529 · Education

Playing 529 Catchup (Part 3)

In my last post, I laid out my plan for contributing to my children’s college education and creating incentives for keeping the cost down without sacrificing the quality of their education. My final contribution goal (including a 3% inflation) came to $299,901. That’s significantly smaller than the original number of $413,264, but still pretty high. Let’s look at some ways to make that more manageable.

The Long Distance

Luckily, we don’t have sextuplets and the full amount isn’t due immediately. Instead, the total amount is spread across fourteen years, $26k a year on average. Since kicking my own student loan debt to the curb last December, we have only mortgage debt remaining. So it feels doable. But it would mean cutting back on our current savings rate in a significant way.

Saving State Income Taxes Using 529s

We live in Virginia where we get a deduction for the first $4k contributed to any 529 account. My state income tax marginal rate is 5.75%. If I can pass every bit of college-bound money through 529 accounts, I can save up to $16,307 in taxes. All for just passing it through 529 accounts. Updated total: $283,594.

In addition to attending fall and winter in 2021, my daughter plans on attending summer as well. I’m forecasting I’ll be out $18,177 for her college expenses in 2021. Her current 529 balance is $11,044. Assuming a year of flat growth, I’ll need to be able to pass an additional $7,133 through her 529 to cover this year alone.

But what about that $4k deduction limit? Will I need to roll my excess deduction into future tax years?

No. In Virginia, the 529 deduction is per account. Accounts are considered different from each other if they vary by either owner, beneficiary, or investment option. To maximize an immediate deduction against my 2021 income, we could double our deduction amount by simply having my wife open accounts alongside my accounts. And with over twenty different portfolio options, the theoretical maximum deduction is more than $160k. I think I’ve got that covered.

Future Rate of Return

As I’ve shared before, I opened the first 529 account in 2006, putting all of the contribution into equities. Over the past 14 years, my internal rate of return was 8%. Assuming an 8% return over the next 14 years and a flat, dollar-cost averaged monthly contribution for each child’s 529 account, my total contribution drops to $188,467 or an average of $31.4k per child or around $12k/year.

Is it reasonable to expect an 8% return for the next 14 years? Maybe not. But frankly, I’m not sure anyone really knows. It could be lower, it could be higher. But you have to start somewhere and 8% seems as good as any. Drop the rate to 3% (pacing tuition inflation) makes it $241,992 and goosing it to 10% takes the total contribution down to $169,590. I suspect it’s somewhere in between.

Dollar-Cost Averaged Contribution

Last year, realizing that I need to play catch up on my college savings, I opened accounts for each child and maximized contributions to two different accounts for my oldest. My modeling spreadsheet includes a calculation of how much I need to contribute each month to their accounts to realize my desired contribution. Here’s a table that breaks it down per child:

Child Year Entering College Current 529 Balance Monthly Contribution
Child #1 2020 $11,404 $1,078
Child #2 2023 $2,076 $546
Child #3 2025 $2,076 $366
Child #4 2027 $2,076 $266
Child #5 2029 $2,076 $202
Child #6 2031 $2,076 $158

 

I’ve thought about contributing more in the next couple years, when I only have one student, to have my money in the market. This diminishes the benefits of dollar-cost averaging some and introduces some sequence of return risk, so I’m not 100% settled on that idea.

Here’s a peak at my spreadsheet that breaks this all down:

Conclusion

College isn’t cheap, whether it’s the student or the parents paying. But using 529s for the state tax benefit and as investment vehicles can both significantly lower the total cost. Telling my past self to save a little bit more in my 529 accounts isn’t an option, but perhaps passing on what I’ve learned to you is the next best thing.

Anything else that you think I should consider when trying to reduce the burden of my expected contribution to my children’s college expenses? I’d love to hear about them in the comments.

Hasta luego!

6 thoughts on “Playing 529 Catchup (Part 3)

  1. Great post and analysis! Your numbers have certainly become a lot more manageable with your more sophisticated analysis!

    The 529 state tax deduction is such a no-brainer. We save 7% on a $10k/year contribution. We’ve maxed it out for 5 years straight now. I can’t think of a better way to save for college. Mercifully, our 529 plan just lowered their plan expenses, juicing our returns by a non-trivial 0.2%/year.

    I don’t think I have much more to add to your analysis, but I hadn’t run the numbers myself before. If we FIRE, I think the cost of college could be cut by >50%. I think I need to think harder about the implications of this.

    1. Thanks for the comment. It still feels like a big number in the aggregate, but spreading it out over 14 years makes it doable. I don’t imagine myself doing anything drastic to reduce the cost, such as FIRE or taking a huge pay cut. I’m happy doing what I’m doing, have good health insurance, and the opportunity cost is not insignificant to save some.

      Yeah, the 529 state deduction is great!

  2. Love the blog David! That spreadsheet you made is awesome! As a fellow engineer, I love to optimize too. I can tell you really want the best for each of your children, and it shows. Keep up the great work!

  3. Big fan of VA 529 though I feel like a criminal everytime I contribute my kids K-12 tuition and withdraw it practically the first day it’s available only to rinse and repeat again next month to lower my tax bill. It’s nice they updated last year I believe to allow my wife and I to do the same with our school loan payments, though it would be nicer if Mr. President et. al. would pay them off for us

    1. Thanks for the comment. If I hadn’t finished paying off my own student loans in 2019, I totally would have been all over this. My current plan is putting my funds in at the beginning of the year and get a whole year of gain before I withdraw it at the end of the year. I end up floating things throughout the year, which isn’t terrible. Also, I have to keep track of it so I don’t forget to withdraw, something that isn’t as likely if you withdraw it immediately like you are doing.

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