Going through old mail on my first day of vacation, I realized that I had not deposited any money into my niece and nephews’ 529 plans this year.
I dug out the quarterly account updates, with attached contribution forms. The plan helpfully shows the current totals in each account, and, on another page, the contributions to date.
Reviewing these numbers, I thought it might be worthwhile going over why I think putting money in a 529 plan is worthwhile, even if my strategy isn’t perfect. As a side note, they also show why investing over time is a great idea.
What is a 529 plan?
First, a recap of the 529 plans (see also savingforcollege.com for more detail than I will ever write):
A 529 plan is a savings vehicle for education–originally for post-high school education only, now one can use it for earlier years if desired.
The great advantage of the plan, however, is the ability to invest the money and have the returns compound tax-free until the money is used (for education), so the longer you can keep the money in the 529 plan, the better.
Ideally, one puts money into an account over time, and sees the the money grow over time. You can (have to) choose what to invest in–you could keep it in cash for years, but then you would lose out to inflation. Some mixture of stocks, bonds and cash seems to work out well; taking more risk when the child is young and college tuition is far away, then transitioning to safer funds (cash, bonds) as the time nears to start writing tuition checks.
Most plans allow for adjusting investments once a year.
Although I write about writing checks for tuition, the money can also be used to pay for “reasonable” housing and food costs, books, etc. Think: paying for a dorm room and a meal plan, or the equivalent if the student lives off campus.
What does this look like for me?
I use after tax money (there is no federal tax break, unlike with retirement funds), and send it to the plan(s) I set up for soon after my niece and nephews were born. Money is automatically invested into a target date fund so that I don’t forget to put it in the market.
I do get a tiny tax break on my state income taxes. It’s not much, but I’ll take it.
When it is time to use the money, I can send it to a college bursar, without paying taxes on any of the gains.
If one of my nephews runs off to join the circus, or eschews school to start a garage band, I can choose to wait this phase out, and see if they decide to attend; or I can tell them “tough luck, kid,” and re-direct their money to their sibling or cousin.
My brother, sounding like the fox complaining of sour grapes, states he doesn’t think a 529 is worth it. There are management fees (true) and not much in the way of tax savings (see above).
However.
As the “rich doctor aunt,” I know that I will likely be asked to help with college. Even if I’m not asked, I will probably want to help.
I and my siblings were able to graduate from college debt-free, and that is a gift I would like to be able to pass on to the next generation.
Time in the Market
Knowing this, I started a 529 plan for each of my sister’s and brother’s children, as soon as they had a social security number. The initial contribution was generous, but not huge; when they were little, holiday presents went here. Now, they get a yearly contribution, usually in April or May (after I pay taxes).
There is no doubt that I pay fees with my plan. The plan ranking has dropped over the years, suggesting that the fees might be worse than for other plans. I am sure that those who like to optimize their finances would advise me to roll this plan over into another state’s plan; Utah and NY state come to mind.
Nevertheless, despite the relatively small contributions I have made each year, and the fees, and the vagaries of the stock market (with drops in 2008 for the eldest, and in 2020 and 2022 for all of them), I think the children are coming out ahead.
For the youngest, his funds are worth 32% more than my contributions (this does not truly reflect his investment rate of return, as money has been added yearly).
For the next youngest, her funds are worth 48% more than my contributions.
For the second oldest, his funds are worth 68% more than my contributions.
And for the eldest, with the longest time in the markets, his funds are worth 87% more than my contributions. (Had I not lost my nerve during the Great Recession, and kept investing in 2008/2009, I am sure he would have had even better returns.)
I know past returns are not guaranteed, and that fees always impact returns; however, that extra 32-87% is a whole lot better than the 0% returns those kids would have if I didn’t invest money for them at all.
Will this money pay completely for college for 4 kids? Absolutely not. However, a full semester, maybe two, is not out of the question. And that’s assuming I don’t start contributing more to their 529 plans.
A sinking fund, with benefits
In total (so far), I have contributed for 16 years to college funds. In no year did I feel a real pinch with each check.
When the time comes, I can write that check without any pain whatsoever. That money was put away a bit at a time, grew tax free, and can be used tax free to send them to college.
The alternative: digging into my pocket for $20 to $30 K each (sometimes double that, as several are close enough in age to be in school at the same time). I’ll have to pay taxes on that money, all the while trying to decide how much I really want to give.
I think the kids and I are better off with the 529 plans, fees or no fees.
Do you use a 529 plan?