529s for children and grandchildren

My wife and I have three children. With our current jobs, we would be
able to pay their college expenses out of our salaries. We have 529
plans for them, whose earnings will be tax free when used for
education. When parents can pay for college with tapping 529s, does it
make sense to keep the money in the plans? Two later uses could be to
pay for professional school for the children or even to wait until
there are grandchildren and to make them the beneficiaries. Would
there be tax consequences for doing the latter?

Beliavsky <> writes:

> My wife and I have three children. With our current jobs, we would be
> able to pay their college expenses out of our salaries. We have 529
> plans for them, whose earnings will be tax free when used for
> education. When parents can pay for college with tapping 529s, does it
> make sense to keep the money in the plans?

It depends on what your alternative options are. For example,
if you still have room to add to a Roth, I'd probably consider
adding to the Roth while using 529 money for the schools, since
the Roth money will be far more flexible down the line.
(Noting that there are some estate impacts here - money in
the 529 is out of the estate - if you've got estate-tax kind of
wealth, this may be an important consideration)

> Two later uses could be to
> pay for professional school for the children or even to wait until
> there are grandchildren and to make them the beneficiaries. Would
> there be tax consequences for doing the latter?

You may change beneficiary with no tax consequences so long as
the new beneficiary is a "member of the family" of the original
beneficiary (and the new beneficiary is of the same generation
for GST purposes, though that may not be a big deal given the
recent very high limits and the ongoing mucking about with the
related estate tax).

Member of the family is defined quite specifically:
son, daughter, brother, sister (or step- of each)
father, mother (do you want to take some classes?)
1st cousin, nephew, niece, aunt or uncle, various
immediate in-laws, or the spouse of any of the above.

Use of 529s also may have impact on available financial aid,
and the impact is different if the 529 is owned by the parent
versus owned by someone else like a grandparent.

In general, especially if folks expect to be able to pay
tuition and such out of then-current income, I urge folks
to max out retirement savings first. (There are certainly
exceptions, of course).


[posting sofware is preventing me from including this disclaimer in the
signature. I doubt the disclaimer is actually of any value, anyway,
but can it really hurt?]
disclaimer: discussions in misc.invest.financial-plan are for educational
purposes only and should not be construed as financial advice. For
personal financial advice, please consult directly with aprofessional.

--
David S. Meyers, CFP(R)
http://www.MeyersMoney.com

On 7/21/2011 11:59 AM, Beliavsky wrote:
> When parents can pay for college with tapping 529s, does it
> make sense to keep the money in the plans?

That's an interesting question. You'd risk giving up a known tax benefit
for a possible one. If it turns out there's no grad school and no
grandchildren, there will be tax+penalty on earnings at the eventual
distribution from the plan, with no way go go back and recapture that
benefit (you paid for the costs directly with non-529 funds). You'd also
need to check the specific plan's rules for how long the money can sit
there if the original beneficiary has graduated from college, it varies
for each (not necessarily an issue).

So given the intended purpose you'd be giving up a chunk of
tax-free-ness for your overall assets. Unlike basis step-up or a Roth,
this one can only be realized when you have offsetting education
expenses. Years with those costs are years to flush out 529 plans and
get that benefit.

To preserve the assets for future uses, an alternative strategy to look
into would be using the 529s up during college while simultaneously
making equivalent deposits to new 529 plan accounts through a different
state. That will in effect "reset your basis" of your overall 529
assets, to the extent of those deposits. But it has to be through a
different state given the earnings-aggregation reporting rules for Form
1099-Q.

-Tad

"Beliavsky" <> wrote in message
news:c2781d95-dd37-4216-af4c-...
> My wife and I have three children. With our current jobs, we would be
> able to pay their college expenses out of our salaries. We have 529
> plans for them, whose earnings will be tax free when used for
> education. When parents can pay for college with tapping 529s, does it
> make sense to keep the money in the plans? Two later uses could be to
> pay for professional school for the children or even to wait until
> there are grandchildren and to make them the beneficiaries. Would
> there be tax consequences for doing the latter?
>

Interesting question - my question is have you maxed out ALL of your
qualified retirement plan options already? In my opinion, that should be
done first before funding 529s for the kids. Assuming you have maxed out
ALL of your and your wife's qualified plan options, have you also maxed out
your IRA options - traditional (deductible or nondeductible) or Roth? This
should be done next, before funding 529s. Assuming you've done that already
too - have you taken care of all the other suggested (required) set asides?
Like 6 months to a year's living expenses and an emergency (liquid) cash
reserve.

The next item I suggest you visit is insurance, life for sure, but also
consider disability. You said you make enough with your current jobs to pay
for the kids college without (I am assuming your WITH was a typo) using the
529 money. But what if you don't have those jobs when the time comes?
Insurance is designed to shift some of the risk of future unknowns to
someone else. Making sure you have enough life, and perhaps disability,
insurance helps to make sure your plans continue into the future the way you
think they will now. AND BE CAREFUL about relying on any insurance you have
through work - if you leave the company will you be able to keep the company
insurance? Even if you wanted to pay the full cost, it is often cheaper to
buy and own some insurance on your own.

Now assuming you've fully funded your own retirements and you have
sufficient life insurance you need to address how to fund college for the
kids.

I always get a lot of flack here for what I'm about to say, so everyone
DUCK - I am not a big fan of 529 plans for the reasons you mention and
because too many people fund them instead of their own retirement. My
suggestion would be to look at Variable Annuities for the following reasons:

A - neither the money you put into a 529 nor a nonqualified VA is tax
deductible. So you're working with the same starting amounts;

B - take the money from a 529 for anything other than school and the
earnings are taxable and subject to a penalty;

C - take the money from a nonqualified VA for anything other than retirement
and the earnings are taxable, and subject to a penalty if you're UNDER 59.5
years old UNLESS you use the money for higher education, in which case you
pay tax on the earnings and escape the penalty. And the VA can be inherited
by a named beneficiary with essentially the same tax consequences as if they
inherit a 529.

D - I believe you get more control over how the VA money is invested and
when and to whom its distributed. You can name anyone as a beneficiary of a
VA but there are some restrictions on who the beneficiary of a 529 plan is.

I do think 529s are great plans for grandparents to set up, I just don't
like them for parents.

Just my 2 cents,
Gene E. Utterback, EA, RFC, ABA

On Tue, 2 Aug 2011 12:20:36 CST, "Gene E. Utterback, EA, RFC, ABA"
<> wrote:

>D - I believe you get more control over how the VA money is invested and
>when and to whom its distributed. You can name anyone as a beneficiary of a
>VA but there are some restrictions on who the beneficiary of a 529 plan is.

I agree with much of your post. But assuming the same asset
allocation, why would you prefer a VA over a parent-owned regular
investment account at Vanguard or Fidelity?

On 8/3/11 1:35 PM, HW "Skip" Weldon wrote:
> On Tue, 2 Aug 2011 12:20:36 CST, "Gene E. Utterback, EA, RFC, ABA"
> <> wrote:
>
>> D - I believe you get more control over how the VA money is invested and
>> when and to whom its distributed. You can name anyone as a beneficiary of a
>> VA but there are some restrictions on who the beneficiary of a 529 plan is.
>
> I agree with much of your post. But assuming the same asset
> allocation, why would you prefer a VA over a parent-owned regular
> investment account at Vanguard or Fidelity?

I still struggle with the whole VA idea. I hear the value of tax
deferral, but then see that VAs turn long term cap gains into ordinary
income (as do 401(k)s and pre Tax IRAs, of course). Given the popularity
of the Roth conversion and claims that taxes are 'going up' it would
seem that those who have already maximized their pre-tax savings are not
going to benefit by adding even more.
For sake of sticking to the point, I'm not going down the cost path
here. The VA discussion always seems to have the pro vs the anti, but I
have yet to see a compelling Pro case.
(I'm not completely closed minded. I can contrive a case where a low
asset, late in life very high earner suddenly has the desire to take
advantage of deferral. I'm asking about the general case, not the very
niche ones.)

"HW "Skip" Weldon" <> wrote in message
news:...
> On Tue, 2 Aug 2011 12:20:36 CST, "Gene E. Utterback, EA, RFC, ABA"
> <> wrote:
>
>>D - I believe you get more control over how the VA money is invested and
>>when and to whom its distributed. You can name anyone as a beneficiary of
>>a
>>VA but there are some restrictions on who the beneficiary of a 529 plan
>>is.
>
> I agree with much of your post. But assuming the same asset
> allocation, why would you prefer a VA over a parent-owned regular
> investment account at Vanguard or Fidelity?

I'm not sure what you mean by a "regular investment account", regardless of
where its held. If you'd clarify a bit, I'll try to answer.

Gene E. Utterback, EA, RFC, ABA

"JoeTaxpayer" <> wrote in message
news:j1eang$p6d$...
> On 8/3/11 1:35 PM, HW "Skip" Weldon wrote:
>> On Tue, 2 Aug 2011 12:20:36 CST, "Gene E. Utterback, EA, RFC, ABA"
>> <> wrote:

SNIPPED

> I still struggle with the whole VA idea. I hear the value of tax deferral,
> but then see that VAs turn long term cap gains into ordinary income (as do
> 401(k)s and pre Tax IRAs, of course).

There are more issues other than just taxes. VAs get preferential creditor
treatment in many jurisdictions.

AND many people, especially in retirement, wind up the 15% tax bracket
anyway. If your taxable income puts you in the 15% tax bracket do you still
benefit from the special 15% capital gains tax rate?

AND VAs allow you put "benefit riders" on the investments to protect either
your income stream, principal contributions OR the death benefit for the
ultimate beneficiary. I had a client last year who's mother passed - the
contract value of her VAs was just about $500K BUT the enhanced death
benefit payout was $1.3M. You can't do that with any other investment (so
what if it costs an extra 1% or 2%).

> Given the popularity of the Roth conversion and claims that taxes are
> 'going up' it would seem that those who have already maximized their
> pre-tax savings are not going to benefit by adding even more.
> For sake of sticking to the point, I'm not going down the cost path here.
> The VA discussion always seems to have the pro vs the anti, but I have yet
> to see a compelling Pro case.

There are always going to be differences of opinion among informed people
and I won't try to change your mind, you are entitled to your opinion -
especially if its an educated one. I would like to note that a LOT of the
anti's positions are gounded in cost. Cost should not be the only, or even
the primary, focus - rather consider where you'll be on the back end and
whether you'll be better off then.

One big advantage to VAs, and one that I see touted in the media now more
than ever before, is the VA's ability to provide a stable stream of income
once you start to draw. If a person has $1M invested and is taking a 4%
draw against that and the value of the portfolio drops by 40% they now have
just $600K. They now have to decide whether to cut back on their lifestyle
OR invade the corpus. A VA, at least for the essential portion of their
portfolio, can help to relieve this - and again, does it really matter what
it costs if it provides what you need/want.

> (I'm not completely closed minded. I can contrive a case where a low
> asset, late in life very high earner suddenly has the desire to take
> advantage of deferral. I'm asking about the general case, not the very
> niche ones.)

Understood, and its a good question. VAs can provide certain protections
that you can't get with other investments. Typically these include -

1 - your investment money is held in a an account separate from the
insurance company's funds;
2 - you can put living benefit riders on many VA contracts so that "when"
the value of the contract itself declines your income stream won't;
3 - you can put an enhanced death benefit on many VA contracts so that when
you die if the market is down and your contract value is less than what you
contributed, adjusted for withdrawals, your beneficiary is made whole - they
get your original contributions less your withdrawals. These death benefit
riders can also provide a beneficiary payout that exceeds your original
contributions if the enhancement selected is greater than the withdrawal
rate.

For example, I have a 67year old client who's fully retired. She's got a
full pension (to which she never contributed a dime) coming from the company
she worked for. She also had about $350K in an old 401k - she doesn't need
this money and wants to leave it to her daughter. By putting $300K into a
VA with both an enhanced death benefit (growth at 5%) and an a living
benefit (a 5% annual guaranteed withdrawal rate) she gets $15K annually to
do with what she pleases AND her daughter will get the full $300K when she
dies.

It is important to note that VAs are NOT for everyone and they are LONG TERM
investments. If you have or want an actively managed portfolio and/or you
have short term goals for the money a VA may not be right for you. And the
BIG caveat always applies - if you don't understand it you probably should
not buy it.

As an aside, JoeTaxpayer posts here regularly. I don't know him and have
never met him and while I frequently disagree with some of his positions, he
does bring a perspective to the forum that should be seriously considered.

Gene E. Utterback, EA, RFC, ABA

On 8/9/2011 12:35 PM, Gene E. Utterback, EA, RFC, ABA wrote:
> AND many people, especially in retirement, wind up the 15% tax bracket
> anyway. If your taxable income puts you in the 15% tax bracket do you still
> benefit from the special 15% capital gains tax rate?

Yes, the rate on capital gains (and qualified dividends) becomes 0%.

-Tad

On 8/9/11 3:35 PM, Gene E. Utterback, EA, RFC, ABA wrote:
> As an aside, JoeTaxpayer posts here regularly. I don't know him and have
> never met him and while I frequently disagree with some of his positions, he
> does bring a perspective to the forum that should be seriously considered.
>
> Gene E. Utterback, EA, RFC, ABA

Your kind words are much appreciated, Gene. It's an honor for me to
engage in intelligent discussions with you and the regulars here.
My well-wishes to you and yours.