529 college savings for military families

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Thanks to Brandi for her comments on an earlier post, and her question:

My favorite part of the book was all of the personal stories. I can understand how the math works – I’ve calculated all of my future pay raises, estimated rate of savings, and projected retirement benefits to figure out how much I should have saved and how much income I will earn when I exit the military. But I still have a hard time firmly believing that retiring in your 40′s is achievable and that people have done it, which is why the stories are great. Plus, retiring straight out of 20 years of service is not very common, so it’s nice to know I’m not the only “crazy” one out there!

Also, for the blog, I’d love to hear your take on saving for kids’ colleges as a military member. Between GI Bill benefit transfers and an increased likelihood of having the military pay for their school (through ROTC, service academies, or enlisting), it’s hard to decide how much to lock up in a 529. Did you save money in a 529 for your daughter, and if so, what are you doing with the money now?

C’mon and paddle out with us, Brandi, the surfing’s great!

Before figuring out how much to save in a 529, let’s figure out how much to save for college. Regardless of my opinion on the quality difference between community college versus Harvard, there’s a significant financial difference.


Save for your retirement first

There are many opinions on how much parents should help their kids with college expenses. It’s a perpetual topic on Early-Retirement.org, and parents’ opinions are affected by their own college experiences.

Conventional financial advice is that you should not sacrifice your retirement savings to pay for your kids’ educations. They can get scholarships and loans for college, but nobody gets those for retirement.

The attitude on saving for early retirement instead of college is more controversial. It depends on how much you feel obligated to subsidize your kids. It may depend on how much support you wish you’d had at their age, and you also have to know your kid. Some will persevere through college no matter what it takes, while others could suck up tens of thousands of dollars with no degree.


Who pays for college?

I think that humans (even teenagers) perform better when they have their own assets at risk. The internal motivation is a lot more powerful when it’s their money/labor, not just Mom & Dad’s. It’s probably a bad idea to have students work two jobs to pay the community-college tuition when they’re struggling to maintain a 2.00 GPA, but you can certainly expect them to find their own funding if they want more than four years of State U.

Another issue, frankly, is personal discipline. I have to admit that I’m hugely envious of our daughter’s college life. Even with the extra demands of NROTC (and keeping up with the academics at a top engineering school among freakishly brilliant classmates), she has more social life & liberty in one semester than I accumulated during four years at mine. However, I’m kidding myself. At her age I had few organizational skills and even less personal discipline, and the U.S. Naval Academy was exactly the “supportive environment” that I needed. If I’d gone to her university I never would’ve finished freshman year.

After observing the college-funding debate for a few years, I think it’s reasonable for a parent to subsidize two years at community college plus two years at State U. For students who want more, I think there’s plenty of financial assistance from scholarships, grants, loans, & jobs. That gives a student enough study time to keep up with the academics while forcing them to put their own skin in the game.

Some parents will feel that their kids “deserve” more. I guess those parents should be willing to work longer to pay for it. Personally, I would not feel guilty about achieving early retirement while funding some of a kid’s public education. I know that my retirement time spent with our daughter has been far more valuable to both of us than the money I’d earn by continuing to work. I’d rather teach her how to live than to buy her a degree.


A 529 account may not be worth the tax savings

Now that a parent can decide how much they really want to save for college, perhaps a 529 account is no longer so significant. Its main advantage is tax-free investment gains (and possibly a state tax deduction), yet many 529s still have high expenses and poor asset classes. It’s also “risky” to lock up $250K in a 529 instead of having it available for other spending, but perhaps not so risky when the amount is “only” $20K.

We didn’t use a 529 for our daughter. She was born in late 1992, before 529s were created, and back then the best option was education savings bonds. We put aside $400/month in EE bonds until their fixed rates ended in 1996.

529s were available by then, but even after taxes their expenses were higher than Vanguard (and even Fidelity). The EE bonds offered enough tax-free savings for at least a couple of years at UH, so it seemed more prudent to counter education inflation by taking bigger risks with equities. We kept investing $400/month until 2010, but we did it in our own taxable accounts and not in a 529. At first it went into a “global value” equity mutual fund. During the 2001-02 bear market we bought shares of Berkshire Hathaway. In 2005 we tweaked the asset allocation with some education I bonds. Holding individual stocks & I bonds is cheaper than mutual fund expenses, we didn’t have to pay taxes on the gains until we sold, and the money wasn’t locked up in a 529.

By early 2008, Berkshire Hathaway had hit an all-time high and the stock markets were heading for record lows. We cashed out the equities and parked the funds in a CD ladder. We incurred large capital-gains taxes on these college funds, but “luckily” we managed the losses in the rest of our portfolio to offset that expense.  The bonds & CDs got us through the bear market, and our daughter started college in August 2010.

While I was juggling the college finances, our daughter had other college plans. At first it was a USNA appointment, but later she elected to go NROTC. The Navy is paying her nearly $18K (!) per semester (!!) in tuition/fees. (I must modestly admit that her military performance and her GPA are great bargains for the Navy’s money.)  NROTC is even kicking in another $5K-$10K for summer school while we parents are paying “only” $6300/semester in room/board and another ~$1000 during summer school. If you’re doing the math you can see that the four-year degree will cost over $200K… but our daughter’s paying for most of it with her five-year service obligation. She seems pretty motivated, too.


Military families already have tax savings

Brandi, your concern is justified– as long as I was in the military, I wouldn’t put much in a 529 account. I don’t have a spreadsheet to back this up, but I suspect that the vast majority of military families don’t save enough in taxes to justify a 529 account. Servicemembers already reduce their tax bills with tax-free military housing allowances, we can defer even more taxes through the Thrift Savings Plan, and few states tax a military pension. Additional tax credits are available to offset college expenses. In some 529 plans, the higher expense ratios will cost more than a taxable Vanguard or Fidelity Spartan index fund. Especially for one-child families, I don’t think a 529’s benefits are worth the liquidity risk or the expenses.

If I was starting over again today, I’d still buy I bonds when the rates were attractive. They’d form the inflation-protected “safe” portion of the college savings for about two years at State U. I’d put the rest of the college savings in a low-cost tax-efficient equity index fund from Vanguard or Fidelity or Schwab (and pay the annual taxes). I’d also sign my kid(s) up for one month of GI Bill benefits, although those benefits are probably best used on parental education.  (Fellow blogger Kate Kashman (Paycheck Chronicles) recommends using the GI Bill for your own education, which will boost your income by far more than it’ll ever transfer to your kids.)  If I had more than one kid and was accumulating a large college fund, then I’d put about half of the equity allocation in a 529 account. At least one of the kids could use the money without me worrying about having to retitle it for my grandkids.

Although our daughter’s college is horrifically expensive, you’ll notice that the Navy is paying nearly three-quarters of the bill. We parents will have money left over, and I’m glad it wasn’t locked up in a 529 account. We could buy a really nice car or even a boat, but I already have enough longboards to entertain me for the rest of my life. Instead it seems like a better idea to move a little “leftover” money to our daughter now instead of an inheritance (much) later. Our profit-sharing graduation gift is enough money to help her max out her TSP and her IRA for the first year or two of her service. The tax-deferred (and tax-free) compounding of that money will be far more significant than any 529 for her kids, and will certainly be more useful than an inheritance. She’s earned it.

Our parental gifting would also fund a mighty nice car or even a boat for her, too, so this profit-sharing generosity might not be justified with every college graduate. Gotta know your young adult, and I suspect that ours will continue to save a large percentage of her paychecks for early retirement. She’s seen us living the dream for over half of her life, and she wants to get her some of that financial independence for herself. We both hope she finds an avocation that she’ll love, but it’s a lot easier to search for it when you’re financially independent!


Related articles:
How much should you save for college?
Early retirement and the kid’s college fund

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WHAT I DO: I help you reach financial independence. For free. I retired in 2002 after 20 years in the Navy's submarine force. I wrote "The Military Guide to Financial Independence and Retirement" to share the stories of over 50 other financially independent servicemembers, veterans, and families. All of my writing revenue is donated to military-friendly charities.

  1. Nords,
    My wife and I are considering opening up 529 plans for our two granddaughters (makes me shake my head whenever I say we have granddaughters – they call her grandma and I prefer to be called “Dude”)…just starting out modestly at $10K each. Was considering the Utah 529 Plan, mainly due to the lower fees than most 529 Plans as well as access to Vanguard funds. While the amounts are modest, as we don’t intend to fully fund their college education, I didn’t think parking the funds in I Bonds or CDs would lead to the desired/projected “growth” like equities would. As such, I am willing to leave the funds in a 529 until the grandkids start going to college…or use it to buy a new car if they don’t.

    • You’re ahead of me in the grandkids department!

      529s largely passed us by since they started out with such high fees. By the time the fees were more reasonable we were already committed to EE bonds and equities. Today EE bonds are a much lower return and not so good even when tax-free as education savings bonds. The only reason to use I bonds would be for safe returns and, when held as an education savings bond, a non-taxed asset.

      I haven’t checked the Utah plan in a few years, but when 529s first started many of them had such high-fee funds that it was cheaper to save in a taxable account (and pay the taxes).

      It’s tough to decide how much to put into a 529 when you don’t know how much (if any) a child is going to need for their college expenses. Today I’m glad we didn’t use a 529 because we would have had a six-figure account locked up while our daughter’s tuition & fees were paid by the Navy. Since the college fund is in a taxable account, we can engage in “profit sharing” without penalties. Otherwise if we someday ended up with grandkids we’d retitle a 529 account for their college expenses.

    Comment? Question? What's on your mind?