CASE STUDY: Funding College While Saving for Retirement

in Financial Planning, Financial Planning-RSS, Personal Finance Essentials by

The Situation

Sam and Bailey are married with three young children. The couple, who are both doctors in their mid-30s, live in Colorado which is one of the handful of states that offers a generous unlimited state income tax deduction for 529 contributions. Because they are successful in their fields and spend frugally, Sam and Bailey have a significant ability to save each year.

The Challenge

The couple wants to provide for four years of college for each of their three children, with expected costs of $40,000 per child, per year – totaling $480,000. They know the importance of saving for retirement and need to figure out how to put away nearly half a million dollars to support their educational goals without sacrificing their future retirement.

The Solution

After reviewing Sam and Bailey’s financial goals, their advisor found their local 529 plan offered an income tax deduction. He recommended they use the in-state plan to reap the tax benefits since plan assets grow tax free, so long as the funds are used for qualified higher education expenses. In addition, because of the couple’s ability to save large dollar amounts annually, their advisor discussed ‘front-loading’ the 529 plans, which gave the family more potential to achieve longer-term growth in those tax-advantaged accounts. ‘Front-Loading’ is putting an upfront lump sum amount into a 529, which can give Sam and Bailey potential for growth over the longest period of time possible(remember any growth in a 529 is tax free if used for qualified expenses). ‘Front-Loading’ also provided Sam and Bailey with peace of mind about college funding goals.

One balance they were careful to strike was the percentage of expected higher education costs to cover directly from the 529 assets. While fully funding a 529 account for the youngest child left more time for the account to grow, it also increased the danger of overfunding the account, which risks leaving unused funds in the account. Their advisor also asked them to consider the impact of significantly contributing to 529 plans, in a situation where one or more of their children might not end up attending college (thereby having a fully funded 529 that would not be used for its original purpose).

In the end, Sam and Bailey felt there was a strong chance their children would attend college, and they could absorb the cost of funding a 529 plan without sacrificing their own retirement. They decided to fund each child’s 529 account with enough money to cover 75% of the expected costs, after assumed growth. The remaining 25% of college costs were expected to be covered from Bailey and Sam’s cash flows, or through small student loans that the children would be expected to take on (for some ‘skin in the game’).

The Results

Sam and Bailey funded each of three children’s accounts with enough money to expect – according to all the assumptions they made with their financial advisor – the appropriate amount of growth to cover the majority of each child’s expected college expenses. When their children are 18, the majority of their educational costs should be covered by the 529 plan. Sam and Bailey adhered to the adage that borrowing for college is always an option, but borrowing for retirement is not, and they’ve since checked in on the growth of each account at least on an annual basis with their advisor.

This case study is fictional and does not depict any actual person or event.

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Paul Deer

Paul Deer

Paul is a Certified Financial Planner® and serves as both a Manager and Financial Advisor at Personal Capital. He has been educating and assisting clients with important investment decisions for nearly a decade.
Paul Deer

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