In less than two months, my oldest starts her freshman year at college.
To put it mildly, it’s going to be different starting college during a pandemic. Most of her classes are online and a couple are “hybrid”, mixing in-person and online components. Everything after Thanksgiving is online.
Like I said, it’s going to be a little different this year.
College Ain’t Free
So how to pay for it?
In 2006, I opened a 529 account using a small inheritance after my grandmother passed away. It’s nearly tripled in size (13% year-over-year return), but it’s still short of paying for college for all six of my kids. I even came up with a complicated but (in my opinion) fair method of dividing the 529 between them.
Who am I kidding.
A college education is important to me. I’m willing to pay for it.
Beyond my one time contribution in 2006, I haven’t made any additional contributions. Instead, I’ve prioritized maxing out 401(k) contributions, paying down debts like my own student loans and mortgage, and investing in a brokerage account. When I started the 529, I lived in Washington state, a state with no income tax and thus no tax advantage for contributing. I opened the 529 in Ohio–a state I’ve never even stepped foot in–because it had relatively low fees and access to Vanguard funds. But with still limited investment options, higher fees than a regular brokerage account, and steep penalties for non-qualified withdrawals, the 529 just didn’t seem worth it.
I was possibly being short-sighted.
State Income Tax Deduction
We now live in a state, Virginia, where we’re subject to a 5.75% state income tax. We can deduct up to $4k of contributions for each 529 account, saving up to $230 for a full year’s contribution. If I contribute more than $4k, I can just roll the excess contribution into future tax years, assuming I continue to live in Virginia in the future. Gift tax limits apply, but I should probably be well under that limit.
In addition, my wife can open accounts for each child, doubling the amount that we can deduct each year. All told, we can deduct up to $48k a year ($4k over 12 accounts) against our state income tax. That’s tax savings of $2,760 tax each year.
Am I going to hit that limit? Probably not. Expect future posts on this.
Doing the Laundry
How does this help right now, when my daughter enters school in less than two months?
There doesn’t seem to be any minimum holding period for 529 funds before they are used to pay for expenses. In theory, I could even contribute to the 529 after I pay tuition, possibly months later. My contribute needs to come before the end of the year and so do the expenses and subsequent withdrawals. I should be good. Sure, the contribution will have next to no time to appreciate any gains, but this late in the game I’m in it for the tax deduction, not for the market gains. I’ll probably put the money in a fixed income option to avoid any sudden downturn in the few weeks that it will sit in the account.
Here’s a quick animation of the steps:
Any 529 funds used to pay for expenses reduces the amount I can apply against other tax credits like the American Opportunity Tax Credit (AOTC) or the Tuition and Fees deduction. However, the income phaseouts already preclude me from using them, but it’s something to consider with this strategy.
Tell me what you think. Any gotchas that I’m not paying attention to? Is this too good to be true?