2. Income generated by a 529 or coverdell is postponed. If not used for school (or counted as used for school), it's ordinary income when it comes out of the account. If removed while the child is still your dependent, it is subject to kiddie tax.
3. If you leave the money in a mutual fund under your name, it's your income when the money comes out. Yes, most of it would be taxed at capital gains rates in the year sold.
4. Your income can be too high to claim an education credit.
I have 2 children and am planning to put away a chunk of money for their college. I plan to add to that by adding another chunk every year or so.
I am aware that there are 2 tax benefit plans - the 529 and the Coverdell savings. The problem with these is I feel that we're tying up a large amount of money and if anything happens (some unforeseen emergency) it's possible we may need to use that money as a worst case scenario. Also it's possible they may never go to college, who knows. If the money is in 529 or coverdell plan, I'm not sure how easy it is to get back.
So I've considered an alternate plan of just investing in mutual funds but then obviously I would have to pay tax on it - Capital gains.
My question is, how much money will we really lose by paying capital gains on the growth?
For example, let's say I invest $10k now in a mutual fund or stocks, and $10k in a 529 plan, and they each grow at 5% for 18 years. At the end, the balance will be $24k in each of the accounts. Correct me if I'm wrong: If I pull all of that out for education, I will only have to pay cap gains tax on the $14k of the mutual fund growth (so that would be.. i dunno $3k? I dont know how capital gains works). But does this $14k count toward that year's income for me and make me potentially pay 1/3 of that ON TOP of the capital gains and maybe even put me in a higher tax bracket for that year? Or perhaps if it's being spent on my child's education I can write off?
Thx!
