529

529 College Savings Plans Get Supercharged in 2018

Leave a Comment

One of the most significant tax changes enacted recently and also one that received very little media attention was the turbo charging of 529 College Savings Accounts.

If you weren’t using one before, you definitely need to start now if you have kids!

In the Olden Days

529 plans allowed parents, grandparents, uncles, aunts, etc… to invest money in stocks, bonds, or money markets and then pull that money out to pay for college expenses without paying taxes on the investment gains.  If that weren’t sweet enough of a deal, most states won’t charge their income tax rate on any contributions.  Essentially, you win on both the front end and back end.  You get a tax break on the state level by putting money in and shielding it from state taxation AND you get a win on the backside by pulling money out and not getting a tax bill from Uncle Federal Sam on the 100-300% appreciation that you’ve likely made ($100 invested for 18 years compounded @ 6% yearly growth would be worth $285.43).

2018 Onward

Now, you can pull the money out of a 529 to pay for K-12 private school tuition.  This is YUUGEE.  As an example, let’s consider a family of four living in the great state of Illinois.

Illinois income tax rate is a flat 4.95%.  For this hypothetical, let’s pretend that private school tuition is $6,500 year per pupil.  That would be 2 kids x 13 x $6,500 = $169,000 in tuition payments.

But if the parents were savvy, they would use a 529 plan to shield money from state taxes.  They could be risk averse and simply choose a stable money market fund that won’t sway with the broader stock market, in which case they’d simply contribute money every year and withdraw it as needed to save 4.95% on tuition.  $8,365 saved!

Obviously, the higher the state’s income tax the more beneficial this becomes.  There is a cap of $10,000 a year of withdrawals for K-12 expenses so it cannot be over abused.

It would probably be a good idea to open two 529 accounts per child.  One for K-12 expenses and another for post secondary education expenses.

More Reading…  http://www.savingforcollege.com/articles/coming-soon-big-changes-to-529-plans

Calculating 529 Performance

Leave a Comment

With the first year of 529 contributions under our belt, it was high time to take a look back and see how they did.  The first thing I did was log into the online account and see the rate of return posted in big bold letters.

3.4%

Wow, that is terrible, especially considering that the fund we invested in returned a healthy 9.9% in 2014.  Obviously something else is going on and you may have already guessed it.

That’s right, we didn’t invest everything on January 1st, instead we made contributions throughout the year.  By giving Frugal Boy a big Christmas present/contribution, it effectively killed our rate of return because of the sudden influx of fresh cash that diluted previous gains.  To properly calculate your return, weighted for irregular contributions, you will need to open up Microsoft Excel and use the XIRR function.

Here’s how to use the XIRR function.

In column A, enter positive contributions and negative withdrawals (or fees).  In column B, use the Date function to enter in the date of that contribution.  At the end of each column, enter the ending balance and date.  Multiply your ending balance by (-1).  So a positive ending balance would be displayed as negative (it’s just how the XIRR function works).

Finally, use XIRR(colA, colB, guess) where guess is your expected percentage return (e.g. 8%).

Here is an example:

RR-4b

Properly weighted, Frugal Boy’s 529 had a rate of return of 10.33%.  Not too shabby 😀

IMG_5318

Like our taxable investment account, we selected a low cost indexed fund that consists of:

  • 70% VIIIX – Vanguard Institutional Index Fund
  • 20% VDMIX – Vanguard Developed Markets Index Fund
  • 10% VEXMX – Vanguard Extended Market Index Fund

The heavy equity exposure and associated risk seems appropriate for his age.

Last Minute Christmas Shopping

1 Comment

This is the last weekend before Christmas and because it was a bit chilly to walk outside with Frugal Boy I braved the mall.  No, I’m not a masochist, I just know that Frugal Boy loves people watching and what better place is there to people watch than the mall before Christmas.

As I was unloading the stroller back at home, one of our neighbors came by and asked if I had finished my Christmas shopping.  I told him no, I had never even started.  He offered me luck on a seemingly impossible task, to save Christmas in less than a week.  What I didn’t tell him, was that while I hadn’t done any traditional shopping, I was in fact done with gift giving.

The Frugal Gift For Your Spouse

Shae and I have always had an aversion to trying to find the ‘perfect’ gift for one another.  The hassle of it all, shopping, buying, wrapping, keeping the secret, and hoping for a genuine positive reaction during the unveiling is all a bit more work than either of us would like to do.  In something of a growing tradition, the goto token gift has become new pairs of socks, simple, practical, and fairly cheap.

Our unconventional gifts to one another are both easy to give and a joy to receive.  This year we both paid off a chunk of our mortgage for a combined extra prepayment of 10%.  All told, in 2014 by living frugally, we have been able to shave off 40% of our mortgage this year alone.

Mortgage Balance Remaining

10% Christmas Gift to Ourselves

 

The quadruple mortgage payments that we started making in April have set us on track to be mortgage free in about 12 months (assuming we give ourselves the same present next year)!  Yippee!

The Frugal Gift For Your Child(ren)

Frugal Boy isn’t old enough to really appreciate presents, so this year we just made a contribution to his 529, college savings, plan.

Merry Christmas Son

Merry Christmas Son

You can see two jumps in the chart.  The first in May when we put inheritance money towards future education and another in December when we gave him his present early.

While a 100% monetary gift works well for babies, because they don’t understand the concept of a gift, it probably won’t be a smash hit with older children.  In the future we will continue to spend a substantial amount of Frugal Boy’s gift budget on 529/savings contributions while spending a bit of money on a token toy.  After all, as parents, it is our job to take care of the needs and necessities first.  We can let his relatives spoil him with the ‘fun’ stuff. If our Christmas tree is any indication, that is exactly what is happening (100% of the presents are to Frugal Boy).

The Frugal Gift For Your Nieces and Nephews

We basically followed our standard method of operation for our own children.  Babies received all cash gifts and should their parents choose to invest that money in an account that compounds that niece or nephew will receive the advantage of time.  Older nieces and nephews received trinkets and a supplement of cash to round out their presents.  As an uncle and an aunt, we tend to be more prone to spoiling than with our own child.  Plus, what kid doesn’t want 1,000 stickers for Christmas?  😀

Wrapping Up

While we haven’t done the traditional gift giving this year, we have done a frugal edition of it.  A grand total of zero items were purchased at the mall, and most gifts came from our checkbook.  Sure it isn’t the picturesque Christmas that you see in the films, but then again is that even the meaning of Christmas in the first place?  With that said, are you done with your Christmas shopping?

Saving for College

Leave a Comment

Great news!  Frugal Boy’s social security card came in the mail today making him an official drone of the system.  His future earnings will power my retirement.  He doesn’t seem to like that concept much at the moment however.

IMG_3338

A big advantage of having a SSN is that all sorts of financial doors are now open to him.  He can now have a bank account to safely save money and even more importantly, he can now be listed as the beneficiary of a 529 college savings plan.

What is a 529 Plan?

SavingForCollege.com describes it as,

A 529 Plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Code which created these types of savings plans in 1996.

My own simplified explanation is that a 529 savings plan works in much the same way as a Roth retirement account.  You contribute post-tax money to the 529.  That money then grows through increases in the stock market until the beneficiary of the account withdraws the money for educational expenses.  If that was too confusing, think of it this way.  A 529 is a legal loophole that the IRS created to encourage parents to save money for their kids future without the normal taxation that would be applied.  The only condition that the IRS puts in place for not taxing the growth in the investments is that the money must be used towards education.

How do I setup a 529?

Start by finding who manages your state’s plan.  Vanguard has put together a handy state map that will make this and comparison shopping easy.  Each state offers a 529 plan.  You do not have to use your state’s plan.  For example, we live in Illinois, but we could enroll in the Nevada 529 plan.  It also does not matter where the college is located.  If you want your son or daughter to attend an Ivy League college, you do not have to use one of those state’s 529 plans.

We decided to use the Illinois 529 plan (Bright Start®; College Savings Program (Direct-sold)).  We can deduct our contributions on our state taxes and the minimum amount to open an account is astonishingly low (only $25).

Bright Start advertises that it only takes 15 minutes to enroll.  If Frugal Boy hadn’t been fussy, that might have been true.  I did like the fact that you can setup a monthly contribution from your checking account.  We started off with a small monthly contribution.  It is money that we have saved by being frugal and cutting costs elsewhere in our lives.  This is part of the reason why we lead a frugal lifestyle, so we can put money towards things that will make a meaningful impact.  Even with a small monthly contribution, the amount set aside by the time Frugal Boy starts college will have grown substantially.  Investing and savings favor the young.

IMG_3341Now that his 529 is set up, any gift money he receives will be put towards his education savings unless specified otherwise.  Thank you all of those who gifted money to Frugal Boy.  That money has been socked away for his noggin later in life!