Determining How Much To Contribute To A 529 Plan: Too Much No Good!

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Wondering how much to contribute to a 529 plan? This article provides a proper framework for 529 plan contributions by age. The idea is to contribute enough so that the 529 plan can comfortable cover most, if not all of your child’s college expenses when the time comes.

For background, I am a father of two young children. Both of their plans were superfunded the years they were born. This way, I got their college savings out of the way so I could focus on other things.

The 529 Plan Has Gotten More Attractive And Valuable

Because of the passage of the SECURE Act and SECURE Act 2.0, the 529 plan has received a functionality boost in 2020.

A 529 plan can now be used for:

• All college tuition and qualified expenses
• $10,000 a year for K-12 tuition and qualified expenses
• Apprenticeship programs and qualified expenses
• $10,000 to pay down a qualified education loan repayment for each of a 529 plan beneficiary’s siblings
• Any leftover 529 plan funds can be rolled over into a Roth IRA starting in 2024.

Conditions Of Rolling Over 529 Into A Roth IRA

With the Secure 2.0 Act, there’s a rollover allowance that starts in 2024 and comes with several limits. First is that the amount rolled over can’t be more than the Roth contribution limit, which is $6,500 this year. You also can’t roll over more than $35,000 total in the beneficiary’s lifetime. You also can’t roll over contributions or earnings from the past five years.

Another condition is that the 529 plan must have been open for at least 15 years. Experts are unsure whether changing the account beneficiary requires a new 15-year waiting period. Also unknown until the IRS issues rules is whether withdrawals of earnings from 529 plans transferred to a Roth account will be subject to the rule that requires earnings to remain in the Roth account for at least five years.

However, the rollover contributions aren’t subject to the Roth IRA income limits of $153,000 for single filers and $228,000 for joint filers this year.

Contributing To A 529 Plan Makes A Lot Of Sense

Given these benefits, if you have kids, contributing to a 529 plan makes even more sense. Always maximize the purpose of your money by taking advantage of any benefits the government throws our way. Goodness knows they tax us hard-working citizens enough!

After a strong year in the stock market, I decided to take a look at my son’s 529 plan. Although it underperformed the S&P 500, it still reached a level that made me question whether it’s possible to contribute too much. That’s right, when determining how much to contribute to a 529 plan, too much might be no good.

Our 529 Plan Performance Review

After superfunding my son’s plan at the end of 2017 with $70,000, my wife contributed $45,000 between 2017-2019. My mother also contributed $30,000 between 2018-2019 for a combined total contribution of $146,500.

At the end of 2019, the 529 plan finished the year at $189,911.45. Therefore, $43,411.45 has been gained tax-free to pay for education-related expenses. Too bad 2018 was a down year. But still not bad for a little over two years of contributing.

The below chart shows the graphical representation of balances.

The follow chart shows the month-by-month performance changes plus corresponding deposit amounts in 2019.

Underperformance of 529 Plan

The final chart shows shows a YTD return of 22.71% versus a 31.49% return for the S&P 500 and an 8.72% for the US Aggregate Bond Index.

Because my son’s 529 plan is 100% invested in a target date fund, it has a stock and bond allocation of roughly 75%/25% that slowly gets more conservative by the time he’s 18.

At the time, a target date fund made sense. I didn’t want to spend any effort trying to actively manage his fund while trying to keep him alive as a first-time SAHD. Further, my own investment allocation was more conservative.

In retrospect, we chose an investment that was too conservative. But this is probably just greed talking. At the beginning of 2021, my son’s 529 plan is now worth $255,000 thanks to a 16% increase in the S&P 500 in 2020.

In 2022, my son’s 529 plan is worth about $322,000.

Too Much In The 529 Plan

Our original goal was to create a 529 plan worth at least $500,000 after 18 years. Given college tuition has been compounding at a rate of ~5% a year for decades, a $50,000 annual tuition today will grow to $120,000 in 18 years. Then there is room, board, transportation, and other expenses to pay.

The X factor is whether our son can get into a good public grade school, thereby avoiding an additional annual expense of $25,000 – $50,000 for 13 years, when he starts kindergarten. Knowing our luck, he’ll probably get rejected by our local public schools. Therefore, it might be better if we try to shoot for accumulating $1,000,000 in the 529 plan.

The other X factor is his ability to get scholarships and having the wisdom to choose an affordable university. Knowing my wife and I are of average intelligence, we assume he will not get any academic scholarships either.

Thankful For Generational Wealth Transfer

But it just seems so ridiculous to accumulate $1,000,000 in a 529 plan to pay for education. Personally, I’d much rather go to public school my entire life and at the end be handed a large check after college to go invest, buy a house, or start a business instead.

At a 5% compounded rate of return, our $189,900 529 plan will grow to $415,000 in sixteen years. If we average an annual contribution of $24,000 a year plus a 5% compounded rate of return, the plan will grow to $1,010,000 in the same time frame.

Now that we have a daughter, perhaps $1,000,000 really is the number to shoot for. Ugh. If we have too much, then we will rollover any leftover funds into a Roth IRA.

Determining How Much To Contribute To A 529 Plan

If you contribute too much to a 529 plan, you are not efficiently allocating your limited resources. Every dollar you contribute to a 529 plan is one less dollar you can contribute to your own retirement savings, your house downpayment fund, and your around-the-world adventure with friends.

My assumption is that you’ve already opened up a 529 plan or plan to open one up because you like tax-free compounding growth and want to give your children more options in the future. My other assumption is that you are happy to pay for at least part of your child’s education.

Deciding how much to contribute to a 529 plan is not easy. Here are some things you should consider before contributing any more to your 529 plan.

1) Identify the current and historical cost of attending select institutions.

Let’s say you want your daughter to attend The College of William & Mary or UC Berkeley, two public universities with excellent reputations at a great price. You should go to the respective schools’ websites and familiarize yourself with the current and historical costs of attendance.

Once you’ve calculated the historical compound growth rate, use that growth rate to make your assumption on how much the college will cost by the time your daughter is eligible to attend. Then calculate how much you will need to earn and contribute to get there.

Many Financial Samurai parents recommend accumulating enough to cover the costs of your in-state flagship school. I like this approach because it covers the bases and provides an important money topic of conversation when it comes time for your child to choose where to attend.

2) Make a realistic assessment of the number of kids you will have.

One of the biggest reasons why I failed early retirement was because I didn’t account for having a second child at 42 years old for me and 39 years old for my wife. After years of trying, we thought we were done after one.

After the age of 40, a woman’s chance to naturally conceive drops to around 5% per try. Therefore, given we don’t want to go the IVF route, there’s a 95% chance we will only have to save and invest for two kids going forward.

But don’t worry. Even if you do beat the odds and are blessed with more children at an advanced age, you still have plenty of time to save and invest for your child’s future. It’s not like your expenses go from zero to thousands of dollars as soon as they are born.

3) Carefully observe the cognitive abilities and interests of your kids.

Objectively observing your child’s attributes is almost impossible. Of course, you will think your baby is the cutest, smartest, best-looking, and kindest kid ever. But try hard to be objective by comparing the progress of your child to various milestones and examinations.

When it comes to your kids, you don’t want to suffer from Dunning-Krueger. If you do, you will give your kids a false sense of security that will be smashed to smithereens in the real world. Praise effort, not results.

Not everybody needs to or should go to college, let alone private grade school or private college. If your child dislikes learning about useless quadratic equations and would rather fix cars for a living, going to trade school is probably a much better move. Trade schools don’t take as long or cost as much as college. Therefore, you won’t have to save as much in your 529 plan.

Match your child’s education to his or her interests. Don’t assume your children will go to college.

4) Pay attention to 529 plan laws and politics.

Even though the SECURE Act passed, none of us are exactly sure how we’ll be able to go about extracting our 529 funds to pay for things until we actually do. I fully expect to one day try and withdraw $100,000 and can’t because I lost my password and forgot to account for some random law.

There is also an increasing chance that within the next 20 years, many more Americans will be able to attend reputable colleges for free. If the bull market continues, the wealth gap will continue to widen. As a result, a socialist might get elected President and many more socialists may be elected to Congress.

Saving and investing heavily for your child’s future is a suboptimal strategy in a more socialist regime. Think about all those parents and students from Howard University who just missed a billionaire alumni’s generosity of paying off all student debt for a graduating class. Or imagine if a new President decides to cancel all student debt. Good for those with debt, but not so much for those who worked and saved to pay for their own education.

If capitalists are in power, you should save and invest as much as possible. If socialists come to power, however, you should try to relax more and take advantage of government programs such as income-driven repayment plans with forgiveness.

5) Make sure you are saving enough for your retirement.

Regardless of who comes into power, it’s always a good idea to make sure you’re financially on the right track.

Achieving financial freedom is much harder for parents because we must not only save for our own retirement, but also take care of our parents and fund our children’s education. As a result, it is extremely hard to retire early with kids. Not only is there a tremendous cost associated with kids, but there is also a motivational fire that makes you want to keep on building wealth.

Your financial well-being should come first. After all, if you can’t take care of yourself, how can you possibly take care of a child? You must be able to max out your pre-tax retirement plans and build your taxable investment accounts. Counting on the government to save you is foolhardy.

Below is a chart from my Average Net Worth For The Above Average Married Couple post, which may help keep you on track.

Think about how much better society would be if every kid grew up in a financially stable household. Parents would be less stressed out about their finances and have more time to spend with their kids. Perhaps there would be fewer murderers, robbers, sociopaths, and bullies.

6) Use realistic return assumptions.

Nobody knows how our 529 plan investments will perform over the coming years. But we do know that stocks tend to return roughly 10% on average. While bonds tend to return roughly 5% on average since 1926. However, we all know that stocks and bonds do go down as well.

More recently, below is an annual return chart of a 60/40 (stock/bond) portfolio since 2009. Based on the data, a wise parent with a 60/40 portfolio would assume closer to a 5% – 6% compound annual return over the next 10 years when determining how much to contribute.

Below is another chart that highlights how strong the past decade was for investors. We should logically expect a down year or two this decade. All the major investment houses have lower return expectations for the next 10 years.

Changing 529 Plan Beneficiaries

If you save too much in your 529 plan, you can always change its beneficiary. Surely there is a relative with a child who could use some help.

The 529 plan can be used for tax-efficient, generational wealth transfer purposes. In other words, if you find your estate will surpass the estate tax threshold, then you can open up and superfund multiple 529 plan accounts.

Worst case, if you remove funds for non-qualified expenses, then you’ll pay a 10% penalty on your gains. You’ll also be subject to income taxes on the gains. You may even have to pay back any state income tax deductions you previously claimed.

What you should also consider doing is opening up a Roth IRA for your child’s earned income. Your child’s Roth IRA can be used for other things beyond education.

Our 529 Contribution Plan For Our Two Kids

As for us, we plan to keep contributing at least $20,000 a year into our 529 plan. The reason is because we haven’t reached our minimum limit of $500,000 yet. We also expect some market declines that will cause our 529 plan to lose money.

We don’t foresee a scenario where we will have hundreds of thousands of dollars left over in our 529 plan because we’ve done our calculations. But in case we are wrong, we hope to live long enough to change the beneficiary to our grandchildren.

Hopefully this post has helped you better figure out how much to contribute to a 529 plan. If you want a specific chart, you can check out my recommended 529 plan amounts by age post.

Even if you contribute too much, the money can be used on education for other loved ones.

Pay For Your Children’s Education Through Real Estate

In addition to investing in stocks and bonds in a 529 plan, I recommend diversifying into real estate as well. Real estate is a core asset class that has proven to build long-term wealth for Americans. 

Real estate is a tangible asset that provides utility and a steady stream of income. If you buy one physical property when the child is born, it could fund your child’s education in 18 years. You can either take out the equity in the property or pay for college with the rental income. 

If you want to invest in real estate hassle-free, then take a look at private real estate investing. I’ve personally invested $810,000 in private real estate to earn 100% passive income and returns.

Best Private Real Estate Investment Platforms

Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. The firm manages over $3.5 billion and has over 350,000 clients. It specializes in Sunbelt single-family homes. 

CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.

My real estate investments account for roughly 50% of my current passive income of ~$380,000. 

Get Life Insurance To Protect Your Family

The best place to get life insurance is through PolicyGenius. PolicyGenius will help you find the best plan for the lowest price tailored to your needs. PolicyGenius provides free, no-obligation quotes so you can get the best rate.

Both my wife and I used PolicyGenius to get more life insurance coverage for lower premiums. For the longest time, my wife had half the amount of life insurance coverage as I did. Further, I mistakenly got only a 10-year life insurance policy when I was 35, two years before I had kids.