Yes! The first week of school is going well for our son. He still says he hates school, but he hasn’t cried or hit anyone yet this year. I know that’s a low bar. We just need to have low expectations because RB40Jr usually has a rough time adjusting to a new school year. Oh well, he still has plenty of time left to work on it. He’s only in 2nd grade and there are 11 years left before he goes off to college. That’s a long time, but I’m sure it will pass very quickly. He’ll be 18 before we know it. Anyway, this is a good time to give an update on RB40Jr’s college savings fund. We are using the 529 plan to save for college. I started saving when he was born and the account has done pretty well. Let’s go over the basics of the 529 plan first.
*This article was originally written in 2013. There have been some changes to the 529 plan and I updated the post to reflect them. If you’re familiar with the 529 plan, feel free to skip to the end to check out RB40Jr’s college savings fund. From now on, I’ll update this post at the beginning of every school year.
Why we’re saving for college
If you’re a parent, you’re probably worried about the cost of higher education. The class of 2017 graduated with an average of $39,400 in student loan debt. That’s a huge burden to start your adult life with. I graduated from college in 1996 and I didn’t owe anything. My parent helped with most of my higher education expenses and I’ll be forever grateful to them. My goal is to do the same for our son. That way, he can start building wealth as soon as he begins working full time. It’s much better to start off at zero than in a hole. That will be our legacy to him as we are not planning to leave much if any inheritance. The best gift we can give our son is a good education. He can build his own fortune after that.
How much will college cost?
Oh man, this is going to be a shocker to all the parents who haven’t looked into this yet. In recent years, the cost of higher education has been rising at about 5% annually. College is already expensive and 5% increase per year is kicking it into the stratosphere. How much will college cost 2029? Luckily, there are some online calculators out there to help us figure it out. We’ll use savingforcollege.com’s online college cost calculator.
The following are needed for the calculation.
- Child’s age: 7 years old
- Current college savings: $78,000
- College cost: $36,000. This is the current cost of attending the college. I use the current in-state cost (living on campus) from our alma mater. You can look up your college of choice at the National Center for Education Statistic.
- Assumptions: I assume RB40Jr will attend college for 4 years on a full-time basis. The default yearly cost increase is 2.95%. I think that’s a bit low so I increased it to 5%. I also assume no scholarship so I can see the full cost.
- Additional contributions: $400 per month. I assume the rate of return is 6%.
The result is a bit discouraging. Check it out.
- The estimated total cost of college in 2029 is $265,284.
- It looks like we’ll be short about $40,000 with the assumptions I used.
This is just an estimate so I’m not worried yet. We will have a more accurate picture as our son grows. I’ll update this post every year so you can see the planning process. We will keep an eye on the $40,000 shortfall. If it grows, then we’ll need to save more or figure something out. Personally, I hope he can get some scholarship and financial aid. That might be enough to bridge the gap.
What is the 529 plan?
One great way to save for college is through the tax-advantaged 529 plan. The confusing thing is that each state has a different 529 plan. You don’t have to invest with your state’s plan either. You can invest with any state you’d like. We live in Oregon and we get a state tax deduction for our contributions. So it’s an easy choice for us.
There are two types of 529 plans, prepaid and savings plan. The prepaid plan allows you to pay tuition at the current price and attend college in the future. The saving plan invests in stock and bond funds. I don’t really like the prepaid plan because it isn’t as flexible as the saving plan. We have no idea where our son will attend college so we’d like to keep it as flexible as possible.
Now, let’s go through the pros and cons of the 529 college savings plan.
Pros of the 529 college savings plan
State tax benefit – Many states provide state income tax deduction for the contribution. For 2018 in Oregon, the tax deduction for tax payers filing jointly is $4,750. Our Oregon tax rate is 9%. So the tax deduction will save us $427.50 this year. That’s not a large amount, but every little bit helps especially if it compound over the years. You can check your state’s 529 tax benefit here.
Federal tax benefit – The distribution for the beneficiary’s college costs are tax free. You don’t have to pay tax on the gain from your investment. Only a few things in life are tax-free so this is a real gift from our federal government. Take advantage of it if you can.
Automatic option – You can set up automatic deduction so you don’t have to worry about it. Many states have age-based funds which will allocate your fund according to when the beneficiary’s age. This makes it easier to save.
Transferable – If RB40Jr declines to go to college, then we can transfer that fund to other qualified members in our family. Perhaps Mrs. RB40 can finally go back to get a Ph.D. Otherwise, we can always gift it to the future generation.
Estate plan – This one is for the grandparents out there who want to help out. They can contribute up to $14,000 ($28,000 for married couples) per beneficiary tax free every year. This is a great way to pass money down to future generations without paying estate taxes while retaining control of the fund. In addition, there is a special rule unique to the 529 plans. You can gift a lump sum of up to $70,000 and still avoid the federal gift tax. We can treat the gift as if it was made evenly over five years. That’s pretty neat.
Financial aid calculation – The 529 college savings account is treated as the parent’s asset. This is good news because only 5.6 percent (or less) of the 529 is used in the calculation for expected contribution toward your child’s college cost. Student’s assets are computed at 20% in the financial aid formula. It’s better to keep the assets under the parent’s name when it comes to FAFSA.
More flexible withdrawal – In 2017, the tax reform package expanded the 529 plan benefits to include tax-free withdrawal for private K-12 schools. This is great if you live in a high tax state and send your kids to a private school. Check your state’s 529 plan to see if this is available.
Disclaimer: Talk to your tax professional when you withdraw or contribute a large amount to make sure you don’t run into any unexpected problems.
Cons of 529
Limited investments – Generally, there are not many investment choices in the 529 plan. The Oregon 529 plan has U.S. equity, International Equity, Social Choice, Fixed Income Index, and Money Market. We can also invest in the age-based portfolios and target allocation portfolios.
Reallocate twice per year – We can only reallocate twice per year in the Oregon 529 plan.
Penalty – The 529 college savings plan is meant to help fund education. If you withdraw from the account and use the money for other purposes, you’ll have to pay tax at the normal rate plus 10% penalty. The state may recapture the deduction as well. An exception to the 10% penalty can be claimed if the beneficiary has passed away or if the fund is not needed because the child received a scholarship.
The 529 college savings plan is a great way to save
Generally, I think everyone should max out their retirement contributions first and then save for college. Your 401(k) and Roth IRA provide great tax benefits and you may not have to pay the 10% early withdrawal penalty if you withdraw the money to pay for college.
I also think it’s a good idea to front-load the 529 to maximize the benefit of compounding. If you put in $70,000 early on, it will earn much more than if you spread it out over 18 years. The earnings will be tax-free so it’s best to get rolling ASAP. The earlier you invest, the longer your fund has to compound.
- If you save $70,000 when your kid is born, you’ll accumulate $294,040 (assuming 8% annual gain.)
- If you spread it out over 18 years and save $324/month until your kid is 18, then you’ll have $156,585. It’s still good, but probably won’t be enough to pay for 4 years of college.
The only caveat is to make sure not to go over the $14,000/year gift limit. For the 529, you can contribute $70,000 in one year and treat it as if you were contributing the lump sum over five years.
Unfortunately, we didn’t have $70,000 sitting around when our son was born. We contributed extra in the first 4 years and then stepped down to the max contribution (around $4,600) after that. You can see the contributions in the chart a bit later.
Currently, we have about $78,000 in RB40Jr’s college fund with 11 years left to go. That’s not too bad, right? Our goal is to pay for 4 years of instate public college. If he wants to go to graduate school or attend a private college, then he will have to get some scholarships and take out some loans.
RB40Jr’s college fund
Okay, here it is.
The first few years were slow, but the momentum has picked up significantly since then. That’s how compound interest works. Amazing, isn’t it? It looks like front-loading the college fund is working out quite well.
Recently, it’s been pointed out to me that you need screenshots to establish credibility. Anyone can say they have a million dollar in the bank. So here are some screenshots of RB40Jr’s college savings fund. What’s the world come to, when you can’t trust strangers on the internet anymore?
In 2017, I moved RB40Jr’s 529 account from Oregon to Vanguard. You can read more about the move here – Moving Our Oregon College Savings Plan to Vanguard. This was done to minimize fees and I think it worked out well. The most important point in the post is we didn’t have to pay recapture tax when we moved from OR to Vanguard.
Oregon 529 plan
Of course, I still want the tax deduction so I continue to contribute to the Oregon 529 plan. Once the balance is large enough, I’ll transfer it to Vanguard again. You can do this once per year.
RB40Jr’s Roth IRA
This year, I started paying RB40Jr for his work as a model and photographer for this blog. All of his income goes straight into his Roth IRA. He can use it for higher education so it is part of his college fund on my spreadsheet. The current balance is pretty small at $845, but I’m sure it will keep growing as he contributes more.
Here is the summary of RB40Jr’s college fund. Not too shabby, right?
|RB40Jr’s Roth IRA||$845|
All in all, I think we’re doing pretty well with RB40Jr’s college saving fund. I’m optimistic that we can cover most if not all the cost of higher education when he’s ready for it. We’ll just keep saving and hope he can get some scholarship.
Don’t forget to check back next year to see if we made any progress.
Ok, that’s it for today. Do you use the 529 plan to save for college or do you have a different plan?
*Sign up for a free account at Personal Capital to help manage your net worth and investment accounts. I log in almost every day to check on my accounts and cash flow. It’s a great site for DIY investors. Check them out if you don’t have an account yet.