Why We Are Using The 529 Plan to Save For College

Oh wow, our son is 12 years old. I started this blog when Mrs. RB40 was pregnant in 2010. She wasn’t too happy when I told her I wanted to quit my engineering career. I was the main breadwinner back then and she was studying for a Master’s degree. Fortunately, it all worked out and we’re doing pretty well today. Anyway, one of the earliest blog posts here was about kids being a big obstacle to early retirement. Check it out to see RB40Jr’s ultrasound picture.

Did I mention RB40Jr is 12 years old now? Wow, time really flies. Soon, he’ll be going off to college and that will be a huge expense. Fortunately, we have been saving up for his college education since 2011. We only have 6 years left to beef up his 529 college savings plan. Today, I’ll share why we’re using the 529 plan to save for college and how much we saved so far. 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 College Savings plan, feel free to skip to the end to check out RB40Jr’s college fund. Starting in 2024, you can convert the 529 plan to a Roth IRA! This is great news for savers.

Why we’re saving for college

If you’re a parent, you’re probably worried about the cost of higher education. The total U.S. student loan debt is $1.76 trillion. The class of 2019 graduated with an average of $29,719 in student loan debt. That’s a huge burden to start your adult life with. I graduated from college in 1996 and didn’t owe anything. My parents helped with most of my higher education expenses and I’ll be forever grateful to them. I worked when I was in college, but I didn’t make much. 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 shock 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 a 5% increase per year is kicking it into the stratosphere. How much will college cost 2029? I don’t know. Luckily, there are some online calculators out there to help us figure it out. We’ll use Vanguard’s College cost projector. I’ll use the in-state expense for our alma mater, UCSB.

The Result

The estimate is a bit discouraging at first glance.

• The estimated cost of 4 years at UCSB, an in-state university is $181,944. Actually, I think this estimate is low. UCSB probably will cost more than this.

Another big uncertainty is which college our son would go to. We’d have to move to California if he really gets into UCSB. The non-resident tuition fee is $31,000 per year! That’ll put it out of reach. UCSB came a long way since I was a student there. It’s a lot more difficult to get accepted now. Our son would have to do extremely well to get in.

We will have a more accurate picture as our son grows. I’ll update this post every few years so you can see our progress. Personally, I hope he can get some scholarships and financial aid. Also, he can work while he’s in school. Those will help fund his cost of living during his college years. He’ll have some skin in the game by working and applying for financial assistance.

What is the 529 College Savings plan?

One great way to save for higher education is through the tax-advantaged 529 College Savings plan. The confusing thing is that each state has a different 529 plan. Also, you don’t have to invest in your state’s plan. You can invest with any state’s plan. We live in Oregon and we get a state tax credit for our contributions. So it’s an easy choice for us.

There are two types of 529 plans, prepaid and savings plans. 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 want 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

***New*** Conversion to Roth IRA! – Starting in 2024, you can rollover the 529 plans to a Roth IRA. That’s fantastic. Read more about it here – 529 plans conversion to Roth IRA.

State tax benefit – Many states provide state income tax deductions or credits for the contribution. Recently, Oregon made a change to the tax benefit for the College Savings Plan. Instead of tax deductions, we can get up to $300 in tax credits for joint filers. This is a progressive tax benefit so it helps lower-income workers more. You can see the tax credit table at Oregon College Savings.

Federal tax benefit – If you use the money in the 529 college savings plan for education, then you don’t have to pay any tax on it. Only a few things in life are tax-free so this is a real gift from the federal government. Take advantage of it if you can. Now, the benefit applies to K-12 education so it’s more useful than ever.

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 the beneficiary’s age. The automatic option makes it easier for parents to save.

Transferable – If RB40Jr declines to go to college, then we can transfer that fund to other qualified members of 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 $15,000 ($60,000 for married couples) per beneficiary 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 $75,000 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 5.64 percent (or less) of the 529 is used in the calculation for the expected contribution toward your child’s college cost. Student 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 only a few 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 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, 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 use the money to pay for college.

I also think it’s a good idea to front-load the 529 College Savings plan to maximize the benefit of compounding. If you contribute $75,000 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 more time your portfolio has to compound.

• If you save $75,000 when your kid is born, you can accumulate $315,043 (assuming 8% annual gain.)
• If you spread $75,000 out over 18 years and save $347/month until your kid is 18, then you’ll have $166,810. It’s still good, but probably won’t be enough to pay for 4 years of college.

Caveat

The only caveat is to make sure not to go over the $17,000/year gift limit (for 2023). For the 529, you can contribute $85,000 in one year and treat it as if you were contributing the lump sum over five years.

Unfortunately, we didn’t have $75,000 sitting around when our son was born. We contributed extra in the first 4 years and then stepped down about $4,000 per year after that. You can see the contributions in the chart below.

Currently, we have about $112,000 in RB40Jr’s 529 college plan with 6 years left to go. 2022 was a tough year and we took a big step back.

Our goal is to pay for 4 years of in-state public college. If he wants to go to graduate school or attend a pricey private college, then he will have to get some scholarships and take out some loans.

RB40Jr’s 529 college savings plans

Okay, here it is.

Ouch. 2022 was a tough year. Hopefully, the account will make some progress over the next few years.

Screenshots

Recently, it was pointed out to me that you need screenshots to establish credibility. Anyone can say they have a million dollars 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?

Vanguard

In 2017, I moved RB40Jr’s 529 College Savings account from Oregon to Vanguard (Nevada.) You can read more about the move here – Moving Our Oregon College Savings Plan to Vanguard. This was done to minimize fees and it worked out well. The most important point is we didn’t have to pay the recapture tax when we moved from OR to Vanguard.

Oregon 529 plan

Of course, I still want the state tax credit so I continue to contribute to the Oregon 529 plan. They made some changes since we moved the plan to Vanguard. Now, the underlying funds are Vanguard funds.

RB40Jr’s Roth IRA

In 2017, I started paying RB40Jr for his work as a model and photographer for this blog. He also helps me make clips for our YouTube channel. All of his income goes straight into his Roth IRA. He can use it for higher education if he needs to. The current balance is $6,650. I’m sure it will grow as he contributes more. Hopefully, he won’t have to touch this account. It will compound very nicely if he keeps it for retirement.

UTMA

This is his personal investment account. He put most of his gifts and side hustle income here. I invest it in Fidelity’s zero-cost total market fund for him.

Summary

Here is the summary of RB40Jr’s college fund. I really hope the stock market performs well over the next 6 years.

All in all, I think we’re doing well with RB40Jr’s college fund. 2022 was a tough year, but we’ll keep at it. Once RB40Jr is in high school, we will need to rebalance his investment to become more conservative. We’ll move a good percentage into bonds. It’s not a good idea to need money when the stock market is crashing.

Anyway, I’m optimistic that we can cover most if not all the cost of higher education when he’s ready for it. We’ll keep saving and hope he can get some scholarship.

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.

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Joe started Retire by 40 in 2010 to figure out how to retire early. After 16 years of investing and saving, he achieved financial independence and retired at 38.

Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!

Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.

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