529 vs. taxable account

[Golfer68]

I live in a state where the 529 is nothing special as far as tax relief (just saves you from capital gains with an extra ER of 0.25% annual in addition to low ER vanguard total stock that is offered in the fund).  I am wondering if it might be better/more flexible to simply invest 5-10k per year in a taxable account for my 0 year old baby.  Could use tax friendly vanguard and that way if baby does not go standard college route can do whatever wanted with money down the road.  Thoughts?

Thanks as always guys

[GXA]

I personally opened a 529 for my first two kids before we had a state benefit.  The capital gains savings can be significant.  I have not looked in a while, but I would shop around to see which states had favorable investment options with a low fee structure.

[DMFA]

You don't have to take your own state's 529. You can choose one with DIY options and low-fee index funds like UT, MA, NV, VA. If that's the stuff you'd invest in anyway, and there's a high likelihood it will be used by *someone* in your family, then a 529 can be great for that.

Even if you end up not using the 529 funds for education for any family member, it isn't the end of the world...you'll be taxed on your gains at income level plus 10% (and pay back state taxes you deducted), but at the very least the dividends and capital gains in growth weren't taxed. Obv not ideal, but not a complete shambles if it didn't go as planned.

[Dr. Mom]

FWIW...Alabama didn't offer anything special when I started 529's so I went out of state.  Then a few years back they changed their plan.  I can roll 10K in a year to get a tax break and no state tax on withdrawals.  I have been rolling the money into their plan annually then withdrawing it immediately to pay for college costs.  It's a nice boost to returns.

[G]

I do both.  Assuming your other financial ducks are in a row, I see little downside in putting some money in a 529 even with no immediate tax benefit.  As I've written elsewhere in this forum, if my kid doesn't use it, there are plenty of ways I can spend it on my own lifelong learning when I have the free time.  And, in 20-30 years, there may be another generation to consider!  As DMFA points out, the penalty isn't ideal, but as a worse-case scenario, it's not the end of the world.

[coastal]

I opened 529s in another state as the in state option was not very good. Not getting taxed on dividends and capital gains was the rationale instead of a taxable account. What you can use the money on without penalty is pretty broad.

Ironically, I moved to the state I opened the 529s in recently - weird coincidence. Now I get a (very small) tax benefit as well.

[ENT Doc]

The odds that one of our children will not go to college or that you would not be able to pass that money on to their sibling is low.  Therefore, I recommend the 529.

[FIREshrink]

Sheltering gains from taxes is kind of a no-brainer for high income earners. The avoided taxes in our 529s would already pay for 4 years of college tuition at a public university. Translated, the 529s have paid for one of our kids to go to school.

[G]

FIREshrink wrote:

Sheltering gains from taxes is kind of a no-brainer for high income earners. The avoided taxes in our 529s would already pay for 4 years of college tuition at a public university. Translated, the 529s have paid for one of our kids to go to school.

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Either you have really cheap public schools or you have a boatload in 529s.  I was fortunate to front-load in 2009 with all equities, so I have a little taste of where you're at.

[ReFinDoc]

529s are somewhat useful if your State  tax rate is high. The tax free compounding is nice, but it can be difficult to get enough money into the plan to really make a difference.

How about this for a plan... start an LLC or LP (for asset protection) with a brokerage . The kids can be members or limited partners if you like.   Invest in Stocks and GIFT the appreciated funds to your kids starting couple years before college. They will pay a 0% cap gains rate and retain the AOTC as a low earner.

Another interesting wrinkle would be to put the money into a 529 plan the year they start college . If your State tax rate is high, you get a nice State deduction and then can  use these funds to pay tuition. Remember you can fund a 529 plan for multiple kids, multiply the upfront tax deduction and then change beneficiaries as you see fit.

[The White Coat Investor]

Golfer68 wrote:

I live in a state where the 529 is nothing special as far as tax relief (just saves you from capital gains with an extra ER of 0.25% annual in addition to low ER vanguard total stock that is offered in the fund).  I am wondering if it might be better/more flexible to simply invest 5-10k per year in a taxable account for my 0 year old baby.  Could use tax friendly vanguard and that way if baby does not go standard college route can do whatever wanted with money down the road.  Thoughts?

Thanks as always guys

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I think the tax benefits (tax-free earnings) will outweigh the additional cost of the 529, even without a state tax discount, especially over 18 years.

[FIREshrink]

The White Coat Investor wrote:

Golfer68 wrote:

I live in a state where the 529 is nothing special as far as tax relief (just saves you from capital gains with an extra ER of 0.25% annual in addition to low ER vanguard total stock that is offered in the fund).  I am wondering if it might be better/more flexible to simply invest 5-10k per year in a taxable account for my 0 year old baby.  Could use tax friendly vanguard and that way if baby does not go standard college route can do whatever wanted with money down the road.  Thoughts?

Thanks as always guys

Click to expand…

I think the tax benefits (tax-free earnings) will outweigh the additional cost of the 529, even without a state tax discount, especially over 18 years.

Click to expand...

I assume the tax drag on a taxable investment offsets the higher costs of a 529 (25-50 basis points per year) and leaves the 529 obviously ahead for qualified expenses.

[The White Coat Investor]

FIREshrink wrote:

The White Coat Investor wrote:

Golfer68 wrote:

I live in a state where the 529 is nothing special as far as tax relief (just saves you from capital gains with an extra ER of 0.25% annual in addition to low ER vanguard total stock that is offered in the fund).  I am wondering if it might be better/more flexible to simply invest 5-10k per year in a taxable account for my 0 year old baby.  Could use tax friendly vanguard and that way if baby does not go standard college route can do whatever wanted with money down the road.  Thoughts?

Thanks as always guys

Click to expand…

I think the tax benefits (tax-free earnings) will outweigh the additional cost of the 529, even without a state tax discount, especially over 18 years.

Click to expand…

I assume the tax drag on a taxable investment offsets the higher costs of a 529 (25-50 basis points per year) and leaves the 529 obviously ahead for qualified expenses.

Click to expand...

Yes, I would expect that for a good 529.

[Golfer68]

As always, extremely helpful, thanks guys!