• Matt Morizio

College planning part 2: What if you didn't use a 529?


My 529 post from a couple weeks ago raised some eyebrows, so let me elaborate.

But before I give a few hypothetical alternatives to dumping all your money in a 529 plan let me explain my personal situation.

Because I’m a financial advisor, a lot of people assume I have it all figured out.

Spoiler alert: I don’t. Where I’m at now and where I plan to be in the future are very different.

Right now I put money in a general investment (aka taxable) account, and I trust our investment strategy to grow it over time. This account will give me ultimate flexibility with both investment and spending options.

I plan to combine taxable accounts with Roths because I like the short and long term flexibility they provide me, but the truth is I currently don’t have enough disposable income to do everything I want.

And in the spirit of transparency, here’s a little more on that “not having enough disposable income.”

2006 to 2011 - I played minor league baseball where my largest salary was $1,400 per month for five months out of the year. Including offseason jobs, I made less than $10,000 every year.

Fall 2011 - After being released from baseball in the Spring of 2011, I enrolled as a full time student for my final semester of college at Northeastern with a degree date of January 2012.

February 2012 - I had my first child. I had no job, a bad resume, and now my wife was out of work.

April 2012 - I finally landed my first “real“ job, supporting my family of three on $40,000 per year (My wife has stayed home with our kids since day 1, God bless her.).

2013 - 2016 - I had three more children, bought a home, and bought another car. I was in a sales role, so my salary was growing, but so were my expenses, by a lot.

January 2017 - As the sole provider with four kids and a wife, a mortgage, two cars, etc, I took a cut in pay, started from scratch, and changed careers to become a financial advisor with Beck Bode. Scary move? Yup. Best decision I could have made? No doubt.

November 2017 - I had my fifth child. The expenses continued to climb while my take home pay fell.

Present - No, I can’t build five substantial nest eggs to pay for my children’s college tuition. I am not able to set aside 30-50% of my gross income to ensure financial independence in 30 years. And I am not maxing out all retirement options right now.

And it’s ok.

These things will come; I’m confident in that. I believe so strongly in what we do for people at Beck Bode that I’m willing to eat a little dirt in the short term to create the future I know I am capable of, and more importantly help others create theirs.

There is a misconception that people in my world have their financial lives in perfect order.

Now you can see it’s a work in progress for me just like it is for you.

On to the hypothetical situations.

**Warning - I cannot predict the future, so these situations are entirely hypothetical. I can almost guarantee they will NOT play out exactly as follows. Take this with a grain of salt.**

Situation 1

A married couple files their taxes jointly and earns over $199,000, the income limit to open a Roth IRA for couples filing jointly, so they debate whether to open a taxable account or a 529 plan for their two children, a three year old and a newborn, 15 and 18 years to invest respectively before college starts.

Morningstar, a well respected site that analyzes funds, rates Nevada’s Vanguard 529 Plan among the top 529 plans in the country, giving it a gold medal, and the couple heard through the grapevine Vanguard funds are cheap, so they compare NV’s 529 to Beck Bode’s Growth Strategy, which they would use in their taxable account. They plan to start with $50,000 and never add money to the account.

After working through the confusion of which Vanguard option to pick (snapshot of SOME options within Nevada’s plan below), they select the Morgan Growth Portfolio.

Assumptions:

- 5 year return for their 529 stays at a constant 14.81% (nearly impossible)

- 4.75 year return for Beck Bode’s Growth Strategy stays at a constant 16.13% (also nearly impossible)

- The couple earns over $479,001 to put them in the maximum 20% long term capital gains tax bracket (for reference, earnings between $77,201 and $479,000 for couples filing jointly pay 15% capital gains).

- Family starts with $50,000 and never contributes another dollar to the accounts

-18 total years until their youngest starts college

- Money compounded annually

Taxable

529

Since capital gains equal 20% of $687,852.70, or $137,570.54, that leaves $600,282.16 left for two college tuitions in the taxable account versus $600,627.08 in the 529.

This couple should opt to invest in the taxable account. Assuming they are willing to forego the few hundred dollars they gain using a tax-free 529, the flexibility of spending options the taxable account provides is invaluable.

Why?

They can’t predict the future. In the event either of their kids do not attend college/they attend a cheaper school/the college bubble bursts/they earn a scholarship to lessen the tuition burden/etc, the flexibility of a taxable account over the restrictions a 529 puts on their money will be in their favor.

Situation 2

Another couple who is married and files jointly earns $150,000/year. They fall below the Roth IRA income limits, so they are debating whether to use a combination of Roths and a taxable account or dump all of their money in a 529 for their two children, ages eight and four, 10 and 14 years respectively to invest before college starts. They plan to start with $10,000 in the account and will contribute a total of $16,000 annually toward college. Let’s say they use the same 529 plan as the previous example, and they intend to use Beck Bode’s Growth Strategy in both their Roths and taxable account.

Assumptions:

- 5 year return for their 529 stays at a constant 14.81% (nearly impossible)

- 4.75 year return for Beck Bode’s Growth Strategy stays at a constant 16.13% (also nearly impossible)

- The couple earns $150,000 putting them in the 15% long term capital gains bracket.

- Family starts with $10,000 and contributes another $16,000 annually: either $11,000 in two Roth IRA’s and $5,000 in a taxable account or all $16,000 in a 529.

-14 total years until their youngest starts college

- Money compounded annually

Roths

Taxable

529

In this case, capital gains tax is 15% of $240,478.56, or $36,071.79. That means the total amount to contribute toward college when combining both the taxable and Roth accounts = $284,407.33 + $164,000 of Roth contributions, or $448,407.33 versus $758,204.61 in the 529.

In this situation, the couple has to discern how much they want to save for college tuition. Although nearly $760,000 sounds absurd for two 4-year degrees, it’s entirely possible that college will cost that much or more in 14 years.

They are left with the question, “Do we want to maximize college savings and hope our kids attend school/the bubble doesn’t burst/they don’t get scholarship money/etc, or do we want to pay less toward college but have flexibility with how we can spend our money should the future not pan out as planned?”

One last point to consider in this example, the remaining interest in the Roth, assuming that rate of return remains constant (which is almost guaranteed not to happen), could grow for another 40+ years when their youngest is retirement age to an astonishing $200+ million.

Key takeaways:

-If your returns in a taxable account outpace your returns in a 529 by more than 1.3%, the final amount you have for college is relatively negligible, but the flexibility in spending is huge.

-You need to consider the unpredictability of the future when planning for college.

-Projections like this are useful in concept but entirely fictional when forecasting actual numbers. Nobody knows what the future has in store.

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Investment advice offered through Beck Bode, LLC, a fee-only Registered Investment Advisor in the Greater Boston area.