Help me understand 529 penalties

[cricketwife]

We'd like to open a 529 for DS. My hesitation is that it's possible he would attend college in the U.K., if that is substantially cheaper option when the time comes. Some foreign schools are eligible, but not all, so I'm playing devils advocate a bit.  I'm not super good at financial stuff so I'd like some help.  It seems like it wouldn't be that bad if we invested and then couldn't use it for qualified educational expenses.  Deposits are tax free.  Assume 10% avg returns.  Penalty is that you are taxed on withdrawls.  You would have been taxed on the money had you not put it in a 529.  Then you are taxed an additional 10% , which more or less would be the earnings covering the penalty. Soooo, obviously, it's not ideal, but if we invested in a 529 that we then couldn't use for educational purposes, it would be a bit like stuffing the money in a mattress for the next 18 years, but not worse than that?  Is that correct? 

And I do realize that mattress stuffing is not a good investment plan, it just seems more likely than not that we'd be able to use a 529 if we had one. 

[niq]

You pay federal income taxes on the money you put in. Some states let you deduct a certain $$ in 529 contributions from state income tax, some don't.

You're not taxed on the dividends while the money is in a 529. So if you put your 529 money into a dividend fund that kicks out 3%, you get the full 3% instead of paying 15% taxes on it, leaving you with (100%-15%)*(3%) = 2.65% in dividend yield per year. And you can trade within the 529 without paying capital gains tax.

I'll leave the numbers to actual accountants/finance people, but broadly speaking, withdrawing with the penalty is better than sticking your money in a mattress, or even in a money market account, but worse than doing the exact same investments in a taxable brokerage account.

[niq]

[cricketwife]

Aug 14, 2015 13:17:29 GMT -5 niq said:

You pay federal income taxes on the money you put in. Some states let you deduct a certain $$ in 529 contributions from state income tax, some don't.

You're not taxed on the dividends while the money is in a 529. So if you put your 529 money into a dividend fund that kicks out 3%, you get the full 3% instead of paying 15% taxes on it, leaving you with (100%-15%)*(3%) = 2.65% in dividend yield per year. And you can trade within the 529 without paying capital gains tax.

I'll leave the numbers to actual accountants/finance people, but broadly speaking, withdrawing with the penalty is better than sticking your money in a mattress, or even in a money market account, but worse than doing the exact same investments in a taxable brokerage account.

This is really helpful. I definitely was missing some important points. Maybe I should not save this type of research for last thing at night, lol. 

[anna7602]

We have decided not to use one for a variety of reasons, one being the possibility of DD attending college abroad. We just use other investment vehicles. We don't get the tax benefits, but we get the flexibility of being able to use the money for college or to fund our retirement or for whatever we darned well please if the investments do well enough. 

[magpie]

Did you look up the schools you think he might attend? We have the same issue (except DD is dual US/Australian), but the universities that would most likely be on the table for DD were listed as the 529 eligible.

[cricketwife]

Aug 14, 2015 15:20:23 GMT -5 magpie said:

Did you look up the schools you think he might attend? We have the same issue (except DD is dual US/Australian), but the universities that would most likely be on the table for DD were listed as the 529 eligible.

I did look up the schools and im not sure if he would end up at one of the covered ones. I mean, there's just do many unknowns.  

I may go the Anna/little Moxie route and just do a different investment. I don't get any benefits on my state income tax, so I'm not sure how beneficial this is, given that it's not certain that he'd use the money at an eligible institution. It's highly likely, just not certain.