Tom: ‘You’ve become a rather tedious man. God bless you for the depths and conviction of your beliefs, but no one likes a one trick pony. Thanks for the CICI stock tip, though. I cleaned up. More of that, please.’
☞ Well then, by my count that’s two tricks . . . but I take your point, so let’s get off the fate of the world and sink our teeth into something undeniably fun: the pros and cons of 401(k)s versus 529s.
Cat fight! Cat fight!
How can that be fun, you ask? The estimable Less Antman, CPA, can make anything fun. So I threw this question to him:
IN THIS CORNER, THE 401(kaaaayyyyy!), AND IN THIS CORNER . . .
Michael Irwin asks: ‘A 55-year-old wage earner making $100,000 pretax plans to retire in 10-12 years. He wants to put aside some money for his newborn’s college expenses. Is it better for him to have regular payroll deductions of post-tax money invested in a 529 plan or to have regular deductions of a similar amount of pre-tax funds put in a 401k? (His employer does not match either contribution.)’
The estimable Less Antman replies: ‘Assuming your tax brackets are the same now and when you are drawing the money out, there isn’t any mathematical difference between using the 401(k) plan and the 529 plan. For instance, let’s assume your tax bracket is 30%, and the total return on the investments inside the plan is 100%. (That is: it doubles.)
(1) $100 of pretax income is put into a 401(k) . . . doubles to $200 . . . then is withdrawn, with $60 taxed away (30% of $200), and $140 remaining.
(2) $30 in taxes are deducted from the $100, with the remaining $70 put into a 529 plan. It doubles to $140 and is withdrawn tax-free.
‘See? No difference. But that said, I think you should go with maximizing your contributions to the 401(k) plan unless your state’s 529 plan offers a tax deduction or credit for the contribution. For one thing, your retirement SHOULD come first, as you can always borrow for college but not for retirement. Student loan rates are usually very low. Second, you’ll have the flexibility to spend 401(k) money as you choose, while there isn’t any choice when it comes to the 529 money: if it isn’t spent on college, the earnings are taxed and penalized. Third, retirement accounts don’t enter into the calculations of assets available, when determining eligibility for college aid. Fourth, you’ll probably be in a lower bracket during retirement (although the effect of 401(k) withdrawals on taxable social security benefits is a bit of a wild card). Fifth, your retirement SHOULD come first. Wait, I already said that. But it is worth repeating: borrowing for college is always an option, at favorable rates. Borrowing for retirement is not.
‘By the way, assuming you are married and your family income doesn’t exceed $150,000, you and your spouse can each contribute $3,500 to a Roth IRA (if you are both over 50). That’s $7,000 per year, and you can still make 2003 contributions through April 15, 2004, so it is possible to shelter up to $14,000 instantly ($7,000 for 2003 and $7,000 for 2004). The contributions can be withdrawn tax-free at any time and for any purpose whatsoever, and the earnings can also be withdrawn tax-free once you reach 59 1/2, which is well before college will start. So it has all the advantages of a 529 plan, and none of the restrictions.’
LESS IS BACK
One the features most worth the price of subscription to this site is the ASK LESS link, blinking at upper left. (For those who were beginning to wonder if Less was ever going to answer, I am told that he has carved out more time, and you might very well get answers just as clear and cogent as the one above. But don’t all click at once.)
Tomorrow: You Mean You Don’t Make $250 Million A Year?