Investing for children's schooling/college

Currently the account is all in my name...

Would it be a good idea to move it to a UTMA account?

This account will only get around $600 in principle a year put into it (at least at my current $50/month rate)

I would recommend a 529 account based on tax free growth. Given you won't have a house payment (and thus little to no mortgage interest to write off) your overall tax rate could rise. Focus this account on education expenses and pay for trip/activities out of your normal account.

Our current home is a starter home, and we plan on buying another house within the next 10 years. (yay! we will be able to itemize again). More than likely we would try and rent out our starter home.

The other thought I had with this account is to give my child a stipend to manage themselves monthly/quarterly for living expenses (that way they learn to manage and pay bills on their own)

What kind of penalties will I get hit with if I try and withdraw from this 529 account for buying a car/paying for rent/taking spending $$ out for my child?

Are you really going so subsidize your child's beer money? My suggestion, make the kid get a part time job during college to pay for stuff like that. Not only will that help lower your savings amount, but it will help your kid learn the value of work.

Could you be over-saving for college through the prepaid tuition plan? If your kid turns out to be reasonably bright, and if the poor continue to subsidize middle-class education through the Bright Futures lotto, your kid could easily get scholarship for 75% of tuition, if not 100%, along with a book stipend. Then, if your kid scores National Merit, or the Lombardi scholarship, you're looking at nearly free room and board too.

What happens then? Is the prepaid tuition $ recoverable? At least with a 529, you can recover the $ with a 10% penalty. UF is one of the cheapest flagship universities in the country, and scoring a 75/100% Bright Futures scholarship (the requirements aren't even that hard) makes it a steal for a flagship state school.

centrifuge41 said: Could you be over-saving for college through the prepaid tuition plan? If your kid turns out to be reasonably bright, and if the poor continue to subsidize middle-class education through the Bright Futures lotto, your kid could easily get scholarship for 75% of tuition, if not 100%, along with a book stipend. Then, if your kid scores National Merit, or the Lombardi scholarship, you're looking at nearly free room and board too.

What happens then? Is the prepaid tuition $ recoverable? At least with a 529, you can recover the $ with a 10% penalty. UF is one of the cheapest flagship universities in the country, and scoring a 75/100% Bright Futures scholarship (the requirements aren't even that hard) makes it a steal for a flagship state school.

From the prepaid website:
Florida Prepaid College Plan: If your child earns a scholarship, such as Florida’s Bright Futures, the best option may be using the full value of the Florida Prepaid College Plan as planned, transferring it semester by semester to the college – and the combination of scholarship and prepaid plan will cover more of the student’s college expenses. Or you may ask for a scholarship refund. Or you may transfer the prepaid plan to another family member. There is a 10-year period beyond a student’s projected college enrollment to use the prepaid plan. There is no time limit for using prepaid benefits if the beneficiary has been serving in the Military.

Not sure if the "refund" is money put into the system, or the actual value of tuition at that time.

I know the way it worked with me (Bright futures, Merit, and local municipality scholarship.. plus various one time/incentive scholarships) was that none overlapped and and had enough $$ to pay for everything.

The way I understand prepaid is that it pays the tution first, and you get the Bright futures money directly paid to the student. When i first used Bright Futures i remember having to apply for tuition deferment until the state paid out (the other scholarships were even slower to pay sometimes).

So does the 529 plan with a 10% penalty come out better than just putting it all in an index fund which gets taxed?

centrifuge41 said: sphinx2000 said: So does the 529 plan with a 10% penalty come out better than just putting it all in an index fund which gets taxed?

As it turns out, you keep the principal and you only get taxed 10% on the gains. Since normal index funds generate dividends, on which you pay a little bit of tax every year, then yes, there is theoretically a break-even time point for the 529, where if you hold the $ long enough, it would be better to pay a 10% penalty upon withdrawal than to pay taxes on dividends every year.

I haven't studied the subject extensively. Nor do I have a lot of numbers to crunch. But here is some reading. Note, I personally don't know much about DFA funds, but this could be a good start for some reading anyway. Most of my mutual funds are with Vanguard.

Thanks for sharing the link... the reading is getting intriguing. I have a lot of research to do

I am not a fan of 529 plans or pre-paid tuition plans because of its narrow and restrictive scope. What would happen to your pre-paid plan if a child goes an out of state school? You really need to find those answers first to make your decision.

One of the few reasons I would say a 529 may be worthwhile is if your state offers some form of deduction for contributions or if changes happen in the future to make them deductible at the federal level. Another would be if a grandparent/relative opens the account for the beneficiary to avoid having it show up as assets for expected family contribution (EFC) calculations, assuming they do not plug this loophole in the future.

529 mutual fund investments almost always have higher expenses for "administration" than the non-529 equivalent... some other entity is making money off of it.

I would attempt to use Roth retirement vehicles first for college savings, preferably if one has both a Roth 401k/403b, eligible to contribute to a Roth IRA, and does not plan to contribute the maximum amount for retirement purposes. Idea is to put what you would normally contribute into a 529 into a Roth IRA/401k/403b and build that vehicle up. When leaving a company or eligible to, you can roll the roth 401k/403b into a Roth IRA for more freedom/control of what to invest in than the 401k/403b plan investments.

When you have a need to withdraw funds for college, you withdraw out of the Roth IRA which remove contributions first tax and penalty free. If you use the Roth for retirement too, you should have a healthy portion of contribution basis to withdrawal hopefully without ever touching earnings. Someone who is familiar with college financial aid rules might be able to chime in... do Roth IRA basis return distributions affect EFC and financial aid eligibility? If they end up impacting subsidized loans, grants, etc... one can consider not taking any $ out during the college period and using subsidized loans/grants/etc to pay for the college up front, and doing a large contribution basis withdrawal after the child has graduated to pay back all the loans. You can't do this with a 529 because the money must be used during the college years.

Also... anybody know if having a large IRA/401k asset base will affect EFC and financial aid eligibility? In 20 years would having say $100,000 in 529 savings and $400,000 in IRA/retirement accounts be at a disadvantage vs having $500,000 in retirement assets and $0 in 529s?

In the end with the Roth approach, you are left with very little contribution basis in retirement and all earnings after taking funds out for college needs. It doesn't matter because in retirement, the earnings portion is tax free if they are qualified distributions.

If you don't have a Roth 401k/403b, use what retirement vehicles you can and plan to get those amounts into a Roth when you can... roll the 401k/403b into an IRA and convert portions each year (whatever amount that makes sense and doesn't push you into higher tax brackets). For example if you have a 401k/403b at a current job (no Roth for this above plan) but have say $25,000 in an IRA built up with all pre-tax dollars from previous job 401k rollovers, you can attempt to convert the same amount each year to a Roth IRA that equals the amount you contribute in your 401k. Say you put $5000 in the 401k to get the company match, this is all pre-tax dollars... you convert $5000 from the IRA to a Roth IRA which you pay taxes on. Even though you do not have a Roth 401k to put away more Roth contributions than the $5000/person/year limit, you use conversions to work around this.

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In order to get specific advice for yourself instead of general guidelines other people use, you need to really go over very fine details of your current financial and tax situations. And you need to forecast of what may/may not change in the future (i.e. spouse anticipated not to work for X years, plan to work for Y years at Z income) about your tax rates.

My approach with the Roth vehicles instead of 529 may not be the best if you are/move into the highest tax brackets and expect to be at lower brackets in the future around the time your children go to college... at that point minimizing taxes today could be a better plan.

On expense ratios between 529 and non-529, I had looked at Vanguard's expense ratios since they are the big name in low expense indexing.

(retail shares / 529 shares)
Total Bond Market 0.22% / 0.49%
Total Stock Market 0.18% / 0.44%
Total International Stock Market 0.32% / 0.66%

Average between three simple total market indexing is 0.29% higher expenses to use the 529 account vs using the same Vanguard funds in an IRA. If you happen to qualify for admiral shares because your combined retirement and "college savings" in the IRA, the difference is greater.

It may seem like a little amount but consider a hypothetical:

$10,000 invested today in a 529 with a 0.29% higher expense than the non-529 funds. If my portfolio of bonds/stocks earns a perfect 6% per year (this is not true because of big bear/bull markets, but for illustrations), it will take about 12 years to double to $20,000 (rule of 72 approximation, 72/6). The average balance over 12 years is about $14,500/year when I wrote a quick spreadsheet model. So 0.29% higher expense times 12 years times $14,500/average annual balance = about $505 in lower returns. $505/$10,000 that you earned in 12 years is about 5% of your total earnings amount ($10,000 earnings on $10,000 initial investment)was lost to higher expenses/hidden cost.

Thanks for all the responses!

I have much more to think about now, and even more to research!

niicceem said: Also consider reviewing the archived discussion on saving for college and still being able to qualify for financial aid.
read this.

I recall seeing that thread a while back... Those are surely some creative ways in which to try to get a low EFC. They are surely gonna be some ticklers to research in the back of my head when college time approaches.

With the wife and I both being white collar professionals, getting our child's EFC low will take some dedication but still potentially do-able. I was "lucky" that my parent was poor during my college, though since I worked and had many scholarships, all I was ever offered were loans. I don't think my child(ren) will be so "lucky"

Now if only I had the insight to take the subsidized loans and invest them in high yield savings accounts during college to make some $$, I could have started myself off better after graduation.

Again to all, thanks for the insight. I will be looking more into some roll over options when I know my tax bracket will be at its lowest.

sphinx2000 said: Well, it really depends on the kid and the situation (major area of study, location, school, etc).... If the kid gets a scholarship to an Ivy league school in a great program, I would like to help out some.

Ivies are "need-blind". They offer merit-based admission, and no merit-based scholarships. The amount you pay is entirely dependent on (what they calculate to be) what your family can afford to pay. If your kid attends an Ivy (and nothing changes in the next 20 years), they'll give you an expected family contribution and expected student work-study contribution, and you (and him) pay it.

the more you know *}>