grandchildren, you transfer it to their 529s)

3)  withdrawals for qualified education expenses are completely tax free

4)  non-qualified withdrawals are usually assessed a 10% penalty and gains in the account are taxed as income

5)  there are exceptions to #4.  Such as if the original beneficiary had died, and you inherit the account, then withdrawals can be made without the 10% penalty -- but I think the person inheriting the 529 has no requirement of withdrawing the money, unlike the recipient of an IRA account.  Also if the beneficiary becomes permanently disabled (under IRS definition) he can take non-qualified withdrawals penalty free.

 

Another thing I noticed is that annual fund expenses in a Vanguard 529 account are generally 40 bps lower than annual expenses in a Vanguard variable annuity.  Over 30 years that amounts to 12% of extra expenses in the annuity -- which is actually greater than the 10% non-qualified withdrawal penalty in the 529 plan.

 

So I had a quiet thought -- if you are going to lock up the money for 30 years or so, it might be cheaper to put it into a 529 plan even if you never intend to use it for education -- I mean, compared to the costs of a variable annuity invested for 30 years, the 10% penalty seems relatively cheaper.  Plus, if you die during that period your heirs can take the gains without the 10% penalty -- so it's cheaper than the variable annuity no matter what (as long as you intend to not spend it for 30 years or your death, whichever comes sooner).

[Ham Hockers]

It's my first post!

 

I've done this myself. I have two 529 plans: one where I'm owner and beneficiary and one where I'm owner but my infant son is the beneficiary. I'm aiming to keep myself as beneficiary on the first plan indefinitely, even if/when I have more kids in the future (I'll open new accounts for them). I figure I'll come up with something to do with the money eventually, and in the meantime I'm taking advantage of the tax benefits.

 

I would add that you have to be careful of gift taxes, which can be triggered by changing the beneficiary on a plan.

 

There's also a per beneficiary limit on how much can be contributed across all 529 plans, though there's no limit on gains. I think it's around $300k per beneficiary.

[ERICOPOLY]

There's also a per beneficiary limit on how much can be contributed across all 529 plans, though there's no limit on gains. I think it's around $300k per beneficiary.

 

I know about the contribution limit, but there is a grey area I'm unsure about with regards to inheritance.

 

Is it treated as a contribution when somebody inherits a 529 plan?

 

So if you establish a $300,000 plan for yourself and it grows to $600,000 over ten years... can your child inherit your $600,000 plan?  Or would he be limited to only a $300,000 inheritance?  Or would he be able to inherit none of it if he already had over $300,000 in his existing plan?

 

Plus I believe when you inherit a 529 plan you can spend the gains on whatever you choose without that 10% penalty for non-qualified withdrawals.  And I believe you can leave the money in there for the rest of your life without being forced to draw it down early.  Compare that to inheriting an IRA plan where you are forced to liquidate it within the first 5 years (not sure if it's 5 years exactly, but it's a pretty quick forced withdrawal period). 

 

Roth IRAs also (as of now) have no forced withdrawal timeline. 

 

Also, does anyone know if creditors can raid 529 plans?

 

[mhdousa]

My issue with all the 529s I've looked at is they are all indexes. Anyone know of any 529s with decent active or self-directed options?

[watsa_is_a_randian_hero]

My issue with all the 529s I've looked at is they are all indexes. Anyone know of any 529s with decent active or self-directed options?

 

+1

 

Also, I oversee the 529's my uncle set up for his family.  Another issue I've noticed is, for Ohio at least, you are limited to 1 trade per year.  Thank you father government for knowing what is best for all of us!

 

I understand the intention...to prevent families from daytrading, or market-timing their funds and, as is common with most retail investors, buying high and selling low.  That said, while I am a long term investor, if the market is hot or if stocks drop, I prefer not to make 1 single trade...my preference is to fade in or out with smaller baby-steps.  This becomes impossible to do.  Also, if you sell a portion of a stock fund because the market is hot earlier in the year, to the extent the market drops later in the year it becomes impossible for you to buy back in.  Aggravating.

[ERICOPOLY]

I know they are all limited with investment choices.  However I figure they still have a place in my overall planning.

 

For example, that can be a place where I make my super-safe bond investments.  The emergency "do not break glass unless severe Depression hits" cash can go there.  It stands a chance of maintaining it's purchasing power given the bond income is tax-deferred.  You are almost certainly going to lose purchasing power in a high tax bracket invested in bond funds.

 

I wanted to do something like this with variable annuities but the annual expenses are too high.  Here, they are not.

 

[ERICOPOLY]

Regarding the trading limitations.  I know, that one trade per year thing stinks.

 

But I figure I can put on offsetting hedges in my taxable account when the market is high.  The cost of the hedges will be a tax write-off.  So the investments are in the tax-advantaged accounts, and the hedges are in the taxable account.

 

I'm basically just figuring on borrowing the funds from my portfolio margin account, hedging the loan with puts, and depositing the loan in the 529 plan.  Thus I generate these tax losses that won't really be losses (offset by gains in the 529 plan).  And since I won't be trading the 529 plan, wash sale rules won't apply.

 

Once the puts expire, I will have some losses to offset some gains for selling down my BAC position (and that pays down the margin loan).

 

I want to eventually get a big cushion of money in some less volatile stuff for my sanity -- but things like bonds are a non-starter for tax reasons unless I can do it tax-deferred.

 

Also, does anyone know if creditors can raid 529 plans?

 

[Dustin T]

My issue with all the 529s I've looked at is they are all indexes. Anyone know of any 529s with decent active or self-directed options?

 

I suggest a Coverdell ESA. I have one set up for my daughter. You can invest the money in anything you could invest an IRA in. I've got her's in common stocks. It really works a lot like a Roth IRA. The only downside I see is it has a lower maximum contribution limit. $2000/yr.

[hyten1]

folks what are your thoughts on the risk of the gov changing the rules midway. i guess with any of these plans there is that risk.

 

in order to completely eliminate the risk is if you have cold hard cash (after paying all taxes)

 

EDIT: eric weren't you talking about this in some other thread (i can't recall which one) something about roth ira etc., having the gov changing the rules.

[ERICOPOLY]

folks what are your thoughts on the risk of the gov changing the rules midway. i guess with any of these plans there is that risk.

 

in order to completely eliminate the risk is if you have cold hard cash (after paying all taxes)

 

EDIT: eric weren't you talking about this in some other thread (i can't recall which one) something about roth ira etc., having the gov changing the rules.

 

They might change the rules, yes.  But until that happens I can pick up some tax-deferred compounding.

 

And you know, maybe when the rules change it looks like this:  "You cannot make any new contributions to tax-deferred vehicles if you already have a combined balance in excess of $1 million".  So, maybe you get as much as you can as fast as you can into such plans.  Too hard to say.  But it seems unlikely that paying taxes every year on bond income is a better plan.

[ERICOPOLY]

Okay, now I'm thinking clearer...

 

Step 1)  have my father establish a Vanguard 529 account for me.  He is the account owner, I am the "student" beneficiary

Step 2)  establish myself as the "successor owner" of the account in the event of his death

Step 3)  I fund the account with $300,000 maximum right away (I believe I'm allowed to contribute that account without triggering gift taxes because I'm the beneficiary.  But I'm not certain about that -- it's just what I believe to be true.

 

So it's invested tax-deferred, and when he passes I can then leave the funds in there throughout my lifetime.  Anything I spend the money on will not incur the 10% penalty, because I inherited the account (the exemption is for inherited accounts).

 

There, that sounds like a pretty good plan.

 

 

[hyten1]

eric is this true?

 

so you put money in, invest tax deferred, later on you inherit the money you put in you can then use it anytime without 10% penalty and you don't need to pay tax on your gains?!?

 

 

Okay, now I'm thinking clearer...

 

Step 1)  have my father establish a Vanguard 529 account for me.  He is the account owner, I am the "student" beneficiary

Step 2)  establish myself as the "successor owner" of the account in the event of his death

Step 3)  I fund the account with $300,000 maximum right away (I believe I'm allowed to contribute that account without triggering gift taxes because I'm the beneficiary.  But I'm not certain about that -- it's just what I believe to be true.

 

So it's invested tax-deferred, and when he passes I can then leave the funds in there throughout my lifetime.  Anything I spend the money on will not incur the 10% penalty, because I inherited the account (the exemption is for inherited accounts).

 

There, that sounds like a pretty good plan.

[ERICOPOLY]

eric is this true?

 

so you put money in, invest tax deferred, later on you inherit the money you put in you can then use it anytime without 10% penalty and you don't need to pay tax on your gains?!?

 

 

Okay, now I'm thinking clearer...

 

Step 1)  have my father establish a Vanguard 529 account for me.  He is the account owner, I am the "student" beneficiary

Step 2)  establish myself as the "successor owner" of the account in the event of his death

Step 3)  I fund the account with $300,000 maximum right away (I believe I'm allowed to contribute that account without triggering gift taxes because I'm the beneficiary.  But I'm not certain about that -- it's just what I believe to be true.

 

So it's invested tax-deferred, and when he passes I can then leave the funds in there throughout my lifetime.  Anything I spend the money on will not incur the 10% penalty, because I inherited the account (the exemption is for inherited accounts).

 

There, that sounds like a pretty good plan.

 

The part that I'm pretty sure about is that you don't pay the 10% penalty on non-qualified withdrawals if the account was inherited.

 

However, the gains in the account are still taxed as income.  But in my case I don't have a regular IRA -- only a Roth IRA.  So if I accumulate some gains in a 529 plan and pull out a little bit each year, the tax rate will be low assuming I do this late in life when I have no other source of taxable income (like when I'm just drawing from the 529 plan and my RothIRA as my only remaining liquid funds)..

 

When I converted my IRA to RothIRA I did 100% of the entire account -- I figured I might go back to work one day and contribute again to an IRA.  But this 529 plan is perhaps the "IRA" now.

 

Then again, I don't have to spend it on myself.  If I wind up having grandkids, I can always assign it to their 529 accounts.  And if I don't, my kids could always inherit mine.  Or once they've gone to college and significantly drawn down their own plans, I could then gift a portion of my account to their account each year.

 

Hmmm... so much to think about.

 

But one of the things I'm not at all certain of is whether I can fund the account with the entire $300,000 right away without triggering gift taxes -- I believe I would be able to since I would in a way be just giving the money to myself (I'm the beneficiary).  But then again, he's the owner and as owner of the account he could change the beneficiary to himself I suppose, which would be a weird way of me funding his education account without gift taxes.  So I'm not sure.

 

But I'm fairly sure that I could fund it with at least $140k right away -- my wife and I can each put in $14,000 a year without triggering any gift taxes, and you are allowed to put in the first 5 years on day one.  So $14,000 each going into this account per year for 5 years, meaning I could put $140k into it on day one.  Plus, we could also set up an account for my wife to inherit.  That's another $140,000 minimum on day one.  Together, $280,000 on day one.  Potentially, we could  be looking at $600,000 on day one with both accounts combined (not sure about that gift tax situation).

[ERICOPOLY]

Hey wait a minute.  There is no limit to how many 529 plans that are set up for you -- the only limit is that people can't make further contributions once your combined beneficiary total amounts to $300k account balance.

 

So if my mother also set up an account for myself and an account for my wife, we could also contribute $140,000 to each of those plans.  So on day one (without triggering gift taxes), each of us could be funded for $280,000 (combined $560,000).  That's near enough to hitting the individual $300k limit that I'd consider it a success.  Then there is my mother-in-law too -- we could have her setup accounts for us and just put the remaining 20k each into those accounts.  So that's the entire 600k joint limit fully accounted for, clear of potential gift tax problems.

 

Although I still could be wrong about that -- I'm not sure if the gift tax limit is considered for each account owner, or if it's just for the beneficiary.  If it were for the account owner, then it would only be 140k for my father, 140k for my mother, and 140k for my mother-in-law.  That's only 420 total.  Hmm...

[Ham Hockers]

The part that I'm pretty sure about is that you don't pay the 10% penalty on non-qualified withdrawals if the account was inherited.

 

Are you sure it's not the beneficiary (you) who has to die in order to get the waiver on the 10% penalty?

[argonaut]

I found the 529 investment choices (at least through Fidelity) quite limiting and mostly indexes as someone wrote above. Eric, are you seeing more choices and or self-directed through Vanguard?

[theantilibrary]

"But I'm fairly sure that I could fund it with at least $140k right away -- my wife and I can each put in $14,000 a year without triggering any gift taxes, and you are allowed to put in the first 5 years on day one.  So $14,000 each going into this account per year for 5 years, meaning I could put $140k into it on day one.  Plus, we could also set up an account for my wife to inherit.  That's another $140,000 minimum on day one.  Together, $280,000 on day one.  Potentially, we could  be looking at $600,000 on day one with both accounts combined (not sure about that gift tax situation)."

 

This is my understanding. You can contribute, as you stated, the first 5 years ($14,000 X 5 each for you and your wife... $140,000 total) all on day one. I believe that anything above that, at that time, will be subject to gift taxes.

 

Some resources:

 

http://www.irs.gov/pub/irs-pdf/p970.pdf

 

http://www.irs.gov/pub/irs-pdf/i709.pdf

 

[CorpRaider]

Hi Eric,

 

  I recently caught some interview where they discussed a really cheap variable annuity.  It made me think of this thread.  I think the linked interview is the one.  I believe it is Cortazzo who talks about a supercheap variable annuity with a flat monthly fee.  Not sure if the investment options have imbedded higher expenses.

 

http://wealthtrack.com/recent-programs/premium-mark-cortazzo-alexandra-lebenthal-2/

[DukeCrow]

Is no one worried that even though these strategies may not violate the letter of the law they definitely violate the spirit (saving for college), which could raise problems with the IRS?

http://www.lorman.com/newsletters/article.php?article_id=1073&newsletter_id=232&category_id=6

 

If the IRS thinks the plans are set up for the express purpose of avoiding estate or transfer taxes, they can invalidate your use of them, and then you've lost a lot of time and opportunity to setup your estate in a potentially more efficient way.

[ERICOPOLY]

Is no one worried that even though these strategies may not violate the letter of the law they definitely violate the spirit (saving for college), which could raise problems with the IRS?

 

 

Let's say my wife and I each give $14,000 to my son's 529 plan.  That's $28,000 total.  It is removed from our taxable estate because it is considered to be a "gift".  It's now in his name compounding away tax-deferred.  Should he spend it on anything other than education, he is going to pay a penalty.

 

Now compare that to....

 

My wife and I each give him $14,000 to a trust in his name.  That's $28,000 total.  It is removed from our taxable estate because it is a gift.  It's now in his name compounding away tax-deferred in a variable annuity.  Should he spend it on anything other than education, there is no penalty (provided he is retirement age).

 

So you really aren't abusing anything at all by overfunding a 529 plan.  The way I see it, I can withdraw the money if I change my mind or reassign it to another beneficiary.  Thus, he has to behave himself because I can take it all away from him at my discretion.

 

So, the IRS really has nothing to bitch about.  Either way, it's not like they are missing out on any revenue.  They're not!  The main benefit of the 529 is the kid can't behave like a spoiled brat or it gets taken away.

[matjone]

Isn't there a pretty good chance that you are going to miss out on more money due to trading restrictions than you'll save in taxes?  Think of how much poorer you'd be if you'd been investing under these rules before.

[ERICOPOLY]

Isn't there a pretty good chance that you are going to miss out on more money due to trading restrictions than you'll save in taxes?  Think of how much poorer you'd be if you'd been investing under these rules before.

 

I get an immediate gain of 66.6%  (assuming estate tax is 40%), yet I can take back the funds at any time.  So I just think that's too great to pass up.  I suppose it would be less exciting of an idea if estate taxes weren't a concern.