Using 529 Educational Accounts To Expand Tax-Sheltered Space

[TripleB]

Anyone who reads my blog and/or forum posts knows that I am a huge fan of tax-sheltered space. Quite simply, taxes suck. Additionally, many tax-shelters also serve as creditor-shelters, and even the ones that are not officially creditor-protected may be granted immunity by a judge on a case-by-case basis. i.e. the judge may not require that you liquidate your 529 to pay a judgment to an asshole who slipped on your sidewalk and won by a 51% preponderance of guilt.

529s are great vehicles because there is virtually no maximum limit to how much you can contribute unless you are super wealthy. Additionally, there is a lot of flexibility in what you can invest the money in.

The purpose behind 529s is to save money for college, for either yourself, or a relative. You can switch who the beneficiary of the money is so that if you initially elect yourself, but you have a child/niece/nephew later in life, you can switch it to that child's name.

The real beauty of 529s lies in their use for retirees who love to continually learn, and who make a lot of money early in life but are already maxing out traditional tax-shelters (IRA, 401k, I/EE-Bonds, Annuities up to $100k state-insurance limit, etc). Imagine a sample person who invests money in their 529 from age 25 to 40. When that person is 70 they decide to take some classes at the local university to keep their mind fresh and active. If that person takes 1/2 of a full time load (currently set at 6 credits, or 2 classes per semester), then the 529 may cover living expenses as well.

These living expenses may be phantom expenses. You won't have to show receipts for your rent/mortgage. You are allowed to take whatever the university calculates as the cost-of-living for a student in that region, which is usually $1000 to $1300 a month in 2011 dollars. Thus, in addition to using the 529 to pay for the classes, you are withdrawing extra money, tax-free, to "live" on.

Or, you can create this plan when you're 25, and when you're 60, get diagnosed with terminal cancer, and change the beneficiary to someone else and brighten someone else's life up. Technically, the beneficiary change needs to be to a family member, but there's ways to lawfully put someone in your family if enough money is involved to make it worthwhile for everyone involved. For example, if someone is single with no family at age 60, but knows a really needy and worthwhile 20 year old, you could temporarily marry someone in that kid's family, make the transfer, and then get divorced. If we're talking about giving $200k to a poor needy family, then they will gladly go along with it.

I like 529s as a shelter for 100% equities (as part of a whole PP) for several reasons:

1) Equities receive preferred tax rates today that may not exist in the future. If you have 20 years of huge capital gains built in, and the tax system changes, you're f*cked.

2) There's already methods to expand tax-sheltered space for cash, such as using a low-fee annuity (up to $100k to stay below state-insurance limits), or using I/EE Bonds. If you're already at 35% cash, you can't increase tax-shelter space by using any of these cash-shelters, because it would throw the PP off.

3) There's already methods to expand gold - by physically holding gold coins. If you're already at 35% gold, you can't increase tax-sheltered space by buying more gold.

4) Over a long enough time horizon, equities are expected to make the largest return, thus making the value of a tax-shelter more valuable.

5) For the state scenario of this post, the 529 is not going to be used for a necessary educational expense. It's one thing to go 100% stocks in a 529 for a 13 year old. It's another to do it for a 50 year old who just wants to take a class in English Lit when he's 70, if the money is there.

6) If the unexpected happens and the stocks do really really bad over long time frames, it doesn't affect the overall PP. You were going to hold those stocks anyway, and you are rebalancing through your other asset locations to maintain the 4x25. So if the 529 drops 50%, it means your IRA has increased in space due to the bonds held in there. Since the future education expense is optional, there's no downside risk to this.

7) If the unexpected happens and the stocks do really really amazing over the long time frame, and you have way too much money than you can imagine in the 529 to ever use for college classes, then you can simply retire sooner, and start enrolling as a 1/2 time student earlier, and take out cost-of-living money. Or decide to take a pottery class in France, followed by a sculpture class in Switzerland, paying for the entire trip from the 529.

In conclusion, I feel that using 529s is a valid tool for the long-term PP investor. I would not advocate pumping all of your non-IRA/401k money into 529s, because then if you have an emergency, it would require you to either liquidate your IRA early, or pay a penalty on non-qualified 529 distributions. However, if you have 2 years of living expenses in a high yield savings account, and are already maxing out all other tax-shelters, then consider using the 529 as an vehicle to hold some of your PP equity portion.

[chrikenn]

I think it would also be a good vehicle in which to hold LT bonds.  Question is, do any 529 plans have an acceptable LT bond fund as an investment option?  All of them have good equity options, at least.

[Liz L.]

Very interesting.

I also found several worthwhile ideas on your blog.