Everyone with children should contribute to a 529 plan. It is a tax-efficient way to save for college since none of the gains are taxable if used for approved college expenses.
Today, it costs about $200,000 in total for four years at the most expensive public colleges and about $400,000 for four years at the most expensive private colleges. With just a 5% compound annual growth rate, in 18 years, we’re looking at nearly $500,000 for public college and almost $1 million for private college.
Without saving for college in a 529 plan, you or your child might end up saddled with tremendous student loan debt. Or they might not be able to attend the college of their choice, which would be a shame if they worked diligently in high school.
If they can’t secure a well-paying job after graduation, they might not launch into adulthood for years. In turn, they might start feeling like a failure and hating the world. And if they hate the world enough, terrible things can happen.
Given the high future cost of college, most households focus on saving and investing as much as possible. Saving for college is one of the biggest strains placed on families today. However, it’s also worth considering when to stop contributing to your child’s 529 plan.
I’ve figured out the answer.
529 Plan Contributions: A Personal Reflection
As parents, we have a responsibility to educate our children and help them launch. It’s up to you how much you want to help pay for their college education. I’ve decided to save enough by the time they are 18 to cover all of it, if need be. My parents paid for my public college education at William & Mary, and I will pay it forward.
In 2024, I haven’t contributed to either of my two children’s 529 plans. It wasn’t intentional; I simply didn’t have enough liquidity to contribute. If I had money, I would have kept contributing like a zombie on autopilot. In turn, I may have ended up over contributing.
We were living paycheck to paycheck for six months after our house purchase in October 2023. During this time, our focus was on saving as much as possible to feel secure again. I also wanted to boost public equity exposure. Unfortunately, for our children, their 529 plans took a back seat.
I thought I would feel bad not contributing to their 529 plans. After all, we had super-funded both plans and we had been contributing to our son’s plan after the 5-year period ran out. But I actually felt relieved because I’m not convinced spending a fortune on college is a good idea.
Then it hit me. You’ll figure out when to stop contributing to a 529 plan just like how you know when you’ll reach your Coast FIRE number. For early retirement seekers, this logic makes perfect sense.
Coast FIRE and the 529 Plan
Your Coast FIRE number is the amount you need to accumulate in your investment portfolio where you no longer have to contribute, thanks to forecasted compound returns by traditional retirement age.
The formula for Coast FIRE is A / (1+r)˄t, where:
- A = the amount needed to achieve financial independence (FIRE), which can be calculated as 25X your expenses or 20X your average gross income
- r = the annual rate of return after inflation
- t = the number of years investments have to compound
For example, someone who is 30 and plans to retire at 60 will need an investment portfolio of $400,000 generating a 7% annual return to reach $3,044,000 upon retiring. The $3,044,000 can produce about $120,000 in passive investment income using a 4% withdrawal rate. Good enough for this person to live their desired retirement lifestyle.
We can use the same Coast FIRE number logic to determine when to stop contributing to a 529 plan. With college expenses, it’s much easier to model because we know what the expenses are today. All we need to do is figure out a reasonable expected college expense growth rate after calculating the current costs today. We know within a one-year timeframe when our children will go to college.
Stopping contributions once you’ve achieved your “Coast 529 Plan Target” is less risky than stopping contributions once you’ve reached your Coast FIRE target for retirement. College is usually only four years, while retirement could last for decades.
To put this Coast 529 Plan target concept to work, let’s use a case study of an Asian-American family with a seven-year-old boy named Jack and a four-year-old girl named Jill. They have a household income of $300,000, live in a modest home, drive a 10-year-old car, and highly value education.
The parents, aged 39 and 42, are wondering whether they’ve contributed enough to their two 529 plans so they can focus more on building up their retirement plans. Their net worth is roughly $2.3 million, including the value of the two 529 plans.
Jack will graduate high school and start college in 2035. Assuming a 5% annual growth rate, the cost of four years at a private college in 2035 will be about $684,000, up from $400,000 today. To be conservative, I’m using the total cost for four years at some of the most expensive private colleges, like USC and NYU. I’ve also rounded up the $400,000 cost today.
Ways To Pay For College
In this example, the parents want to pay for 100% of all college expenses from a 529 plan. However, households can pay for college through income parents earn while their kids are in college. College students can contribute by working part-time. Parents or students can take on student debt. Or, parents can even try to game the financial aid system to receive free money.
The parents say they are of average intelligence, hence, it is unlikely their kids will be geniuses who win academic scholarships. In addition, as Asian Americans, their kids don’t fit the profile for colleges to give them special treatment. Instead, their kids will likely have to try harder to gain the same chance of admissions. Such is life.
If we assume the worst financial outcome, there is upside. If we assume the best financial outcome, there is downside. Always assume the worst when conducting financial modeling.
Jack’s Current 529 Plan Balance With 11-14 Years to Go
After super-funding Jack’s 529 plan in 2017 and receiving contributions from the father, mother, and grandparents, Jack’s 529 plan balance hovers around $400,000. During the low of the 2022 bear market in October, his 529 plan balance was around $256,000. Hence, there is no guarantee his 529 plan will keep performing steadily by the time he attends.
Unfortunately, because his parents chose a target date fund, Jack’s 529 plan has significantly underperformed the S&P 500 by at least 30%. If they had invested 100% of the contributions in an S&P 500 index fund, he would have over $530,000 today. The plan’s compound annual return is only about 7.7%.
If your kid is still 10+ years away from attending college, it’s probably best to invest the majority of their 529 plan in an S&P 500 index fund. The potential returns will likely be greater.
The parents no longer need to contribute to Jack’s 529 plan because he has reached his Coast 529 Plan Target. Assuming a 5% compound annual growth rate over 11 years, the $400,000 will grow to about $684,000.
Given that all proceeds from a 529 plan are not taxed, Jack’s realistic worst-case college education costs are covered. His parents will not let him be a “super senior” and take five years to graduate. Instead, they will urge him to graduate in three years to save money.
How the 529 plan will be spent starting in 2035:
- One-fourth of the $684,000, or $171,000, will pay for his first year in 2035. This leaves $513,000, which may grow at 5% to $538,650.
- One-third of $538,650, or $179,550, will pay for the second year, leaving a 529 plan balance of $359,100. This $359,100 balance may grow by 5% to $377,055.
- One-half of $377,055, or $188,527, will pay for the third year. The remaining $188,527 may grow by 5% to $197,953, which will be used to pay for his senior year in 2038.
The risk is that a 5% annual compound return assumption may be too high or college costs rise higher than 5% a year. If the compound annual return is only 4%, the plan’s balance falls to $615,000, leaving them about $69,000 short. However, if that’s the case, the difference can be covered through active income, passive income, or Jack working summer jobs.
Once the compound annual 529 plan return drops to under 4% is when the shortfall will start to be significant. Beware.
Daughter’s Case Study On When To Stop Contributing To A 529 Plan
Their daughter, Jill, is four and a half and will likely go to college in 2038. Using the same worst-case assumptions, $400,000 for four years of private college today, with a 5% compound annual growth rate, will cost $791,972 in 14 years. But if the compound annual growth rate rises to 6%, we’re talking $904,000. Ouch!
With 14 years of growth to go, is $330,000 in Jill’s 529 plan enough to pay for all four years? Let’s run the numbers in a compound interest calculator. During the October 2022 low, Jill’s 529 plan was only $185,000. Unlike college tuition, sadly, 529 plan values can and will go down.
Jill’s 529 plan would need to compound at 6.5% annually for 14 years to reach $796,000 to pay for all four years at a private college.
While 6.5% is certainly possible, it’s a little aggressive given that most of her plan’s money is also in a target date fund as well. As the plan approaches the college start date, more money will be allocated to bonds to reduce “sequence of returns risk.”
Need To Save More In Her 529 Plan
A more realistic return assumption is 5% (not 6.5%), like the one I used for their son Jack. With a 5% compound annual return over 14 years, Jill’s 529 plan will grow to only $653,337. This leaves us short $138,635. To grow the plan to $791,972, which is the projected cost for four years of private college starting in 2038, she needs $400,000 today using a 5% compound annual growth rate.
As a result, the parents need to focus on contributing more to their daughter’s 529 plan. The problem is, they don’t have $70,000 lying around to make her plan worth $400,000 this year. Hence, their goal is to try and contribute $35,000 this year, followed by $35,000 next year.
Depending on performance, they will likely have to contribute another $20,000 the following year because they will have one less year of compounding. The four-year cost of college starting in 2025 will be around $420,000.
The Coast 529 Plan Target Amount
If you haven’t figured it out, once your child’s 529 balance equals the current cost of all four years of college today (private or public), you can stop contributing to the 529 plan. You’ve reached your Coast 529 Target Amount, which should grow at a similar rate, if not faster, than the cost of college.
Below is a chart I’ve modeled using $140,000 for a cheaper public college, $200,000 for an expensive public college, $240,000 for a cheaper private college, and $400,000 for an expensive private college for four years as a base case. I’ve increased these amounts by 5% each year until 2045.
These amounts represent your Coast 529 Target Amounts. Choose which route you’d like your children to take and save accordingly.
If your 529 balance is below these amounts for a given year, your goal is to keep contributing if you want to fully fund college. The one caveat is that once your 529 plan balance exceeds a certain amount, you’re not allowed to contribute anymore.
Currently, the balance limit ranges from $305,000 in New Jersey and Hawaii to $575,000 in Arizona. Hopefully, the law will continue to raise these limits as college costs rise.
The Coast 529 Plan Target amount where you can stop contributing might seem obvious now. But it wasn’t clear to me until I wrote this post. Before, I was essentially estimating how much would be enough and using my son’s balance as a barometer for my daughter’s balance.
The Simple Plan To Save Enough In A 529 Plan To Fully Fund College
Once you have a clear financial goal, it’s easier to achieve it. Do the following if you want to save enough in a 529 plan to fully fund four years of college:
- Superfund a plan before or once your child is born, or come as close to possible.
- Contribute the maximum annual gift tax exclusion amount after the five-year period post-superfunding is over. The current limit is $18,000 per person and will go up over time.
- Invest 100% of the 529 plan contributions in an S&P 500 index fund for 15 years or until you hit your Coast 529 Plan Target. Then, lower your equity allocation by a percentage equal to 50 divided by the number of years left until college begins. For example, if your child is five years away from college, reduce the equity allocation by 10% a year until you have a 50/50 equity/bond allocation.
- As long as the 529 plan balance is below the Coast 529 Target amount, keep contributing up to the maximum gift tax limit per person. If you can enlist help from grandparents, even better.
- Once you hit the Coast 529 Plan Target, stop contributing. If the plan balance falls behind that year’s estimated four-year all-in cost of college, then start contributing again.
Be as serious about contributing to your 529 plan as you are contributing to your 401(k) plan or other tax-advantaged retirement accounts. Over time, the balances should snowball to amounts of significance.
Change The Plan If Conditions Change
Obviously, there is a chance you might never hit the Coast 529 Plan Target amount. That’s OK. Just do the best you can by continuing to save and invest in a 529 plan. Your family will be much better off compared to a family who didn’t aggressively save and invest for college.
If you reach the legal limit for contributions to a 529 plan, then invest in a taxable brokerage account, real estate, or venture capital. Invest with a long-term time horizon.
One of my favorite investments to pay for college is buying a rental property when your child is born. By the time your child turns 18, your rental should generate enough income to help pay for college. Alternatively, you could sell the rental and use the proceeds to cover part or all of the college expenses.
During your savings journey, you might also decide that private college isn’t worth it. If so, you could cut your Coast 529 plan target in half by opting for a public college. The great thing about you is that you’re dynamic and no longer a zombie college saver!
Be Realistic About Your Children’s Abilities
If you think saving $500,000 – $1,000,000 for college per child is ridiculous, I agree! But I also encourage you to run the numbers in a compound interest calculator yourself. Just as college expenses will grow, so will your investments, most likely.
Lower your expectations of your children’s academic achievements and extracurricular prowess. Chances are, they won’t get straight A’s, score 1500+ on the SAT, or earn a bunch of merit scholarships. They also might not opt for the practicality of going to community college before transferring to a public college to save money.
The less you expect from your children, the more you need to save for college in a 529 plan. On the other hand, the more you expect from your children, the less you need to save for college. However, you also face a higher chance of disappointment with high expectations.
Carefully observe your children’s intelligence, work ethic, and talents. By the time they are 14, you will know whether your child is “gifted and talented” or just an average person.
If you are fortunate enough to have money leftover in your kids’ 529 plans, roll over as much as you can into Roth IRAs for each child. Then, choose new funds to invest that’s left over in the 529 plans and hopefully use the funds for your grandkids.
I’d much rather gift a 529 plan to fund higher education than just money. Wouldn’t you? You shouldn’t fear over-contributing to a 529 plan because it is one of the best ways to tax-efficiently transfer generational wealth.
My Additional Investment Beyond The 529 Plan
Since I’m willing to invest $500,000+ in two 529 plans to pay for college, I’m also willing to invest $500,000+ in various public and private artificial intelligence companies that might make their education obsolete. AI is my hedge as well as my potential home run investment.
With the way technology is progressing, millions of well-paying jobs could be eliminated in the future. We constantly see the Millennial generation (born 1981-1996) complain about the Boomer generation (1946-1964) for having it so easy with cheap housing and plentiful jobs.
I’m sure Generation Alpha (2010-2024) will complain when they are adults about how my generation, Generation X (1965-1980), had it so easy too. What luck to be able to invest in AI early on, along with own cheap housing and have plentiful high-paying jobs too. Of course, nothing seems cheap today. But I’m pretty sure they will 20 years from now.
We parents must invest for our children’s futures because they are unable to do so for themselves. We must also impart as much wisdom as possible before they leave home. If we can do these two things, we should be able to rest easy knowing we did our very best.
Reader Questions and Suggestions
How do you figure out when to stop contributing to a 529 plan? Do parents and grade school students realize how expensive college will be in the future? What do you think is a reasonable college expense growth assumption into perpetuity, if not 5%? Are parents expecting too much out of their kids and not saving enough for college?
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