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529 college savings plan

What if I told you there was a way to contribute $10,000 less to your child’s 529 college savings plan while providing him or her the same amount in the end? Of course you’d want to take advantage of that opportunity if you could. Your child ends up with the same amount of money for college, and you have $10k more for your retirement. This isn’t a secret hack or pyramid scheme either. The idea came to me when I was reading about the concept of Coast FI in the financial independence community.

Introducing the Coast 529

You should read about Coast FI in this great article by the Fioneers if you are unfamiliar on the particulars. The short story is there is a point on your path to financial independence where you could theoretically stop contributing to your retirement accounts and “coast” into your target number by traditional retirement age. At that point the compounding growth will take it the rest of the way.

Wait, Coast FI is for retirement accounts, right?

The same idea can apply to a 529 college savings plan if you are able to front load the contributions. A while back, I was building spreadsheets (shocker) to justify firing our investment advisor. I was playing with the funding scenarios when the idea occurred to me. At first I was just curious to see what the account would grow to if we doubled our monthly contributions. I started experimenting with how soon I could cut off the payments and still end up with the same amount. The answer surprised me and prompted this article.

I’ll go over the actual numbers and what I found a little later in the article. But first I feel like I need to talk about the 529 college savings plan. Well, not just what it is but why we are using one to save for our child’s future expenses. Also how we are contributing and why we changed that amount.

We all want the best for our kids

I imagine there are very few parents out there with no desire to save for their child’s college education. I’m willing to bet every parent wants to pay for college even if some cannot for some (valid) reason.  We all want our children to have an easier go at life than we were afforded, right or wrong. 

Like most millennials, I left college with a sizable amount of student loan debt. Debt that took me more than 10 years to pay off. Any amount of college savings my parents could have provided me would have significantly reduced my payback period. Please don’t do the math on what that monthly payment would be worth now if I had invested it instead. I’m going to pretend it doesn’t exist.

Just imagine where you’d be financially

If nothing else, I’d love to give my son a start in life free of the student loan debt burden.  Just imagine how much further along the path to financial independence you’d be right now with no student loan.  All of that money could’ve been invested for your future instead paying for your past.

The two main concerns with starting a college fund are how and how much. The how involves what type of account or method.  The how much is complicated depending on the situation. You could pay for college out of pocket, from a taxable investment account, from an IRA, or not at all. I’ll mostly talk about the two most popular methods when we were setting up ours.  

Your account choices may vary

The Prepaid College Fund and the 529 College Savings Plan seemed to be the top two options for most people. We were setting up our son’s account a few years ago and honestly both appeared to meet our needs.  In the end the 529 afforded the most flexibility in regards to funding amount and investment options. Instructions for setting up a 529 college savings plan are relatively simple and covered by Wealthtender and their 529 Guide. I’ll leave the mechanics to the experts.

I should note at this point that it actually matters who the account holder is on the fund. The child is the beneficiary in all cases, but who the account holder is will affect the eligibility for need-based financial aid when applying for college.  Funds in a 529 plan owned by the student or parent will lower the need-based eligibility by around 5.64%. Funds in a 529 owned by another person, like a grandparent, could lower the need-based eligibility by up to 50%. 

Anyone can contribute to an account, regardless of who owns it. So before a well-meaning relative sets up an account for your child, set one up yourself and have them contribute to it. There’s no need to accidentally reduce your child’s financial aid eligibility based on a technicality.

The real question: How much?

As for the “how much” part of the equation, we eventually settled on a projected $70,000 balance by the time our son starts college.  I’d like to pretend this was a highly scrutinized, data-driven forecast based on current and future college cost estimates, but it wasn’t.  Both of us left college with roughly half that amount in student loans. We figured giving him double that amount to start was generous.

There is a lot of contention regarding how much you should be have in a 529 college savings plan. Investment advisors and the like will suggest amounts between $150,000 and $250,000 on the upper end. Some sites suggest far less, and its hard to determine where to fall as parents with limited funds and big desires. The College Investor has a handy chart to benchmark how much you should have saved by a certain age with range.

I know, I know… College is going to be super expensive

I fully understand that the projected four year total cost of college in the 2030s is expected to be several multiples of that amount according to some online college cost estimators. We know this, and we still feel it is reasonable.  First, by its very nature, funding a college savings account is taking money out of your retirement account contribution each month. We view this as a “secure your own oxygen mask before helping others” scenario. You shouldn’t be funding a 529 college savings plan if you aren’t fully funding your own retirement first.

Second, having a known amount of money set aside for college should hopefully encourage our son to do everything in his power to keep the expenses down. It’d be in everyone’s best interests if he works hard to get scholarships or takes the community college to university path to save on the overall expense. Also, it might discourage the 6 year undergraduate path so many of my college friends took.

Third, it is entirely possible that he may not even need the money due to his career path choice or changes in the political environment as it pertains to higher education costs.  In the slim chance of this event, it’d be best not to over-fund this account for obvious reasons.

Amount picked… now start saving

After we decided on the future amount we wanted, the monthly contribution amount was calculated out to be about $200.  This was added to the monthly budget to make sure it is accounted for and tracked.  You did add it to your monthly budget, right?  I know it is technically a balance transfer from one financial asset to another and not an “expense”, but you should treat it as one to make sure it gets properly funded.

Saving $200 per month for the next 16 years invested at an average annualized return of 7% results in a balance of approximately $75,000+.  Not a bad college fund for setting $38,400 aside over that time frame and allowing it to grow. 

Easy. Case closed. Moving on, right? Maybe not.

Coast 529 College Savings Plan ?

I don’t mean to throw a wrench into things here, but I will. This is just an idea for those of you slightly more adventurous. I was doing the math one day on how much money would be in the 529 college savings plan when he graduated high school if we doubled up on the $200. Spoilers: a lot more (not really a surprise because… math). 

As a thought experiment, I wondered how many years I would have to double up on contributions to still end up with the around $75,000+ I should expect in the base case scenario.  That, to me, was a far more interesting personal finance problem to solve.

The exciting part –> MATH! 🙂

I did the math, and assuming the same 7% average annualized returns in both scenarios, I would only have to double up on contributions for the next five years to let it coast into the same ending balance.  I could continue contributing $200 a month for 14 more years or $400 a month for just the next 5 years. 14 years versus 5 years is not really much of a competition.

Over the course of the entire fund, the base case involves me contributing $38,400 over 16 years contributing $29,800 over 7 years (2 original + 5 at new rate). If we could afford doubling up the contributions without undue stress on our budget we could save a fortune in theory.

Same result for less = no brainer

Front-loading more of the money into the fund so that it is in the market for much longer allows us to “spend” around $10,000 less on our son’s college education while, in theory, providing the same amount of benefit since the accounts will have roughly the same ending balance. Another example of “time in the market beats timing the market” to some degree.

I’m not saying this is recommended or even feasible for everyone out there but definitely something to consider if you can fit that into your monthly budget.  When I first did these calculations, I was so excited I showed it to many of my coworkers in the office.  I was hoping at least one of them would see the magic of compounding returns and how it can save them money on funding their college funds.  I’m sharing it here and hoping it helps at least one more person.

Here is the data already

Since my situation (already being in year 3) isn’t entirely unusual, if you are reading this and wondering how you can save money too, I’ll show the numbers for that. Below you can see side-by-side comparisons between the two scenarios described earlier. First, the traditional method where you contribute $200 a month until they graduate high school. Second, the Coast FI method where you contribute $400 a month for the next 5 years only and let compounding do the rest of the work. Berkshire Hathaway, Business Insider, and other outlets note that the average S&P 500 return over the last 10 years was at least 10%, but I’m using 8% in the example to be more conservative.

Year$200/monthTraditional Balance$400/moCoast Balance
START$4,800$5,500$4,800$5,500
4$2,400$8,446$4,800$10,936
5$2,400$11,638$4,800$16,824
6$2,400$15,093$4,800$23,201
7$2,400$18,836$4,800$30,106
8$2,400$22,890$4,800$37,585
9$2,400$27,279$0$40,704
10$2,400$32,033$0$44,083
11$2,400$37,182$0$47,742
12$2,400$42,758$0$51,704
13$2,400$48,797$0$55,996
14$2,400$55,337$0$60,643
15$2,400$62,420$0$65,677
16$2,400$70,091$0$71,128
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Total Contributions$38,400$28,800

You can see above that, starting in year 4, we changed our plan. We decided to double the contributions for the next 5 years only instead of continuing for 14 more years. The Coast 529 method means that we’ll be contributing $9,600 fewer dollars (a huge savings for us!). The best part is that our son’s 529 college savings plan should have roughly the same amount in the end. He still gets around $75,000 for college (way more than we had), and we have ~$10,000 more for our retirement. Wins all around.

My College Savings Story

I would like to pretend I had a “back in my day college was the same price as a night at the movies, and I could work 4 hours a week at a part time job to cover the tuition” types of stories to share here.  Unfortunately, I am a millennial, and college was already very expensive.  I also voluntarily chose to attend a private university instead of one of the state schools I was admitted into, and I’m sure that didn’t help. You can read how I worked to keep my college expenses down in My College Savings Story.

NOTE

This article is also part of the Personal Finance Path to Financial Independence Series that you can find on the dedicated page above.  Feel free to start planning college now, but you might want to wait until you are adequately saving for your own retirement first. There is a lot of advice out there on how to start saving for your child’s college and not enough on when you should start (or whether you should at all).

TL;DR

Determine if you want to save money for your child’s college expenses and what amount to save.  Open a 529 college savings account and contribute accordingly to meet your goals.  Stack as many ways to reduce the cost of college as you can. The parent should be the owner of the account for FAFSA aid eligibility reasons. If you can, front-load the contributions early and let the account coast into the desired balance by the time they graduate. You’ll end up with the same result while contributing a lot less.

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