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OK, I've read the 4100+ posts on this board. I think the posts have clarified enough issues so that I have slightly modified my still all too rudimentary plan for paying for college for our two daughters (19 months and 2 months old). Let me explain what I think I understand and what I think I want to do and y'all can point out to me any egregious (or small, I suppose) errors in my understanding of the issues and/or my take on financing college.

Some parameters: I want our daughters to go to an (unfortunately) pricey private school K-12. I don't want my daughters to have to work while in college. I understand there are different opinions on this one, but I'm gonna stick with "no work" for now. I don't have a state income tax. Need-based aid just ain't gonna happen.

529 plans
As I undertand it, we're talking about (a) prepaid tuition plans and (b) college savings plans.

Prepaid tuition plans seem to be the way to go if you believe that tuition costs will rise faster than the after tax gain on other investments. If you believe the opposite, there's not much point in a prepaid tuition plan, right?

The upside for college savings plans is tax exempt growth and (currently, at least) tax exempt withdrawl. The downside is a potential hefty tax bite and penalty if the withdrawls are not for educational purposes (overpayment or non-attendance, e.g.) and a hefty tax bite even if the money is withdrawn because it is no longer needed because of a scholarship. Another downside is the uncertainty of rules regarding these accounts in the 18-20 years between now and when I will be able to use them.

The account formerly known as an Educational IRA
Starting next year, $2000 per year per child. Can be used for primary and secondary educational expenses. (Did I really see that computer equipment and internet access that the child uses while in school would be valid expenses here?) Tax exempt in growth and withdrawl for the right kind of expenses. Penalties for the wrong kind of expenses.

Roth and 401(k)
I have no desire to use my retirement money toward college expenses.

Non-tax-exempt/deferred investments
Our 401(k)'s are currently maxed, either by total or contribution percentange. Roth's are maxed at $2000 each, $3000 each next year. Additional investment dollars, to the extent there are any, are going into index funds.

After all that long-windedness, here's what seems to me to be a reasonable plan. Please feel free to rip it to shreds so I can make it better where possible.

Continue to max our 401(k) and Roths. Immediately open ESA's (E-IRA's) for both daughters, funding each to the max until each enters kindergarten. Invest as much as the budget will allow in additional after tax (index fund) investments.

Pay for the private school as an ongoing budget item, supplemented when necessary by the ESA's (E-IRA's). Although I doubt seriously it is an item with which I will have to be too concerned, make sure the ESA's are empty by high school graduation, putting any freed up funds (LOL) into the index funds.

Once college begins, each year gift as much as necessary (or $10K per parent if that is less than what is necessary) to each daughter from the index funds to be sold by her to spend toward college. If I understand things correctly, she will pay the cap gains at her rate. If I misunderstand, it may be time to go back to the drawing board.

My thinking is that I am trying to balance the "sure thing" of paying at least some cap gains along the way against the possibility of a huge tax bite and/or penalties should things not work out as planned if the money were in a college savings 529.

Any shortfall in the index funds will be made up with loans. Not sure in whose name at the moment.

Does any of that make sense? Is it a reasonable way of going about things? What areas should I rethink? What areas are just plain wrong?

Thanks for any help...

-- Mark
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>Prepaid tuition plans seem to be the way to go if you believe that tuition costs will rise faster than the after tax gain on other
investments. If you believe the opposite, there's not much point in a prepaid tuition plan, right?

Yes. Additionally, IMHO the plans don't adequately discount the time value of money. People would be overpaying for pre-teenagers.

>My thinking is that I am trying to balance the "sure thing" of paying at least some cap gains along the way against the possibility of a
huge tax bite and/or penalties should things not work out as planned if the money were in a college savings 529.

Keep monitoring the websites, because many states are either getting into the game or adjusting their plans. For example, Virginia announced last month an additional 529 plan that will be effective beginning next year.
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My thinking is that I am trying to balance the "sure thing" of paying at least some cap gains along the way against the possibility of a huge tax bite and/or penalties should things not work out as planned if the money were in a college savings 529.


I don't know if I see this as the "sure thing" that you do. I understand your thinking and it makes sense, but I don't buy it. This is way I see the tax issue of teh 529.

Right now, if you use it for qualified expenditure, it is a sure thing that you will pay no taxes. Qualified expenditures include just about everything for many plans - tuition, fees, books, room and board, etc.

As far as the future, I don't see the tax law changing. The public would be furious and politicians don't like that. It's a gamble I'm willing to take.

As far as taking it out for non-qualified reasons I see it two ways. The first, and most logical for me is that there probably won't be any money left over after paying for all these expenses. Tuition alone has been increasing, on average, 6.5% per year. A lot of degrees are now requiring more training - translation, more years in college, graduate school, etc. = more money to be paid.

Second, if there is money left over you can change the beneficiary to someone else, another child, a grandchild, a cousin, a brother, etc.

Third, if the beneficiary were to get a scholoarship I have the OPTION of taking that amount out penalty free, but I don't have to. I can keep it in. If I take it out, then yes, I'll have to pay taxes on it, but I did get tax free compounding up until this date. It works the same as any other retirement plan and I think it's great.

Fourth, if I really needed the money then I can, at my option, take the money out for an unqualified disperment and pay the 10% penalty on earnings and taxes on the earnings BECAUSE I NEED THE MONEY. If I didn't need the money I wouldn't do this and I'd be paying no taxes. If I did need the money, then it works like an additional retirement plan, only I'm penalized for the tax-free compounding. Well, depending on how many years I've been enjoying this tax-free compounding, I figure worst case sinario, I'm break-even with the penalty, so it's no real penalty. It's more like having this money in the bank for that many years. It could be worse.

So, that's my take, FWIW (probably what you just paid for it).

e
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I thought of a fifth...

If any of the money is taken out as qualified expenses and tax-free then it makes the penalty paid on the remaining even less. I mean you got $X tax-free and paid penalty plus taxes on $Y. Add the two together and I bet the penalty disappears.

Obviously, I'm all for the 529 plans. I'm not in one yet, but I'm working on it.

e
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euphoriant wrote:
I don't know if I see this as the "sure thing" that you do.
The "sure thing" was that if this money were in a non-tax-advantaged account, someone would definitely end up paying cap gains at some level. I didn't mean it was a "sure thing" that this was the better way to go.

However...

I think where I went astray was using the cap gains rate, rather than my marginal rate, in looking at the returns on the non-529 option. Using the marginal rate (instead of cap gains rate) applied to dividends over the 18 years before college probably make the 529 more attractive, even with the 10% penalty and my marginal rate being used on the gains. Once I sorted out the error in Excel, it looks like a 529 savings plan is the way to go, regardless.

Thanks for your response. When I went back to look at the numbers to reply to your thoughts, I saw where I was making the mistake.

-- Mark
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One consideration with the prepaid plans, read the fine print. Not all plans guarantee 4 year's worth of tuition.

Jenn
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Mark,

I hope I didn't sound rude in my response. I was only giving my opinion. It really is a numbers game and I'm sure the figures work out differently for each person (for instance, how many years until college, etc.).

e
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Mark,

I think where I went astray was using the cap gains rate, rather than my marginal rate, in looking at the returns on the non-529 option. Using the marginal rate (instead of cap gains rate) applied to dividends over the 18 years before college probably make the 529 more attractive, even with the 10% penalty and my marginal rate being used on the gains. Once I sorted out the error in Excel, it looks like a 529 savings plan is the way to go, regardless.

You may not have calculated it wrong the first time. If you invest in non-dividend paying stocks than the capial gains rates is what you should use.

If I were doing an excel spreadsheet (which I haven't done) the one "tricky" part would be to make sure that in the 529 plan the income is compounded tax free. In the taxable plan the income is not compounding tax free.

So, which way to go probably is very individual specific. I don't know how long you've been in the market. I've been in for a little over a year and I have a negative return, so I'm kind of excited about handing over the investment responsibility to someone else. Most people would not feel as I do with this. There are other reasons why I like the 529 option as well, which again have nothing to do with the potential taxes and/or penalties. So, it's more of a personal decision than I originally took it to be.

Good luck,
e


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You didn't sound rude at all, I just wanted to make sure we were both on the same page with the "sure thing".

I was looking at using something like the Vanguard S&P 500 I have some money in now. Not a ton of dividends, but enough to swing the balance more in favor of the 529.

I'm trying to take the "individuality" out of the decision, to the extent possible. There's some peace of mind to be had with a prepaid tuition plan, for example, but it just doesn't seem, for me, to be the right way to go.

It sounds like a low fee 529 savings plan is the way to go.

Thanks for the help and causing me to keep thinking it through...

-- Mark
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