The Pros and Cons Of Front-Loading A 529 Plan

Pros and cons of front-loading a 529

Pros and cons of front-loading a 529Mrs. Financeforthefamily and I want to pay for our 4 children’s eduction.  Our parents helped pay for most of ours.  We have decent incomes so we feel that we should be able to help.

We also think that our incomes and assets may pose challenges in getting loans in the future.  Our children are currently 9, 7, 3, and 1 so we have 9, 11, 15, and 17 years, respectively, to fund their college savings accounts.

Will Our Children Even Go To College?

 

College is not for everyone.  However, we anticipate our children will likely go to college.  Our parents went to college, we went to college.  Our parents immigrated to this country for opportunity and education.  We stress the importance of college at home.  College is the cost of entry into the marketplace.  College educated individuals statistically earn more than folks who did not attend college.

That’s not to say that college is for everyone.  That’s also not to say that only college educated folks are more successful than non-college educated folks.  There are plenty of people who went to college, but can’t find a job.  There are also many people who didn’t go to college, and are millionaires.  Statistically, however, there’s a much better shot at a steady job with a decent income if one goes to college AND chooses a major that is desired in the marketplace.

How Much Will College Cost?

 

College tuition has been increasing faster than inflation.  Using a simple college calculator, below is the estimated cost of college for our 4 children (tuition, room, board, books, & fees) when they start college at the age of 18.  This assumes a 5% growth in tuition cost, which I believe is conservative.  I don’t even want to imagine the cost of college if tuition rises faster than 5% per year.

 

In-State Public University (future cost)
  1. 9 year old – $179,261
  2. 7 year old – $197,259
  3. 3 year old – $238,858
  4. 1 year old – $262,839

TOTAL: $878,217

Private University (future cost)
  1. 9 year old – $359,251
  2. 7 year old – $395,320
  3. 3 year old – $478,686
  4. 1 year old – $526,746

TOTAL: $1,760,003

Yikes!

Our Plan To Pay For College

 

There are many ways to fund your child’s college including coverdell account, pre-paid tuition, minority accounts, and using a Roth.  For reasons I won’t go into in this post, the 529 is the best option for us.  It’s flexible, offers tax benefits now, offers tax benefits in the future, and can be passed along to other family members.

We also plan on cash-flowing any difference.  I’ll be 41 this year.  I calculated I’ll start paying for college when I turn 50 and paying for every year after that for 10 years with some years paying 2 tuition bills!

Here’s what we have currently in 529 Plans along with their future value at age 18 (assuming a 6% growth on investments in the account)

  1. 9 year old
    1. Current Value of 529 – $113,825
    2. Future Value of 529 – $192,304
  2. 7 year old
    1. Current Value of 529 – $104,170
    2. Future Value of 529 – $197,745
  3. 3 year old
    1. Current Value of 529 – $75,381
    2. Future Value of 529 – $180,654
  4. 1 year old
    1. Current Value of 529 – $53,105
    2. Future Value of 529 – $142,999

TOTAL FUTURE VALUE of 529 PLAN ACCOUNTS: $713,702

In-State Tuition Difference: $164,515 ($878,217 – $713,702)

Private Tuition Difference: $1,046,301 ($1,760,003 – $713,701)

Yikes!

Ok, let me address how we even saved up this much already.  Ever since our first child was born, I used to set aside a small amount (about $250/month) into a 529 plan.  I just cash-flowed this amount.  We did the same when all the other children were born.

It was a good plan until I did this very calculation about 2 years ago.  I calculated that when my kids start college, I would have a ton in my taxable investment account, and not enough in the 529.  I could have continued the plan and just funded the difference from the taxable account, but that’s just the problem.  Its taxable.  Money in a 529 plan is not taxed.  So I took out a lump sum out of my taxable account, paid the tax, and front-loaded all the 529 accounts to the max last year.  I plan on taking a lump sum and doing it again this year.  I also stopped the monthly contributions to the 529 plan.

Step 1: The 529 Plan

Benefits to Front-Loading

The maxximum you can front-load a 529 in a single year is $30,000 per child ($15,000 per parent).  Assuming you have a long time horizon, you can take advantage of compounding over a long period of time on a large sum.

The research shows that if you have a lump sum to invest, then invest it all now.  Do not use dollar-cost averaging.

The other benefit is that you will never pay tax on the gains.  That could be a huge tax savings if you are planning on funding your child’s education.

There’s even the option to super front-load your 529 with 5 years worth of contributions!  Federal tax rules allow annual gifts excluded from gift taxes of $15,000 per child or other recipient per year.  That equates to a $150,000 contribution ($75k per parent) in 1 year...imagine the compounding on that over time.

Downsides to Front-Loading

The money is locked into the 529 plan.  You HAVE to use this money for higher education or pay a penalty if you want to withdraw it for any other reason.

If you have a lump sum in a taxable account right now, you will have to sell the assets and pay tax on any gains.  We paid a small tax bill when we sold our ETFs.

Step 2: Cash-Flow

As shown the calculations above, if we don’t add anything to our kid’s 529 plans ever again, we will fall a little short in covering their full ride.  That leaves us two options:

  1. Take out a loan
  2. Cash-flow the difference

We think we’d be able to cash flow the difference if they attend an in-state school.  If they attend a private university, we’ll have to explore our loan options.

Any thoughts on our approach?  Could we be doing anything differently?

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