Thoughts on 529 vs. Taxable

[Hudama]

Hello - I am a medicine attending 7 years out from training and spent most of 2021 finally becoming financially literate. I now have an IPS, well defined goals, am moving towards them, etc. It feels great! Lurking on this forum has been very useful, thank you all. I am posting now to get feedback on strategy when saving for our kids' college.

Stage of life: mid career attending
Social situation: married to non-working spouse, 4 kids
Gross income: 370K
Maxing out retirement accounts (403b, gov457b, 401a, BDR)
Marginal tax rate: 24%
State: no income tax
Student loans paid off
Appropriate insurance in place
Assets: $500K in retirement accounts + 30K e-fund
Liabilities: just mortgage
Mortgage: 625K at 2.875% with about 70K in equity
Savings rate 22%

I have 4 kids who will all finish high school in between 6 to 10 years. We have no state income tax where we live. Each kid has a small 529 owned by a grandparent that I used to contribute to - approximately $10,000 are in each account. They are smart kids and will likely go to a state school, so I think scholarships are reasonably likely. We pay for private school now which is approximately $13K a year for each kid.

I would like to save 75K for each of them and plan to cash flow an additional 13-15K for each kid per year if needed (based on our current spending plan which includes private school). I have stopped contributing to the less than ideal grandparent advisor based 529s due to fees and lack of control (and want to try and roll them to 529s that I own or use them for private school tuition next year to drain them). Per my IPS I opened accounts via the Michigan 529 plan but of course get no state tax deduction because I don't have state income tax.

I've done the math and know how much I need to save monthly to reach the 75K per kid goal. My question is more about the pros and cons of moving away from 529s: would it be foolish to invest my monthly contribution for all 4 kids in a taxable account to provide more flexibility for how the funds could be used in the future?

Since my investment time horizon is relatively short (especially for the oldest who is 6 years from college), it seems like I won't benefit dramatically from compounding and I don't have a big lump sum to put into 529s now - I budget these savings as a monthly expense. I have a lot of tax advantaged space through my academic retirement plan options so have no assets in taxable brokerage accounts. I like the idea of having more flexibility to use college savings for other goals if my kids get scholarships. Of note we give about 35-40K to charity annually so when needed I should be able to flush capital gains out through a DAF.

1 year ago the above post would have been greek to me - I am very grateful to all the WCI resources that have rescued me from financial illiteracy and doing dumb stuff with our money. Thanks in advance for any suggestions/advice/criticism!

[CordMcNally]

would it be foolish to invest my monthly contribution for all 4 kids in a taxable account to provide more flexibility for how the funds could be used in the future?

No.

[PWMDMD]

My plan is to first fund the 529 to a sufficient level (but not overfund) and then fund the taxable account.

[bovie]

First thought: you should probably try to jump
start that nest egg first.

For that reason alone (and in addition to several others you noted), I would specifically suggest you put it into taxable and forgo the 529.

Also, $13k per year x4 for private school is hurting you. Probably is what it is at this point and I’m sure you have your reasons, but something to consider.

[Hudama]

Great, thanks to all for the reassurance that focusing on growing a taxable account instead of funding 529s is reasonable and appropriate.

I agree that 52K to private schools is a big bite that could be very useful elsewhere - we have weighed that for sure and in the end the school and its curriculum are key parenting priorities for us.

[StarTrekDoc]

Congrats in the plan!

A penny earned and tax free is just that....tax free. Fund the 529.

Find the 529 plan that fits your desires. Choose a later date if you want more agressive plans and tolerate a dip in funds if you don't mind that. So ce all four kids same generation you can move mix match the funds together.

Fyi you can even use for secondary school...we did

By not using 529 you're leaving earned dollars taxed. Cadhflowing post tax is just that

[Dewangski1]

4 kids x 75k = 300k
300k total egg, assume 150k contributions and 150k gains.
150k x 15% LTCG tax = 22.5k

Is the flexibility worth 22.5k to you? Keep in mind you can pay yourself out for scholarships…

[uksho]

I invest in 529, when I have 200k for each ( principal plus interest), will stop . I don’t think it is a bad idea due to state tax advantage which gives me 4-5 percent return immediately. Plus tax free withdrawal obviously .

question: just realized that our 529 default has given 13-15 percent return in 2020 and 2021 for a kid 9-10 years from college and 11% for a kid 6-7 years from college

Option is to do 100% VTSAX . Shall I do it for the younger one ? If the money was in taxable , probably I would have done that

I am just realizing how much I have lost by going to default investments between target funds and now this ( in hindsight )

[Larry Ragman]

No right or wrong answer here. I will add one negative factor on using 529s: the distribution rules are a bit cumbersome when you have to match the 1098T to your taxes. That said, the 529s do allow the funds to grow tax free and that has a real monetary value, especially over 10 years to the youngest.

On balance, if I were in your position I’d start at least one 529 that I could fund a roll kid to kid. Why do it that way? Well, easier to track, some kids will need less than others(e.g., scholarships), no orphan accounts, etc. But for the record what I actually did was have one for each kid. In your case that would allow different risk profiles for each account.

Either way, direct or 529, give some thought to a withdrawal plan. For example, obviously you want to spend the grandparent 529 money first. You might then cash flow the first kid to allow some tax free compounding in the 529s for the younger kids.

[OldSoul]

The fact that you have four kids to put through college adds a lot of flexibility if you were to go the route of 529s. We put 3 kids through college in a manner similar to the plans you described. All have/had 529s of about 140k, and we cash flowed any shortages. You say that they'll all go to your state schools. Perhaps that's a hard and fast rule that you'll stick to, but perhaps not... For us, one went to a state school, one went to a private regional university and then went to state grad school, and the last is going to a top 10 NESCAC school (most expensive). We kept some of the 529s with age-based investments, and others were kept at 70:30 equity:bond ratios. It sure was nice that we didn't have to pay LTCG tax on the ~15-20k of growth in the 529.

The bottom line is that with 4 kids, you can mix it up regarding investments and different state 529s. Don't worry, you'll zero out the accounts by the time you pay for the last kid.

[JBME]

I invest in 529, when I have 200k for each ( principal plus interest), will stop . I don’t think it is a bad idea due to state tax advantage which gives me 4-5 percent return immediately. Plus tax free withdrawal obviously .

question: just realized that our 529 default has given 13-15 percent return in 2020 and 2021 for a kid 9-10 years from college and 11% for a kid 6-7 years from college

Option is to do 100% VTSAX . Shall I do it for the younger one ? If the money was in taxable , probably I would have done that

I am just realizing how much I have lost by going to default investments between target funds and now this ( in hindsight )

it's easy to think you were wrong in hindsight. When I started ours, I initially went with the age-based aggressive growth funds at Vanguard. Two years ago I switched to 100% VTSAX for all kids for now. Kids are 3,5, and 8. No regrets on doing that. I need to add more money and turbo charge this year the contributions

[FIREshrink]

No.

Not foolish, but the tax savings in a 529 can be substantial. It's a personal decision whether the tax savings are worth the reduced flexibility. With four kids i think the latter is insignificant. Even with two kids and a creative mind (look at that fantastic French literature class at CUNY!) I didn't feel constrained with 529s.

100% 529s for two kids, no state income tax benefit, currently ~$600k balance including $400k gains which is a tax savings of about $125k. Not worried about overfunding. This money will pay for someone's education in the next fifty years tax free.

[CordMcNally]

Not foolish, but the tax savings in a 529 can be substantial. It's a personal decision whether the tax savings are worth the reduced flexibility. With four kids i think the latter is insignificant. Even with two kids and a creative mind (look at that fantastic French literature class at CUNY!) I didn't feel constrained with 529s.

100% 529s for two kids, no state income tax benefit, currently ~$600k balance including $400k gains which is a tax savings of about $125k. Not worried about overfunding. This money will pay for someone's education in the next fifty years tax free.

Maybe or maybe not. Flexibility costs money but is worth that cost to many people. We have about $60k in a 529 but that was mainly because my wife was given money for education from her grandfather that she never needed so we put it in a 529 in his honor to earmark it for education. We'll likely never add to it. I would prefer to have even more in my retirement accounts than in a 529. I don't know much but I do know that something will have to give in the education system regarding tuition. Costs can't continue to rise like this for the next 50 years.

[Bev]

You will not regret sending your kids to a private school. There is a difference.

[Sampter]

You will not regret sending your kids to a private school. There is a difference.

This is a family/personal choice for sure. However, not all private schools are better than public schools. I recently moved mine from private to public and the public schools are significantly better.