<p>we are trying to decide the best option to fund a 529 plan.
Here is a hypothetical senario:
(1) Current 529 plan has $20,000
(2) Current home equity loan amount is $35,000
(3) Retirement account has $35,000 available to withdraw</p>
<p>Goal is to pay off the home equlity loan within five years and to fund as much as possible to 529 plan</p>
<p>Possible five year plans
Plan 1: Pay off the home equity loan in installments over five years (total cost, principal and interest ~$42,000).
Paln 2: Pay only the interest in home equity loan ($8,000) and invest $7,000 per year for five years to 529 plan.
Plan 3: Take a $35,000 loan from the retirement fund and invest in 529 plan, pay only the interest in home equity loan. </p>
<p>I am wondering which one of these options would yield a higher outcome at the end of the five year term</p>
<p>I am not a financial advisor - just a parent but here is my 2 cents worth. My first thought on looking at this is why would you ‘borrow’ against the retirement fund at this point? If you borrow it tomorrow you would be incurring interest on the loan starting tomorrow so would pay 5 years of interest in order to move the investment from one investment vehicle to another - the 529 account would not neccessarily make more money than the retirement account so you are incurring a pointless expense. $35,000 at say 6% interest for 5 years is going to cost you $10,500 over 5 years.Makes no sense to me. If you find you need to borrow from it for college do it when the time comes - not now. Depending on your ages I would not really recommend touching your retirement accounts as you need to provide for your own futures as well as the kids education.</p>
<p>If your child/children are likely to be eligible for financial aid bear in mind that money in retirement accounts and home equity are not taken into account as assets in the FAFSA calculation.</p>
<p>I am sorry I didn’t make it clear.
In above scenario, there is an existing $35K equity loan which needs to be paid off anyway at the end of five year term.<br>
The question is whether to pay off the equity loan in $7,000 installments over five years or wait till the end of five years to pay off the equity loan.
If the equity loan is paid off at the end of five year term, there is more money to put in to the 529 plan during the five year term.</p>
<p>At the beginning total funds = $20K + $30 - $30K
At the end of five year term total funds in th e529 account is (according to my calculation):
Plan 1 = $ 34 K
Plan 2 = $ 85 K
Plan 3 = $ 87 K</p>
<p>Total funds in all accounts after five years (529 + retirement - mortgage)</p>
<p>Plan 1 = $42 K<br>
Plan 2 = $65 K
Plan 3 = $76 K </p>
<p>Above assumes that equity loan interest to be 8% and the interest gain from 529 and retirement accounts to be 15%. And the 8% interest for retiremment account loan is paid to yourself.
Above numbers seems to be too good to be true!<br>
I am wondering whether others had done similar calculations.</p>
<p>Ijmom. You are very optimistic. What happens if your situation becomes very pessimistic? We ran scenarios on a tax program and a financial program (msmoney or quicken). Our situation changed after 9/11 and we had to change, although much too slow, to match the new situations.</p>
<p>Your question is really confusing. It’s unclear why you are looking at a five year scenario and it’s unclear if you expect to be eligible for financial aid.</p>
<p>I encourage you to read the book How to Pay for College without Going Broke.</p>
<p>If you are preparing to send a child to college in five years or so, the general advice is to:</p>
<ol>
<li>Put as much as you can afford into your retirement accounts.</li>
<li>Put as much as you can reasonable afford into your home. Most schools allow a certain amount of home equity to be “safe” from financial aid calculations. Plus, interest expense on mortgages is tax deductible, so you may as well take advantage of this. Even if your home equity eventually exceeds the financial aid limitation, parking money in home equity is a good idea and you can borrow against it in the future.</li>
<li>The only reasons to put money in 529 accounts are because (1) your state may allow a tax break (usually only up to the first $2000 in deposits each year); and (2) because the interest/capital gains is tax free so long as the proceeds are used for eligible educational expenses. So, it can be a good place to shelter assets if you don’t expect to qualify for financial aid. Otherwise, a 529 account is treated as any other parental asset in financial aid calculations. So having a ton of money in a 529 account isn’t necessarily a good idea if you expect to quality for financial aid. It may be a good idea if you don’t expect to qualify, but usually not at the expense of retirement accounts and home equity.</li>
</ol>
<p>I was curious about the borrowing against the retirement account thing - as far as I can see there are some potential pitfalls that you may wish to consider. You have 5 years to repay it (unless it is for a down payment on a house) and if you do not pay it back in a timely manner it may then be treated as a withdrawal then you will incur penalties (10%) and taxes. The amount you ‘borrow’ stops growing until you pay it back. You generally have to repay through payroll deductions so this will reduce your monthly income. Also if for any reason you leave the job (volunterily or otherwise) you have a very short time to repay the loan (@60 days) and if you do not it is treated as a withdrawal - again with penalties and taxes. Just some things to consider. I personally would not do this. Please investigate further and look for possible pitfalls before you do this.</p>
<p>Usually if something sounds too good to be true it is too good to be true.</p>
<p>Stop funding the 529 plan. think of all of the fees and expenses you are paying for each deposit and try to determine when you will recvoer those lost dollars. Also they are very restrictive as far as “qualified education expenses” as determined by the IRS. Also, if you receive any scholarships or federal loans, and you use 529 money for the difference, you could be liable for taxes, penalties and interest, if you exceeded the qualified education expense amounts. Also, you can ge giving up educational tax credits - dollars back in your pocket - if you use 529 money. Unless you get a great state tax break, stay away from them Tax free amy not be tax free after all.</p>
<p>I would refinance the equity loan into a HELOC - home equity line of credit- in case you need to tap this for college down the road - and you are still able to write off the interst on your taxes.</p>
<p>the home equity does not count against you in the fin aid formula UNLESS your student is going to a private school which uses the institutional metholody - CSS Profile- to calculate your expected family contribution.</p>