There's been a lot of talk recently about 529 plans. This leads me towonder... are these things really necessary? There are alreadyprovisions in the IRC that allow parents to use IRA funds to pay forcollege tuition. Some 401k plans allow hardship withdrawals to pay fortuition, but you pay a 10% penalty. So I'll focus on using IRA fundsto pay for college. Of course you can buff up your IRA balance with a401k rollover.First, there's the Roth option. Suppose you put $8K per year (self +spouse) in a Roth IRA for 18 years. Assuming 7.22% return, you'll endup with $296K. Of that, $144K is contributions. You can withdraw thecontributions without tax or penalty to pay for junior's education.Assuming the contributions are enough, you've still got a nice chunk ofchange ($152K + left-over contributions) in the Roth. If thecontributions aren't enough, you can start to use the earnings. Ifyou're under 59.5, you have to pay ordinary income taxes on theearnings, but not the 10% penalty.Then there's the traditional option. If the contributions aredeductible, you'll realize a tax benefit every year you contribute.But then, when you go to make a withdrawal to pay for college, you willpay ordinary income taxes on the money. However, since you're usingthe money to pay for education expenses, you're exempt from the 10%penalty, even if you're under 59.5.OK, that stuff is pretty standard knowledge. But I believe there areother advantages to using your IRAs to save for college:1) Flexibility. If your child gets a scholarship or decides not to goto college, that's fine. If you decide that you can't afford tofinance junior's education, that's OK, too. You can do whatever youlike with the money.2) More tax benefits. The IRC specifically bans double benefits forcollege incentives. Money taken from a 529 or ESA cannot deducted orapplied to the Hope or Lifetime Learning credits. As far as I cantell, the same is not true of money taken from IRAs.3) Control. As opposed to a...

You're dead on as near as I can tell on everything up to this point. 529's remain an asset or the parent on in the paren't scontrol. Sojunior can't go buy a Corvette. Correct. And benefits can be shifted to other children, I believe,though I haven't tested this mechanism with my own state's plan. This is the compelling point for me, in a state with a 3% income taxrate--I can deduct the contribution from income. Being free offederal and state income tax in most cases on the gains (guaranteed to2010 federally at least, IIRC) and deductible in many cases on stateincome tax starts your earnings 3% ahead straight away. You seem to have a good handle on it based on my past months ofresearch into the subject. I'm curious what folks have to say aswell.Best Regards, --Todd H.

That's true and it wasn't long ago that capital gains were taxed justlike ordinary income. Still are in many states (eg here in CA).But I'm not a fan of IRA-for-college. Just some general points on allthis stuff...1. very few people save "too much" in their IRAs, it's much more commonfor people to be behind. So the notion of using an IRA (a tax-advantagedaccount for retirement) to fund college (a financial need that typicallyoccurs well before retirement) seems a waste of a tax-deferred "bucket"that's made available through the tax code. Specific cases might pointto it but those cases are also the ones where someone has a lot of moneyand probably wants to use the 529.2. Doubly so for a Roth IRA. It's hard getting money into them, and Idon't think it's a good idea to deplete them even during earlyretirement, let alone many years before that.3. If the goal is to save money for college (a big "if"), not-using a529 is probably leaving money on the table (tax money) for mid-to-highbracket...

Is the 529 really necessary for college savings?

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Tad Borek 19 years ago

That's true and it wasn't long ago that capital gains were taxed just like ordinary income. Still are in many states (eg here in CA).

But I'm not a fan of IRA-for-college. Just some general points on all this stuff...

very few people save "too much" in their IRAs, it's much more common for people to be behind. So the notion of using an IRA (a tax-advantaged account for retirement) to fund college (a financial need that typically occurs well before retirement) seems a waste of a tax-deferred "bucket" that's made available through the tax code. Specific cases might point to it but those cases are also the ones where someone has a lot of money and probably wants to use the 529.
Doubly so for a Roth IRA. It's hard getting money into them, and I don't think it's a good idea to deplete them even during early retirement, let alone many years before that.
If the goal is to save money for college (a big "if"), not-using a

529 is probably leaving money on the table (tax money) for mid-to-high bracket taxpayers. If nothing else it's a way to shelter some of your index funds from tax, in exchange for a slightly higher expense ratio (marginal cost of 529 wrapper). And when you think of it there are very few "income-tax-free" carve outs in the code and most have strings attached:

Roth IRA - actually, very few strings, which is why you should leave these dollars alone
muni bonds - pay low interest rates because of tax-free nature
250k/500k home-sale gain exclusion - but you need to sell your home to get it, and downsize your home or take out a loan to get at the cash
life insurance proceeds - free of income tax - but you need to die to get them!
step-up of cost basis at death - ditto! Any others? Well, 529s which, if you sift, include some pretty good investment alternatives.

Beliavsky, in your sub-par-IQ scenario (setting aside THAT topic entirely), have you thought about going back to school during retirement? Don't laugh, I could see it, I've thought of it myself. Excess 529 dollars...change beneficiary to yourself and fund another degree. Semester abroad anyone? I believe the rule is that any overseas institution for which you could receive financial aid qualifies for 529 withdrawals. LSE class of 2050?
Or...worst case you take the money out and pay a 10% penalty on gains/income, which by some of my spreadsheet analyses might not be so bad after a long-enough period of receiving tax-deferred growth, at a marginal cost of perhaps 30-40 basis points. Tax drag on a portfolio can be well above that (1-2%+ per year depending on asset class?).

If I saw more overfunded IRAs I could get behind the idea of using them for college funding, but the opposite is the case. And I think there's a benefit to the mindset "these are to be left alone until retirement, because it's my responsibility to fund my retirement." Nipping into that for college, for a home purchase, etc, could be a slippery slope.

-Tad

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beliavsky 19 years ago

If I put money in John's (to pick a name) 529 account, I may feel morally obligated to use that money to send him to college if he wants to attend. I would not feel that way about a regular taxable account.

Even if John is college material, if I put only limited amounts in a

529, I can more easily say, "do you want to me to spend X for a private university or Y for a public one", with him pocketing X-Y (maybe at age 30 -- many teenagers cannot be trusted with large sums of money) in the latter case.

As I explained earlier, I think college is an overly expensive credentialing machine. I won't need new credentials in retirement. I do think that learning is important throughout life, but I can and do use books and online academic research for that.

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kastnna 19 years ago

I agree that college credentialing is a "broken system," but if that's what the broken system demands, then that's what its gonna get.

I have heard similar arguments that the only reason we wear suits to job interviews instead of more casual clothes is because somewhere a long time ago one guy did it to "get ahead of the game" and now everyone does it because that's the new standard. BUT, I am not going to be the person that shows up in sweatpants just to protest the flawed standard.

The biggest thing I learned in college was how to set priorities and handle responsibilty. If I chose to party instead of study, I suffered the consequences. Sometimes I learned the hard way.

All of that aside, I don't see the system getting changed anytime soon, and in the meantime college tuition is climbimg at a rate much higher than general inflation.

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Is the 529 really necessary for college savings?

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