Striking right balance on 529 amount
PETE THE PLANNER
Q. Is there a good plan for reaching the right 529 target balance? Our goal is to pay for our boys’ instate college tuition, room, board and fees. Our oldest is going to be starting first grade, and the youngest has a year before he’ll start kindergarten. I am concerned we could overfund the 529s, which leads to taxes and penalties if we have excess funds which would not be used for education. If you use today’s cost, I believe we already have about 25% saved.
I know this isn’t an exact science and that market fluctuations and inflation/ cost increases will be factors but wondering if we should continue funding at the current rate, then stop upon reaching our dollar target or if we should reduce current funding now and continue to invest for the next 10-12 years. — Amy
Time alone should double your current balance in about 10 years, which could mean your one-fourth funded turns into one-half funded without any additional effort. In other words, funds when properly invested should compound every 10 years or so. Your focus should turn to getting as many funds stored away for college as soon as possible so that this compounding effect can do the heavy lifting for you.
I do think 529 plans are a good vehicle to use for college planning, although there are some alternatives that have advantages.
For instance, some people like to aggressively fund their Roth IRA instead of a 529 college savings plan because it can be used for both retirement and college expenses, which means you don’t have to worry about overfunding. But I don’t really like that method. I prefer not to commingle college and retirement funds. Retirement is my No. 1 priority, and paying for my kids’ education out of those funds is contrary to my goals.
As you mentioned, if you overfund your 529 accounts and choose to use the money for non-eligible expenses, then you have to deal with a 10% penalty and taxation on the accounts earnings (not deposits). Don’t forget, you can always change the beneficiary on an account, which would allow you to use excess funds for another family member’s education.
You may also consider the obligation elimination strategy that I’m utilizing. My mortgage, like the majority of Americans, is my biggest monthly expense. When it goes away, we will have a huge monthly surplus. This will allow us to pay for college as a monthly expense, if for some reason we don’t have enough money in our 529 plans. By utilizing this strategy, I don’t worry about overfunding or underfunding because I’ll have a backup funding strategy if there isn’t enough money in the 529 accounts.
You won’t really need to slow your funding until about four or so years prior to college. At that point, some of the many variables will start to clear, and time will have been working for you, as opposed to against you. Now is the time to make tomorrow easier, and the only way to do that is to get as much money working for you today as possible.
Note: Peter Dunn appears in 529 college savings plan commercials as a paid endorser. He is an author, speaker and radio host, and has a free podcast: Million Dollar Plan. Email him at Ask Pete@petetheplanner.com