Saving on Taxes with a 529 Plan

November 10, 2020 bogleheads [investing]

Every now and then a post like Any 529 Abusers Here? appears on the Bogleheads about using a 529 account as a tax-shelter for non-education purposes.

Like most posts, people post a bunch of speculation but no one does the math. Most, I suspect, don’t even think before posting.

A simple thought experiment should suffice.

• The penalty on non-educational withdrawals from a 529 is the both the current income tax and a 10% penalty on the gain.

• The “penalty” on a taxable account is capital gains tax on capital gains plus current income tax or less on the dividends.

• So using the 529 for non-education expenses only makes a difference if the income tax at withdrawal is 10% less than the capital gains tax paid and the income tax paid on the dividends.

Of course this all assumes no changes in current tax law. It is always possible the penalty on 529s may change or capital gains tax increased to stick it to the fat cats.