Saving for college via a 529 account can be a great thing for freedom lovers with kids. But what about when it comes time to pay for college? The timing of your 529 withdrawals can dramatically impact how much you pay for college. I ran scenarios at three different universities, and found that the right 529 withdrawal strategy can save me tens of thousands of dollars to put my two kids through college. Here’s how 529 withdrawal strategies can reduce your cost of college.
The Good And Bad of 529s
Section 529 college savings accounts are a wonderful way to protect your savings from the tax bite for years or even decades as you child grows. If you’ve maxed out your retirement accounts, then I recommend putting money into 529s due to the tax efficiency and flexibility of withdrawals.
But, once your child gets to college, a 529 account can cause some problems. That’s because the more money you have in a 529 account (or any other unprotected investment account), the more you will likely pay for your child’s college. But no worries, where there are rules, there are ways to bend them!
Financial Aid Forms
Anyone who wants money for college – loans, grants, scholarships – has to fill out either the FAFSA form or the CSS form. The two forms are similar. They look at the student’s and parents’ financial situation, including income and assets. Public universities generally use the FAFSA to determine the amount of any financial aid the student may receive, while private universities often use the CSS.
Generally, the more income you earn and the more reportable investments you have, the more you will pay for college. Reportable assets generally means any assets other than retirement accounts, health savings accounts, or your primary residency. (Although some colleges do include a portion of your primary residence too).
529 Accounts – Ownership Matters
How universities view your 529 account depends entirely on who owns the account. If the parents or student own the account, then it is a reportable asset.
Universities can take up to 5.64% of your reportable assets each year via higher net tuition and fees. Over four years of school, that can easily add up to a 20% total drag on your savings – just because you have the savings. That can easily wipe out any tax advantage you may have had from the 529 in the first place! Have more than one kid? You might want to get yourself some tissues.
On the other hand, if some other relative owns your 529 – such as a grandparent – then the universities will ignore the account. That is, until you withdraw. At that point, the withdrawal is counted as income for the student – which is even worse than having unprotected assets. A withdrawal from a grandparent-owned 529 account is assessed at 50% (to the extent the student’s income is above a student income allowance of $6,570 in 2018).
Related Content: Why Paying For College Is A Horrible Reason To Delay Retirement.
So, depending on who owns your 529, it could be counted either as assets or as student income. And that leads to completely different 529 withdrawal strategies depending on account ownership.
529 Withdrawal Strategies
Parent Ownership – The Early Withdrawal Strategy
A parent-owned 529 account is a reportable asset that will increase your cost of college (to the extent your assets exceed a “parent asset allowance”, which is generally around $20k under FAFSA, and varies for CSS schools).
That means you want to spend your parent-owned 529 as quickly as possible (again, to the extent your reportable assets exceed your “parent asset allowance”). If you don’t have enough savings to cover four years of tuition and fees, no problem! Spend any excess over your parent asset allowance on qualified expenses in the first year or two, and then after that your college bills will be reduced.
Some parents make the mistake of trying to make their 529 account last until their child graduates, even while taking student loans in the first year. It’s better to spend your 529 account during the early years (to the extent your assets exceed your “parent asset allowance”), and leave the loans until the latter years instead.
This early withdrawal strategy can be applied to any reportable assets, not just 529 accounts. If you have any reportable savings or investments that exceed your parent asset allowance, spend it in the first years of college to reduce your college bill in the latter years.
Grandparent Ownership – Delayed Withdrawal Strategy
If grandparents or anyone else owns a 529 for your child, then the opposite withdrawal strategy applies. That’s because withdrawals from third-party 529s generate student income. And student income should generally be avoided like the plague (thanks to the “University Tax“). For grandparent-owned 529s, the best strategy is thus to wait to withdraw until the last two years of college.
Why the last two years? FAFSA and CSS forms look at your financial situation in the “prior prior year”. Thus student income in any given year impacts how much you will pay two years later. If you withdraw from a grandparent-owned 529 during your student’s junior or senior year, then it won’t impact her net tuition and fees at all.
The 2017 Tax Reform
The 2017 tax reform (aka The Tax Cuts And Jobs Act of 2017) has introduced another twist to these 529 withdrawal strategies. Under the new law, 529 accounts can be used to pay for up to $10,000 in qualified primary or secondary education costs per year. That includes public and private school tuition and other qualified expenses.
This means you can get a head start on drawing down your parent-owned 529. Since universities are looking at “prior prior years”, if you spend some of your 529 savings during your student’s high school years, then you can reduce your college tuition and fees even earlier.
Qualified K-12 expenses include tuition and fees, curricular materials such as books, plus tuition for tutoring or educational classes outside of the home (if the tutor/instructor is not related). SAT classes, anyone?
Just how much money are we talking about? It highly depends on your own financial situation and on your university too. But, just for fun, I decided to run my own hypothetical scenarios at some of my favorite universities. Nearly every university has a “Net Price Calculator” on their website where you can run your own scenarios too.
I ran scenarios of these 529 withdrawal strategies at three schools. Here’s what I assumed
- Family of four, with two kids in college
- Parents’ income is $50,000
- Parents’ reportable investments are $50,000 (including any parent-owned 529 accounts)
- Parent’s primary residence is worth $700,000, with no mortgage
- Student income and assets are otherwise zero, except if a grandparent-owned 529 withdrawal generates student income.
- Grandparent-owned 529 accounts of $30,000 ($15,000 per child)
This profile roughly reflects what my family will look like in eight years, as I execute my stealth wealth strategy to optimize the FAFSA and get massive college discounts. I’ll already have huge savings off the sticker price of tuition. But, by following the right 529 withdrawal strategies I’ve outlined above, I can still reduce my cost of college even further. How much? Here we go:
I ran two scenarios at three different schools. Under the first scenario, I spend all my parent-owned assets ($50,000) during the first years of school until it’s all gone. Then I start withdrawals from the grandparent-owned 529 accounts (another $50,000). Under the second scenario, I do the opposite: first withdraw from the grandparent-owned 529s, then use the parent assets. I compared the total cost of college under the two different scenarios to see how much a good 529 withdrawal strategy will reduce my cost of college.
University of California, San Diego
This is kind of our go-to public school. It’s just a few miles from our house, and I suppose there’s a pretty decent chance one of our kids might end up going there. UC San Diego’s sticker price of admission is $31,161 for tuition, room, and board.
My stealth wealth strategy gives me a nearly 60% discount off the sticker price in just the first year of college. But let’s dive further to see how much more I can save with the right 529 withdrawal strategies.
If I maximize my parent-owned 529 withdrawals in the first years, and delay withdrawals from the grandparent-owned 529s until the later years, then my total cost of four years of college will be $114,318, or $57,159 per child.
Under the second scenario if I accelerate the grandparent-owned withdrawals, and delay the parent-owned withdrawals, my total cost of college for two kids will be $121,388 for two kids, or $60,694 per child. That’s a 6% higher total cost of college – over $7,000 – just due to the timing of my 529 withdrawals! Damn!
You can see that the timing of your 529 withdrawals matters. I’m fortunate that I have some grandparent-owned 529s (thanks grandma!). But, you don’t need them in order to implement this strategy. The point is to use parent-owned assets in the early years, and then other sources in the later years. For example, you can withdraw from a Roth ladder, or you could take student loans in the later years.
Thanks to the University Tax, income is absolutely the worst thing you can use to pay for college.
Stanford (A Guy Can Dream, Right?)
Lets take a look at Stanford. The thing about Stanford is that my stealth wealth strategy will already give me a whopping 93% discount off the sticker price. I would pay only $5,000 per student per year, which is the lowest anyone pays at Stanford. While the right 529 withdrawal strategy can still still reduce my total cost, it won’t make nearly as big of a difference.
Here’s Stanford’s Net Price Calculator.
Under the first scenario (spend parent money early, delay grandparent money), my total cost to send two kids to Stanford is $40,000 ($20,000 per child). That’s an amazing deal right there if I ever saw one.
Under the second scenario, my total cost at Stanford rises to $41,400 – still a great deal. The wrong 529 withdrawal strategy will cost me $700 per child, or $1,400 for two kids at Stanford.
University of Southern California
I like to look at USC because its a private school without such a massive endowment as Stanford, and thus doesn’t so easily shower students with free money. My stealth wealth strategy gives me a 75% discount off the sticker price at USC. How much more will the right 529 withdrawal strategy save me?
Here’s USC’s Net Price Calculator.
Under the first scenario, I would pay $118,616 at USC ($59,308 per child). Under the second scenario, I would pay $140,738 ($70,369 per child). So, the right 529 withdrawal strategy saves me a whole $22,122 , or 16%, to get two kids through USC. That’s a pretty massive savings for such a simple thing.
529 Withdrawal Strategies Matter
So, you can see that just how much you save by implementing the right 529 withdrawal strategy really depends on the school. It also heavily depends on your personal financial situation. But, whether you save just a few hundred dollars or tens of thousands of dollars, it is rather easy money. It just takes a little planning.