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529 plan to front load or not?

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  • Drop it into MD Drop it into MD 
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    10% returns?!?!?  Sounds great.  but with 7% returns the tax in that situation would be 43K.  Still a lot but the start tax deduction does knock that down a little and this is the extreme.  Most people will put some in the 529 and some in taxable reducing that further but keeping some flexibility.

     

    #180573 Reply
    Avatar FIREshrink 
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    Joined: 01/11/2017

    10% is the average long term return of the US stock market so that’s not an unreasonable assumption for these investors. Remember the ideal candidate to do a large 529 lump sum at child’s birth are high income, high risk tolerance, and will be in 100% stocks for these accounts almost forever. We were 100% stocks til Oct 8, at which point I shifted ~20% into a prepaid college savings plan. Still 80% stocks. since this could be a 2 generation educational trust of sorts, there’s no reason to ever go conservative. In the event of a large stock decline just before we need the money, we’ll use income/cash flow or taxable investments to pay for college and let the 529 investments ride.

    #180580 Reply
    Liked by tjohn7, ZZZ
    jfoxcpacfp jfoxcpacfp 
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    Actually, long-term returns for small caps is 12% and LC’s is 10%, both with dividends reinvested, but you are making an excellent point. And, whichever results you go by, they makes a great case for a long-term, well-balanced long equity portfolio. Even projecting 8% avg long-term returns (which we model to be conservative), you are making a great recommendation to invest in same when the child is young. How to Stack Education Savings is (imho 🙂 ) a helpful article.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #180617 Reply
    Liked by portlandia
    Avatar Tabaxus 
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    Status: Attorney
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    I’ve struggled with whether to front-load or not, because my state deduction is capped at $20k/year, and I lose it if I frontload (unlike some other states there is no provision to get the deduction in years 2-5 if you have an excess contribution in year 1).  My kiddo was born in 2018 and, in each year (2018 and 2019), we’ve just done the single-year $30k contribution.

     

    That being said, because of how the deduction works in my state and interacts with the credit for “foreign” (i.e., other states) taxes, I get very limited benefit from the annual contribution–about $300 a year.  I imagine if I really ran the math I would find that the additional tax-free growth from superfunding would outweigh the  $1,200 of lost state tax benefit.  But, superfunding in this way would represent the vast majority of my investment savings for the year in which I did it, which I’m not totally comfortable with, so I think I’m likely to stick with the 30k/year contributions.

    #180726 Reply
    Avatar okayplayer 
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    Status: Physician
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    Joined: 05/25/2016

    Just throwing this out there…Why don’t you guys who are contemplating front loading your 529 but fretting over loss of your state tax deduction do the following: keep paying just enough in your state 529 to get the tax deduction every year and open a Utah (or whatever state you want) 529 on the side to front load more aggressively?

    #180940 Reply
    Avatar saildawg 
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    Joined: 01/24/2016

    Just throwing this out there…Why don’t you guys who are contemplating front loading your 529 but fretting over loss of your state tax deduction do the following: keep paying just enough in your state 529 to get the tax deduction every year and open a Utah (or whatever state you want) 529 on the side to front load more aggressively?

    Click to expand…

    That was my plan, but limits me to 15k per year total per child to be within the gift tax allotment.  So 11k at another state, and 4k in state per year.  But if I am going to frontload I would prefer to go ahead and do a lump sum of 75k per child.  This would make me ineligible to contribute more for 5 years, so it is a question of lump sum out of state now vs splitting 11k out of state and 4k in state over the next few years.  Leaning toward front loading all of it as state tax deduction only equates to  $326 in tax reduction per year.  My back of the envelope math: tax savings over 5 year will be $1,630.  In order to match those tax savings $75,000 front load would need to increase $10,866 over that time (assuming 15% capital gain tax) to $85,866.  This is an annualized ROI of 3.44%.  Historical math would suggest frontloading would be the better choice than the guaranteed tax savings.  I am trying to use logic here, of course no one knows what the market will do.  I guess there could be a case made for doing 11k out of state and 4k in state as a hedge on both.  Somehow I am more confused now than when I started.  Appreciate any other opinions or critiques on my math/logic

    Thanks!

    #181270 Reply
    Avatar G 
    Participant
    Status: Physician, Small Business Owner
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    Joined: 01/08/2016

    “I think I value flexibility”

    You’re overthinking this. Contribute enough to get your max state deduction and throw the rest into taxable (superfund) with that money earmarked for education expense.

    #181374 Reply
    Liked by childay
    Avatar saildawg 
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    Update:

    I decided to fund 30k into each child’s 529 this year to get some tax free growth over 18 years.  I still plan to contribute 4k per year to get state tax benefit over next few years.  This seemed like a good mix of front loading and having flexibility.  I can always not contribute in the future.  Thanks for all the feedback!

    #182390 Reply
    Liked by okayplayer, Peds
    Avatar JWeb 
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    Status: Physician
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    Joined: 02/21/2017
    Lump sum $75k at birth and let it compound at 10% for 20 years, and you end up with $505,000. In a taxable account that $420,000 is taxable at 15-23.8%… call it 20%. That’s an $85,000 tax bill. It could be somewhat less and it doesn’t include the state tax benefit. But that wish for flexibility comes at a steep price.

    Click to expand…

    Isn’t this math correct and wrong at the same time? You need to compare lump sum $75k to 5 annual contributions of 15k.  In the annual contributions you have 15k compounding for 20 years, 30k for 19 years, 45k for 18 years etc in your 529 and you’ll get the tax deduction each year.

    And sure you put 75k in taxable 20 years earlier. You’re not going to be using those shares to pay for education. In fact, if you have the means to frontload, you’ll probably never touch those shares. They’ll be donated tax free. Or given to your heirs in a step up basis.

    It’s probably slightly better to frontload. But you’re not saving $85k doing so.

    #182629 Reply
    Avatar FIREshrink 
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    Status: Physician
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    Joined: 01/11/2017

    I thought I was clear but maybe not. I am comparing the tax savings of front loading in a 529 vs front loading in taxable. And explicitly state I excluded any state tax benefits.

    #182834 Reply

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