Cheating Our 529 College Savings Plan

Money Babies for 529 College Plans

It’s almost the end of July and despite our best intentions, Johnny and I still haven’t started contributing to a 529 college savings plan for our future scholar, Sally. When we wrote about 529s in a post last November, we calculated that we wanted to save $30,000 for her college tuition. If we saved for the next 17 years, we would need to save $104 per month. Johnny informed me that that’s a lot of Wendy’s Junior Bacon Cheeseburgers that we’re sacrificing every month. I informed him that that’s disgusting.

But here we are, over six months later, and we haven’t contributed a single cent. Yet. But that doesn’t mean we haven’t been talking about it. And as we’ve been talking about it more, Johnny and I came to the decision that we’re no longer going to save $104/month for the next 17 years. Sorry, Sal. After you threw my potted plant and my iPhone this weekend and broke its screen for the second time, we’ve decided you’re on your own. Kidding. But, seriously, don’t do either of those things again. Ever. So instead, we’ve decided to contribute two big chunks of money this month and early next year. And here are the two reason why:

Our Sitting Savings

We just renewed our lease at the condo we’re renting. And that means we won’t be buying a home for at least another year. That said, we’ve already saved up enough for a down payment for a modest house, and so we have a decent chunk of savings just sitting, bored out of its gourd and fighting to keep up with inflation. And with our “best in the market” savings interest rate nearly at a whopping 1%, inflation is beating the pants off our dough.

So here’s what we’re thinking: we’re going to take $7,500 of our savings and put it into a 529 for Sally the next two years. We’ll keep saving and putting money into our savings account as usual so that we’ll replenish our fund with the $7,500 (and hopefully more) we’re taking out. And assuming everything works out (famous last words, I know) we’ll do the same thing early next year. The end result? We’re still on track with our housing fund AND we’re (hopefully) done saving for Sally’s college fund. FOR-E-VER. So how does that work? Glad you asked…

Compounding Interest

By putting in a large chunk of money now, rather than small chunks of money over the next 16 years, our 529 savings will have the chance to have a lot more money babies over a longer period of time.

Here’s a hypothetical. Let’s say you wanted to save $100k for your child’s education. You have 18 years to save with an average interest rate of 8% (minus inflation). Here are two different options.

OPTION 1: Fun Size Contributions

  • Contribution: $280/month x 18 years
  • Total contributions: $61,200
  • Total 529 savings: $100,000

OPTION 2: King Size Contributions

  • Contribution: $22,000/year x 2 years
  • Total contributions: $44,000
  • Total 529 savings: $100,000

With option two, you contribute far more up front, but end up contributing $17,000 less. The question is, how many of us just have $22,000 laying around, ready to throw at whatever we please? Not many. In fact, the maximum an individual can even contribute to a 529 each year is $14k (while a couple can contribute $28k). The point of that hypothetical is to once again show the power of compounding interest — it pays to keep more money for a longer period of time.

A few other things of note:

  • The total we plan to save for our children’s college is lower than some because the school we have in mind for them to attend (our alma mater) is very economical. If our kiddos decide to attend a different, more expensive school, that’s totally fine. That just means they’ll have more expenses to cover on their own.
  • Based on the feedback the last time we mentioned 529s, we’ve decided to put the 529s in OUR names, rather than Sally’s. That way if Sally decides not to go to college and instead become a trapeze artist (since that happens all the time), or if she doesn’t use/need all the money we’ve saved up for her, we can gift that money to one of her younger siblings. If she treats other little kids the way she does my potted plants, we may never be comfortable giving her a younger sibling. Kidding again. Sorta.
  • In our research, we’ve also realized that sometimes it doesn’t matter which state you choose to use to open up your 529. The tax credit received is almost negligible in our state (Utah), and the more important issue seems to be choosing a plan with good investment options with low fees. We’re big fans of Vanguard, which is where we’re doing all of our retirement investing for our Roth IRAs, so we’re in the process of deciding between a few different options that they offer.
  • Saving for your child’s education should fall pretty far behind other financial priorities: emergency fund, debt, and retirement. In the case of retirement, you can likely save for both concurrently, but don’t sacrifice funding your retirement.

Would you consider funding your 529s in large chunks? Obviously, it wouldn’t be an option for us if we’d already pulled the trigger on buying a home. But since we’re still not homeowners (sad face), we’re going to put our savings to work in the meantime.

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  • Reply Retired by 40 July 21, 2014 at 8:42 am

    Love it! The math seems counter intuitive, but once you sit down and actually think it through, it makes total sense! Plus, I love that you’re really hoping for an affordable school for Sally. Too often, expensive schools are played up, and you really aren’t getting a better education for the money.

    • Reply Joanna July 23, 2014 at 1:22 am

      Agreed, for the most part. If our kids choose an expensive school, we’ll support them as much as we can, but financially we’ll only have so much to give!

  • Reply Tarynkay July 21, 2014 at 9:54 am

    Oh, I think you called it. Sal is totally going to be a trapeze artist. I thought our son was set to be a sumo wrestler, but then he started to lean out, so maybe not.

    I like the idea of putting the 529 in your names- can you then use it for things other than education? Like can you transfer it into retirement or something if she and her younger siblings decide to join the circus instead of pursuing higher education?

    • Reply Wade July 21, 2014 at 2:22 pm

      Verify a 529 can be transferred from parent to child. I know money can go from child to child, but there are rules governing transfers. I heard a Dave Ramsey call and he said 529 money cannot go from parent to child. I never confirmed that. Maybe it varies state by state.

      • Reply Joanna July 23, 2014 at 1:29 am

        The research I’ve done says that a 529 can be transferred from parent to child. I’ve also read several articles that recommend that method so the parent has more discretion over the money.

    • Reply Joanna July 23, 2014 at 1:25 am

      Perhaps we’ll have a family of circus children!! The 529 can still only be used for education, but we’ll be able to more easily choose which child the money goes toward.

  • Reply Michael July 21, 2014 at 10:47 am

    I have a very limited understanding of how the 529 savings plan works. What are the advantages of putting your money there vs. a good mutual fund?

    Seems like a good way to go about it since you’re able to and you don’t yet have house fever.

    • Reply Danny C. July 21, 2014 at 11:57 am

      The 529 provides tax-exemption status on all of the earnings of your contribution, as long as the money is eventually spent on education related expenses. There is also typically a state-level tax deduction or credit to encourage savings.

      The only drawback is that it is earmarked for education and can’t be reversed without penalty. You can always change who it is intended for if one child decides not to go, such as another child, grandchild, or other relative.

    • Reply Joanna July 23, 2014 at 1:32 am

      Great points by Danny. You put money in a 529 post-taxes, and it won’t be taxed again. Money you put in a mutual fund will have a capital gains tax applied to it.

  • Reply Danny C. July 21, 2014 at 12:04 pm

    If you guys do end up going with one of your state sponsored plans, it would probably be worthwhile to consider if a tax efficient strategy is worth pursuing. I know for Arizona, it is a tax deduction of up to $4,000 per year for a married couple, which doesn’t add up to much in lowering your total tax bill, but it is something. If Utah is similar, it may be worth scheduling the max tax-deductible contribution over a couple more years to get the maximum tax benefit.

    • Reply Joanna July 23, 2014 at 1:33 am

      Thanks for the pointers, Danny! We’ll look into it!

  • Reply Nadine July 21, 2014 at 2:15 pm

    Hi Joanna,

    Let me first say your future scholar Sally IS adorable. Your approach makes perfect sense, and you bring up a very good point most people don’t realize. You can open a 529 account in any state you want, you don’t have to live there. My daughter is keeping her money at home in Colorado where they let residents who invest in a 529 plan deduct from their state taxable income the entire amount of the yearly contribution. Yes entire amount!

    Taking this first step can be challenging. We see this everyday here at giftofcollege and agree that opening a 529 account, which is dedicated to college savings is a move in the right direction. Next step is automating deposits, which forces you to pay yourself first. Then encouraging friends and family to contribute can be as easy as signing up for our registry and planting your link on Facebook. You’d be surprised how relieved relatives are to be able to pull out a credit card and fast-forward their gift giving. While following you they will share in the hopes, dreams and progress of your child’s future.

    Sally I wish you luck and please stop by and visit us. We are going to be running a contest in August where we giveaway multiple $100 prizes toward college savings plans.

    Hope to hear from you!


    • Reply Joanna July 23, 2014 at 1:35 am

      Great reminder on ways to have friends and family contribute. If and when we have another baby, I might put that on the table since we won’t need any additional baby gear. There’s no better gift!

  • Reply Wade July 21, 2014 at 2:20 pm

    Not being sure that any of our 3 kids will with 100% certainty go to college, we opted for a dual approach. A 529 and a taxable account at Vanguard for each kid. The 529 is a combination of monthly $100, some one time deposits and $1,000 on each birthday. The Vanguard taxable account is also $1,000 on each birthday with some lump sums. I keep taxable pretty “safe” 25% stock index, 75% tax-exempt bond index fund. Vanguard funds are in parents names, but have 1 account “designated” for each kid.

    Taxable money could be college, housing, a car. It all depends on what happens. I was worried that a kid won’t go to college or on the other end get scholarships and we have too much in 529.

    If you can drop $22k in for 2 years, that is a great option. Let it grow and compound. $100k should pay a good chunk of a reasonable college education.

    • Reply Joanna July 23, 2014 at 1:37 am

      Very cool. I love hearing how other people do it. Johnny and I obviously haven’t ironed out all the details yet, so hearing your point of view is really helpful! I really like that you mix the 529 with a taxable account for each kid. Thanks for sharing!

  • Reply Brian July 21, 2014 at 2:24 pm

    We opened a 529 in our home state for two reasons:

    1. The fees are pretty reasonable, not the best not the worst.
    2. 20% state tax credit (refundable) for the first $5K put in each year. I don’t know too many investments that get me a 20% return that quick.

    We are BLESSED because my dad wants to make sure his grandkid(s) can go to college, so he alternates putting $5K into my kids’ 529 and a 529 he set up for my sister’s kid. Of course, he is always looking for a way to lower his state tax liability. It is just so hard to shelter money in my home state.

    • Reply Joanna July 23, 2014 at 1:38 am

      What an awesome grandparent. And 20% return? Not too shabby! Your kid is gonna be set!

  • Reply MomofTwoPreciousGirls July 21, 2014 at 7:16 pm

    Thanks…I went from being concerned about my kids college to obsessing over fun size snickers and king size kit kats…boo hoo

    • Reply Joanna July 23, 2014 at 1:40 am

      Those names might have made an appearance because I likewise couldn’t keep them out of my mind! They *might* have been the fuel that got me through writing the rest of this post :).

  • Reply Rob July 21, 2014 at 10:25 pm

    Sounds like a plan, guys. In our case, being Canadians, we didn’t contribute to a 529 plan but rather to its RESP equivalent. When each of our 2 kids were born we set up an RESP plan for each of them, electing to make automatic monthly contributions (for easier budget purposes), rather than making lump sum amounts. Mind you, given that this all happened years ago (when income / expense levels were a lot lower than they are today), our monthly contributions were a lot lower than the $104/month that you mention. Of course, in addition to these RESP plans, we were throwing any additional $$$ that we might have saved into other private investments that could later be used to help fund our kiddos’ education expenses, if needed. So, starting off with monthly RESP contributions for our daughter, it wasn’t too hard two years later to also start to contribute monthly contributions to a 2nd RESP plan when our son came along. Granted, we didn’t benefit from compounding (from bulk contributing) but, given today’s low interest rates (which have been around for some time now), is that much of a consideration? Anyway, it’s really a personal decision that parents must make, having analyzed all the pros and cons that best meet their situation..

    • Reply Joanna July 23, 2014 at 1:43 am

      The low interest rates we’re referring to are in our current savings account. And while putting our money into a variety of investments exposes us to a little bit more risk, we’re confident that we’ll not only beat inflation but have that money working for us (and Sally) for the next 16 or so years.

  • Reply Halsy July 22, 2014 at 7:30 am

    That is awesome you were able to put a huge chunk in at once! We just used our savings to buy a larger house but I would have never thought to do something like that with the money! This is a good reminder we need to set up a 529 for our youngest (born in May) and do our oldest daughters birthday contribution. We have no set amount decided for 529 we just put in what we can when we can. However, we do a birthday contribution and also encourage family to contribute as gifts for birthday, Christmas etc.

    • Reply Joanna July 23, 2014 at 1:45 am

      I like how you think, Halsy! What a great idea to do a birthday contribution. I have a feeling that with future kids we won’t be able to do a large chunk of money at once like we are with Sally, so that’s an awesome idea we might just have to steal!

  • Reply Newlyweds on a Budget July 22, 2014 at 7:08 pm

    I think that sounds like a fabulous idea and you guys are in a good position to put a lot of savings right now. So worth it! Most families aren’t that lucky so I think you should take full advantage.

    • Reply Joanna July 23, 2014 at 1:45 am

      Thanks! Fingers crossed it pays off!

  • Reply M.C. Sommers August 27, 2014 at 10:56 pm

    So I found your site through a link in your instagram and I have been going back reading all of your posts. I am a huge personal finance nerd and so I am loving it. I had honestly never thought of saving for Rory’s education this way. It’s really smart. It can be hard to come up with a chunk of change, but it’s nice that you can make two deposits and then really not think about it. We currently have several savings goals so I’m not sure we could swing putting that much into a 529, but I’m thinking of doing a much larger yearly deposit instead of our small monthly ones.

    • Reply Joanna August 28, 2014 at 1:17 pm

      Hello! I always wonder who the closet personal finance nerds are out there. I figure the longer we wait and the more children we have, our expense are just going to increase. So doing it this way now will make it easier. With any future children (whenever that day may come), I really like your idea of a yearly deposit. Glad you found our site! Enjoy hearing your thoughts!

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