The following is a list of items to reduce income:

• If you have kids, and you want to help to pay for their college, plan to have more of it funded by 529 accounts. If you have to sell investments or draw down from tax-deferred accounts, that increases your MAGI.
• Pay off mortgage if possible to eliminate income requirement. Again, same thing as college funding, if you have to sell investments or draw down from tax-deferred accounts, that increases your MAGI. Without a mortgage, you have less need to realize capital gains or draw down from tax-deferred accounts.
• Derive income for ongoing expenses from tax exempt bonds (tax exempt income does not figure into MAGI).
• Use a short term tax exempt fund to hold non-immediate cash needs instead of a high yield savings account. Perhaps top up the checking account once or twice a month. This reduces the amount of interest payments reported in MAGI.
• Shift equity investments into lower yield equivalents, while still keeping the general composition of the portfolio reasonably unchanged. One potential candidate would be to invest in US LargeCap Growth instead of US LargeCap Blend. Does not work for US SmallCap (US SmallCap Growth has a poor historical record).
• Invest in rental property and use rental income to fund ongoing expenses (rental income is typically offset by property depreciation).
• Look into MLP investments that shield income for as long as the investment is not sold (you can control when to sell if necessary).
• Delay signing up social security.

Even though it looks like I could potentially benefit from the healthcare reform if I retire early, I don’t agree with the changes. They simply penalize people who are successful and are a disincentive to work. This can’t be good for the economy. But that is another story.

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• January 26, 2011 — Substitute Dividend Payments in Margin Accounts (0)
• July 30, 2009 — Squeezing out more tax efficiency from my portfolio (1)
• July 22, 2008 — Running out of tax-deferred space (2)
• January 31, 2008 — Tax harvesting from 529 plan? (0)
• February 9, 2007 — Sell mutual fund with short term CG after distributions (0)

A thought came to my mind — since unqualified distributions from the 529 plan are taxable, is it possible to tax harvest from the 529 plan?

I asked this question on the Bogleheads forum, and here’s a reply from LH2004 (who had previously demonstrated to have very good knowledge on tax matters):

Yes. See “Losses on QTP Investments” in Publication 970. You’ll be subject to the 2% of AGI floor, though, so you’ll need to have really extreme losses, or a big account, or low AGI, or other miscellaneous itemized deductions to reach that floor.

Alternatively, under the IRS’s new theory regarding wash sales, you could take the position that a sale of an individual portfolio in the 529 plan at a loss, followed by a purchase of a substantially identical fund in your taxable account, is a wash sale, increasing your basis in the newly-purchased fund, which you could then immediately sell at a loss; that would be an aggressive position to take.

Taylor Larimore kindly found the link to the relevant section in Publication 970 — http://www.irs.gov/publications/p970/ch08.htm :

Losses on QTP Investments

If you have a loss on your investment in a QTP account, you may be able to take the loss on your income tax return. You can take the loss only when all amounts from that account have been distributed and the total distributions are less than your unrecovered basis. Your basis is the total amount of contributions to that QTP account. You claim the loss as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23, subject to the 2%-of-adjusted-gross-income limit.

If you have distributions from more than one QTP account during a year, you must combine the information (amount of distribution, basis, etc.) from all such accounts in order to determine your taxable earnings for the year. By doing this, the loss from one QTP account reduces the distributed earnings (if any) from any other QTP accounts.

At this point, it doesn’t look like something I would do.

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I was pleasantly surprised to learn that the Ohio State’s College Advantage plan has lowered its fees again from May 2007. If I remember correctly, it last lowered its fees last year.

The reduction is not much, averaging about 2 basis points reduction for all the investment options that I had chosen. But, I am encouraged to see that at least it is a step in the right direction.

The following shows the old and new expense ratios.

My overall expense ratio for my 529 portfolio drops from 0.373% to 0.357%.

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For high income earners who are priced out of the Roth IRA, the 529 college savings account can become somewhat like a “giant” Roth IRA for you to sock away your savings, up to the limit of the estimated college costs. A Roth IRA is a great location for asset classes that have high expected returns but would otherwise be severely eroded by taxes due to high capital gains or dividend (especially the unqualified kind) distributions. This would include assets like the REITs, small-cap value and international small-cap asset classes.

Taking this view, one would then wonder why the 529 account should not be treated as part of the entire portfolio, instead of just treating it separately. When the 529 account is considered as part of the entire portfolio, an investor would have more freedom and less limitations as to where he/she can place the asset classes in the most efficient manner.

Conversation 54876 from the Diehards forum has a lively discussion on this issue. Personally I have not given serious thought into considering the 529 contributions as part of my portfolio but I believe it is an interesting idea that is worth exploring.

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Rewards card reduced to 1.5%

The new rewards card is issued by American Express. According to the web page, the features of this card are

• 1.5% of your net retail Card purchases are automatically contributed to your Fidelity-managed 529 Plan account⁴

• Up to $1,500 in annual contributions per Card to your 529 account managed by Fidelity

• Family and friends can also carry College Rewards Cards linked to your Fidelity-managed 529 Plan account

• Identity theft recovery and fraud protection

• No annual fee

The rewards are good by itself but pales in comparison to the old 2% rewards card.

Note that according to this thread on the Fatwallet finance forum, at least one user has reported success with application on the old card. This might be the last chance to get in on the old 2% card. But YMMV.

Indexed investment options added

With the transition of California’s 529 plan from TIAA-CREF to Fidelity, new indexed investment options were added to all of the 529 plans managed by Fidelity. The new options are

The expense ratios of the new options are all at 0.5%. These are all lower expenses compared to the old actively-managed options

I am submitting a request to switch my investments to the lower-cost indexed options. Note that now is a particularly good time for the switch since you are limited to one switch per calendar year and it is already almost December.

From an earlier post, I mentioned that my main college savings actually goes into the Ohio plan. Currently, the college investment allocation is

• 30% US Large cap equity
• 30% US Med/Small cap equity
• 30% International equity
• 10% Fixed income

Compared to Fidelity’s 0.5% expense ratio for all indexed options, the expense ratios of the Ohio plan are

The international equity option from the Ohio plan has the highest expense ratio and the corresponding Fidelity option costs only 7 basis points more. It therefore makes sense for me to use Fidelity’s international equity option for my funds at Fidelity. The following table shows my new overall 529 college allocation.

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The first step in selecting a college saving plan is to check if your home state provides any financial incentive (e.g. state income tax deduction) to invest in the state-sponsored college plan. For me, the state of California provides no such incentive. The California plan, managed by TIAA-CREF, is fairly respectable. It’s costs (ER 0.8%) is reasonable, but not the lowest; so I looked elsewhere.

My main criteria for selecting a college includes the following:

• Cost of the plan (expense ratios and account fees),
• Range of investment options, and
• Other special incentives.

The two accounts I ended up with are the following.

Account 1: Fidelity’s Unique College Investing Plan (sponsored by the state of New Hampshire).

I selected this plan based on the special incentives available with this plan. With this plan, I was able to apply for the Fidelity-MBNA co-brand 529 College Rewards credit card. This card gives you 2% back on practically anything you charge to the card. In addition, it also offers you online Bill Payment service which lets you pay many merchants including even your mortgage or electric bill (but no rewards for these). The rewards are accumulated and posted to the 529 plan once every calendar quarter.

The overall expense ratios of this plan are on average about 1%. These are reasonable numbers but not particularly attractive. The following table shows the expense ratios of the funds and the account fees:

Note from point (6) that there is an account maintenance fee of $20 a year but this can be easily avoided by setting up a systematic contribution of at least $50 a month. This is the amount I am contributing to this plan.

To summarize, the main benefit for me to contribute to this plan is to get the credit card rewards. By my calculations, I would get about $500 to $600 in rewards a year from this card, almost the same as the amount I would contribute from systematic contributions (12 x $50 = $600).

Account 2: Ohio state’s College Advantage Plan

The second account is where I do my serious college savings. This plan was selected based on its very low costs and a respectable range of investment options.

I was interested to have the following asset allocation for the investment plan: 30% US Large-Cap equity, 30% US Small-/Med-Cap equity, 30% International equity and 10% fixed income. With that in mind, I started looking at the various plans available. Some of the plans I considered are tabulated below.

The Utah plan has always been touted as the cheapest 529 plan but what I found was that based on my options, it is not the cheapest (especially if you are not a resident in Utah). Besides, I dislike its confusing account fees, and I think this could actually be the reason why some think it is the cheapest: simply because the various UESP add-on fees were not accounted for.

The Vanguard 529 (Nevada) plan is interesting for those who like to see their 529 account with one Vanguard login. The funds in this plan can also be counted towards the qualification for Voyager / Flagship status. This is quite an attractive benefit.

Those interested in DFA’s funds can also look into West Virginia’s SMART529 plan. The fees range from 0.75% to 1.05%.

In the end, I found that the plan that makes the most sense for me is Ohio’s College Advantage Plan. The total expense ratio for this plan is only a mere 0.352%. Besides, I see no reason paying almost double the expense ratio for the Vanguard 529 plan just to get the ability to qualify for Voyager / Flagship.

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