Question about 529 v 401K

deniseandspikeFebruary 5, 2009

I was reading this article on Investopedia. I'm trying to decide how to save for my son's college. We will be 57 years old when he starts college. Right now we're each saving 8% in our 401K (no where near the max contribution) which is enough to get the matching contributions from our employers. If we have a limited amount of extra funds, should we up our 401K contribution or put a minimal amount in both 401 (or IRA) and a 529. I'm confused and the article doesn't help me understand it any better.

"2. Are you already carrying a heavy debt load?

Middle-income families are more likely to be headed up by college-educated parents, so they're more likely to include private schools in their application pools. These families generally don't qualify for Pell Grants or the full Perkins loans, but usually qualify for fully subsidized Stafford loans. Although they generally have less financial need, they may also lead high-consumption lifestyles that leave them feeling that their expected family contributions are too large. Furthermore, those that opt for private colleges tend to take large PLUS loans, which they may struggle to repay. In addition, their kids often take maximum combined subsidized and unsubsidized Stafford loans, and higher-rate non-Federal private loans, often resulting in eventual repayment delinquency and default.

By recognizing these traps in advance, these families can benefit from careful budgeting. This will enable them to save more, receive full matching 401(k) contributions where available, and make significant IRA contributions, preferably to Roth IRAs in instances where traditional IRAs are not suitable. As noted earlier, those Roth IRA balances will not reduce their aid eligibility, yet the principal amounts will be available for withdrawal without taxes or penalties as supplements for burdensome loan payments that might otherwise be defaulted on. (For more insight, read The Beauty Of Budgeting and Six Months To A Better Budget.)

Meanwhile, the untouched earnings on their Roth IRA investments will continue to grow and, combined with 401(k) and other retirement savings, will give them a good start toward a retirement nest egg. Even though 529 plans allow individuals to contribute more than the amounts permitted in 401(k) plans and Roth IRAs, they make little sense for these families because they will likely not need 529 saving amounts to pay for college. Therefore, if they can find the financial resources to save enough to fund more than is required to receive 401(k) matching contributions and fund their Roth IRAs, choosing to fund a 529 plan instead is not worth the risk that their kids decide against going to college, which could cause the 529 earnings to be taxable."

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Hi dktrahan,

Most often, 529s fail in comparison to a properly constructed universal life contract. With the minimum term insurance coverage established within it such that the legal cash-accumulation allowed fits your college-funding needs... you beat several of the 529 failures;

A) the funds are available for, but NOT restricted to your kids college use,
B) the funds are tax-free for ANY alternative use,
C) there are no college-choice restrictions,
D) if you accumulate more than needed, the benefits aren't wasted,
E) if one kid doesn't use it all, or any, another kid can,
F) if all kids don't use it up, it remains as retirement funds, tax-free,
G) the annual contribution caps are determined by you, relative to minimum term insur coverage,
H) the annual contribution caps are much higher than 529s, ROTHs, et. al.
J) you can increase the contribution caps at anytime by increasing the term coverage.
K) certain universal account types (those that are market indexed) let you get upside credits relative to the stock market's upward movements WITHOUT any risks of losing your money from downward movements.
L) the account does NOT have to be in your kid's name, nor yours, for the kid to be able to use the funds tax-free,
M) because of "L" the assets accumulated DO NOT hurt your kid from qualifying for means-tested grants and loans (Pell, Perkins, et. al.)

The downside; Such strategies are married to a term-life insurance policy based on a life coverage of 100 years.

The counter-upside; Since it generally doesn't matter who's life is covered (when used for financial planning purposes, not death beenfit purposes,) the strategy can be used based on the youngest, healthiest person in the family (with certain caveats) such that the actual insurance costs are very low.

There are "load" and "no load" universal policies that work for these strategies... the "load" type is most common because the client then pays nothing out of pocket. The "no load" type is the most financially effective, as it has no surrender costs and the lowest insurance & administrative costs... but it requires up-front professional fees to the planner (most often offered by fee-only planners.)

CAREFUL of the planners that push VARIABLE universal policies for such strategies... as variable policies (as opposed to indexed policies) are vulnerable to stock market LOSSES, as well as gains. Only fixed and indexed strategies come with a principal guarantee against loss... and are thus considered "safe" enough for retirement & college planning accounts.

Dave Donhoff
Leverage Planner

    Bookmark   February 5, 2009 at 4:01PM
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What the article is suggesting is that you put the money you would have put in a 529 into a Roth IRA and contribute as much as possible into a Roth as both retirement income and a source of college tuition money. It also suggests you take advantage of 401Ks. I am unclear what it is isaying in terms of what 'savings' is used to determine grant eligibility except it notes that Roth's are excluded - not sure about 401Ks. A Roth IRA is different from a 401k with regards to the annual contributions, minimum age you have to start receiving contributions and other rules that govern such accounts.

I think one of the main points the article is trying to make, which is a little known fact about Roth IRAs, is that you can take out any principal (original contributions) at any time, for any reason, without any penalty or any 'loan' to pay back while your earnings (ie, growth or interest) will continute to grow in that account as you approach retirement. It is also suggesting that is a better investment vehicle for college funds than a 529 plan for the reasons listed.

I know Dave is a well respected advisor on these boards, but I have to say I have always been told to steer clear of anything other than Term Life. Dave perhaps you could clarify why Universal Life is a good option in general and also specifically in this case? I have been on this site off and on for a very long time, however, I have not read that many posts on this particilar board to know your general philosophy on this.

    Bookmark   February 6, 2009 at 3:18PM
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Hi Christine,

I know Dave is a well respected advisor on these boards, but I have to say I have always been told to steer clear of anything other than Term Life.

Thanks... uhh, I think? Hopefully I'm not losing any respect from the lack of financial planning experience from whoever 'always' told you to steer clear of anything other than Term Life.

Many people here have also "always" been told to pay off their mortgage as fast as possible, "period," regardless of the risks & harm it can create too.

What many have "always" heard is not always so valid.

Dave perhaps you could clarify why Universal Life is a good option in general and also specifically in this case? I have been on this site off and on for a very long time, however, I have not read that many posts on this particilar board to know your general philosophy on this.


FIRST off, it is most likely the case that "everyone" who "always" advised you to avoid anything but "term" was specifically talking about buying life insurance for the purpose of the insurance DEATH benefits... not the financial planning features available within certain types of it.

For the best death benefits "bang for the buck"... Term life premiums are state regulated, so for the most part you pay for the benefit coverage you get, and nothing more, regardless of the carrier (which is GOOD if what you want is a payoff at death.) Differences in term life premiums are generally quite small, and when one carrier appears to be "cheaper" per $1,000 of benefit than another (i.e. if you Google for 'cheapest term insurance' etc.) its generally because that carrier has less capital reserves to protect its policy-holders, thus less costs... and is thus more at risk of being illiquid... *OR* it fights harder NOT to pay all of the benefits expected when its policies mature, and thereby it has less costs of fulfillment.

There are OTHER very important financial benefits to life insurance contracts, however, OTHER than the ultimate payoff of a death benefit at policy maturity. Congress has written legal "tax-shelter" features into the IRS code such that cash values sheltered within properly structured life insurance contracts grow and are harvestable UN-TAXED.

Universal Life *IS* a term life policy (underwritten through age 100,) that offers a SEPERATE (un-comingled) cash accumulation account with the unique tax sheltered benefits only available inside cash-value life contracts. (NOTE that this is distictively different from old-fashioned "whole life" contracts that inseperably comingle insurance costs with their cash-values.)

For FINANCIAL PLANNING purposes we want the maximum shelter benefits with the LEAST actual insurance coverage we can get away with (since, for this particular purpose, we don't care about death benefits.)

The cash account within a Universal policy is allowed to grow tax free (no annual capital gains nor income taxes,) and is allowed to be accessed for spending tax free (via zero-interest policy "loans" which have no repayment requirement until the policy "matures"... aka when the insured dies.)

Our OP is concerned about college tuition fund planning. The general strategy with college funding is to take advantage of *ALL* external funding resources (public assistance, grants, loans, and public/private scholarships) *BEFORE* dipping into the family-accumulated funds.

THe catch-22 is that *MANY* external funding sources are "means tested." This means that they look at the student's fmaily's financial profile 1st... and if the family has funds in reserves, the external sources DEDUCT those from the support calculations (in essence saying "you guys drain your OWN accounts before we'll offer you any support!")

Of course, this is completely contrary to the idea of rewarding those who are responsible... which is the whole point of using Universal Life insurance contracts to accumulate college tuition (and subsequently retirement funding for the parents.)

Universal Life policies can also be "owned" by someone other than the person that the policy is insuring (the "insured.") The owner can be grandparents, uncles/aunts, god-parents, seperate trusts, or simply trusted friends. Because the ownership of this accumulation asset can be legally seperated from the student's family balance sheet, the student's family does NOT have to drain all of their own reserves before taking advantage of external educational support resources.

PERSONALLY (and professionally,) in regards to actual death benefits... I would probably almost "always" harmonize with whoever else was "always" telling you to avoid anything other than term life. For death benefits (replacement of a parent's income for family support, most commonly,) term is generally the best way to go.

For FINANCIAL PLANNING, however... age-100 term life coupled with cash values (in the form of Universal Life,) can be a very sharp strategy from both the tax-shelter perspective, and the avoidance of means-testing punishment of the more financially responsbile.

Dave Donhoff
Leverage Planner

    Bookmark   February 6, 2009 at 5:05PM
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BTW... I re-read what I wrote, and thought "geez... that sure sounded snarky!"

SO... my apologies... not what I intended at all.

Dave Donhoff
Leverage Planner

    Bookmark   February 8, 2009 at 4:20PM
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None taken. Like I said, I know I haven't been on this forum much, but I have been here long enough to know you garner a lot of respect, and there must be a reason for it. I am only starting to begin...I aced Finance in college, love to look at money, love math, and I am overwhelmed because I have now started wondering what kind of investments my money should be in for the best tax benefits in my lifetime, and minimum required distributions, minimum age distribution, and the option to pass a Roth along as an inheritance. It's mind boggling to me, and I like the topic!

    Bookmark   February 10, 2009 at 12:28PM
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Thanks for the explanation guys. Now I have some decision making to do.

    Bookmark   February 10, 2009 at 10:16PM
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