Is College 529 Financial Planning Really That Simple?

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All college planning begins with a job. Or more correctly stated – an educational pathway that leads to a job. In principle this sounds like it should be easy, and it actually is for many families. However, far too many families find (particularly those with deep financial resources) unlimited ways to complicate the process, while at the same time making it far more expensive than it need be.

We’ve been doing actuarial work for student lenders since 2008. And we have provided millions of families with practical college planning information through our website. Additionally, we’ve personally conversed with thousands of families at various stages of preparing their kids for college. With confidence, we can say that we know the college planning landscape from all sides.

Every parent wants their kid to derive essentially the same result from college – a good career with decent earnings. And then they overcomplicate and sometimes unwittingly sabotage the execution.

Enrollments at four-year colleges are down. Discounts on tuitions are up.

The Covid pandemic turned the higher education universe upside down. And that’s a good thing. There are some kids who are not cut out for college, and they’re no longer enrolling, failing, and then leaving with a pile of student debt. A ‘C’ student has a 30% probability of graduating in six years from college. Those students have essentially given up on college, as entry level wages for high school graduates are now in the $20 per hour range.

A nineteen-year-old earning $40,000 annually and living at home is not doing too badly. Especially when contrasted against a twenty-five-year-old earning $40,000 annually and living at home with $75,000+ in student debt. And the career opportunities in the ‘trades’ are better now than they’ve been in decades.

From a marketplace standpoint, the college admissions officers won’t tell you this, but many of them are reeling from the decline in enrollments. They need you more than you need them. Tell them you are aware of this, and that will change the entire tone of any discussion. And ask the question directly: “What is the best approach for my kid to receive institutional aid from this college?”

Then have an extended discussion, all the time knowing that the average student in a 4-year public college pays about 30% to 40% less than the ‘sticker’ price. If you’re thinking this sounds like a negotiation process, you’re right. That’s exactly what it is.

The effect of AI on the job market

You want to be careful when anticipating how artificial intelligence (AI) will impact the job market. It is not going to take over the world, but it certainly will eliminate jobs where repetitive tasks are performed. Think of what brings value to the end user of a system.

With the spread of the internet, a travel agent was no longer necessary to book an airline ticket, and therefore almost all were replaced by travel sites (no small irony that there are almost as many programmers in the travel business as the travel agents they replaced). However, a travel agent who could add personal value is still working and luxury travelers pay top dollar for their knowledge and ability to get things done.

Think in terms of where someone can add value as a worker. A person is not going to be more efficient than a bot or robot, but being an analyst who assesses the efficacy of systems which use automation tools is a high value skill. The most real-world example of this has been in effect for decades on the factory floor.

Manufacturing companies are continuously investing in automation technologies. Robots are replacing workers who previously performed the same task, over and over. But someone needs to ensure that the robots aren’t malfunctioning. Factories now employ mechatronics technicians to ensure that everything is working properly. A layer above them are the mechatronics engineers who designed the systems and process with the robotics manufacturing company.

And what about those ‘trades’?

A few years ago, most upper-income parents viewed anything less than a four-year degree as unthinkable. Now, the majority of skilled tradespeople are over 40, and with a shortage of young people entering the field. This means plumbers, electricians and the like are commonly earning over $100,000 annually.

The WSJ recently published an article by Te-Ping Chen (on Oct. 12, 2024) titled - America’s New Millionaire Class: Plumbers and HVAC Entrepreneurs. The article goes on to detail how private equity is “pouring money into skilled-trade small businesses.”

Non-college educated individuals are finding that they are achieving the American dream of wealth, homeownership and beyond – without the years-long effort to obtain a college degree – unburdened by crushing loan debt.

The bottom line is that college is definitely not for everyone, and the opportunities for those without a four-year degree are better now than they have been in decades.

When borrowing for college, families should ask their financial advisor if it makes financial sense to borrow at approximately five percent in order to send their kid to an elite college, where the perceived increase in future earnings is a false assumption. If a Parent Plus loan is needed to send a kid to a specific college, then choosing a lower-cost college makes sense. And every financial advisor should remind their clients that they’ve already paid for state college tuitions once — with their taxes.

The correct “529 number”

An excellent way for a family to save for college, while sheltering income, is a 529 plan and its counterpart, education savings accounts (Education Savings Accounts [ESAs] or Coverdell accounts). The IRS allows a family to fund a tax-deferred account for a child, which can invest in stock or bond mutual funds and money market funds. 529 plans and ESAs provide a family with an obvious income tax advantage, and a sound strategy for financing college tuitions, which are high, and rising at over four percent annually. Putting income into a college savings account is a no-brainer.

Like anything though, the execution requires planning and financial expertise.

Is there a clinker to all of this? Well, yes. The six-figure question is, “How much money will I need to accumulate in a 529 plan?” Coming up with a “529 number” is tougher than it sounds. Should we put in $25,000 or $125,000? A large advisory firm was telling clients to budget for $150,000 per child. I asked them how they arrived at such a nice, round figure – their response was, “We’re not sure, but it sounded good.”

Because of the wide array of costs, families don’t know how much to budget. And those costs can vary by factors of five or more. Tuition alone can range from $5,000 to $75,000 annually for undergrad programs. Families assume their child will graduate in four years, yet the nationwide average is 5.3 years. Tuition accounts for only about half of the total cost of college for families who send their child to a state school. According to Sallie Mae, families commonly underestimate the total cost of a four-year college education by 50 percent.

Creating a financial plan for college is crucial, and that financial plan determines a family’s 529 number.

529 plans and ESAs

As we previously stated, there are two choices for tax-advantaged college savings plans: 529 plans and ESAs. Both offer tax-deferred growth, provided the proceeds are used to finance qualified education expenses (tuition, books, computers, and room and board). Though the principal and any gains can be withdrawn tax free from both 529 plans and ESAs, there are important distinctions regarding eligibility and contribution amounts provided by these plans.

529 plans are state-sponsored and each state offers at least one 529 plan. Plans vary by state and differ on fees, features and investment options. Each state plan has a distinct program manager. Your clients are not required to live in a state to participate in that state’s 529 plan, but you should verify that any out-of-state plan offers the same tax treatment and other benefits as your in-state plan.

529 plans offer high funding limits (approximately $300,000, though the exact amounts vary by state) per beneficiary. The sources of funding can include family and friends. Funds held in 529 plans can also be used for K-12 education. For families who are late in establishing a 529 plan, the option exists to “jump start” a plan with a single-year contribution of up to $75,000 ($150,000 for a couple) without incurring a gift tax, provided that a special election is made.

ESAs have specific limitations regarding who can open them and the annual contribution that can be made.

ESAs can be opened only by couples with an adjusted gross income of less than $220,000 ($110,000 for individuals). But that’s not the only restriction. Contributions are limited to a maximum of $2,000 per year until the beneficiary is 18 years old. However, that is for couples with an adjusted gross income $190,000 or less for couples ($95,000 or less for individuals). The maximum contribution decreases for higher earners.

Fully funding a 529 or ESA

Because of tax advantages, it is prudent for a client to open and fund a 529 or ESA when a child is born. It is an excellent means of tax deferment. What percentage of the eligible population takes advantage of this tax shelter? Far too few. Most families end up playing catch-up when their child enters high school and they’ve forgone the opportunity for many years of tax deferred growth.

The amount needed to fully fund a 529 plan or ESA depends on multiple factors. When trying to calculate college costs, the cumulative input costs create a net cost. What are the input costs? The big ones are tuition and fees, living expenses, plus incidentals, multiplied by the number of years required to graduate. Determining the tuition of a specific school is very challenging because tuitions are highly negotiable.

Yes, you read that right – see my prior article on Admissions Probability and Negotiating Tuition. When you’ve completed that aspect of the plan, you’ll then need to pencil out the earnings opportunity from the job that the student is preparing for, along with the living expenses of the newly minted graduate and see if the education investment makes actual financial sense.

We all know of numerous examples of a college grad with a shiny new degree – who is also drowning in student loan debt, while working in a job that required only a high school diploma. Long story short, you need a financial plan.

We’ve done the math

My firm offers a free program, the College Business Plan, which calculates all of the input costs for you and your client – tuition and fees, housing, incidentals and every major line item. The program includes in-state and out-of-state tuitions, as well as the offsets, such as federal, state and institutional grants.

We sum everything and show you if you’ll need student loans to get to the finish line. Then we provide you with a pro forma income statement that you can share with your client. This shows the earnings their child will have upon graduation, with all of the living expenses required for the specified region of the country. It includes everything: state and local taxes, healthcare, transportation – all of it. Yes, it also includes the 529 number for the family. And it’s free.

If your client’s child may require six years to graduate, the College Business Plan offers all of the same data and it’s provided in an income statement format in an Excel worksheet. It shows all of the same assumptions, modeled on graduation terms of four, five and six years. The incentives to graduate on time are… sobering. The Excel output is $10.

College financial planning’s bottom line

The opportunities for accumulating savings for college and putting away income tax deferred with a 529 plan or ESA should not be ignored. Not knowing how much to save for college is a blind spot, even when families are on the verge of choosing a college.

Putting too much into a college savings plan isn’t a good strategy for deferring taxes, as you’ll incur a 10 percent penalty on withdrawals that are not used for education. Having a realistic 529 number is a key component of a good college financial plan.

The 529 number that a family needs as their savings goal is a great target for them to work towards. As an advisor, you’re providing the family with a value-added service by putting forth that 529 number.

Just as importantly, in getting to that 529 number, you’re building a realistic financial plan for college for the family. It is a financial plan that you can implement, maintain and update, as the student goes through college, obtains a good paying job and works toward opening their own investment account with you.

Final thoughts

It's important to stay informed regarding the latest updates to 529 college savings plans, for both current account holders and prospective savers. In recent years there have been significant changes, including The Setting Every Community Up for Retirement Enhancement (SECURE) 2.0 Act in December of 2022, which helps enhance the flexibility and benefits of 529 plans. Additionally, for the 2024–2025 school year, distributions from a nonparent-owned 529 account will no longer count as income to the student on the FAFSA.

Applicable to distributions starting in 2024, SECURE 2.0 introduced a significant change: the freedom to roll over unused funds from a 529 college savings plan into a Roth IRA for the same beneficiary. This new option for long-term financial planning should alleviate concerns about leftover funds in a 529 plan. However, specific criteria must be met:

Plan duration: The 529 plan must have been open for at least 15 years.
Contribution age: Only contributions made more than five years prior, along with their earnings, are eligible for rollover.

Limits: Annual rollovers cannot exceed the IRA contribution limit, and the beneficiary must have earned income that matches or exceeds the rollover amount. There is also a lifetime cap of $35,000 per beneficiary.

Hill and Michael Havis are the cofounders of Educate To Career (ETC). ETC is a nonprofit, specializing in providing college planning programs and data to over 1,000,000 families, financial advisors, and campus career centers each year. We are the leading vendor of actuarial analysis of college outcomes data to student lenders. Our charter is to help young people get an affordable education, leading to a real job, with no student debt.

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