Should I put lump sums in the 529 instead of dollar cost averaging?

One of the reasons this blog seems to have become a spendapalooza is that there’s really not any obvious place for extra money to go.

But there actually is one place for extra money to go– the kids’ 529 plans.  (A 529 plan is an awesome way to save for college or vocational school such that the earnings are tax-free.  But, it’s a good idea to max out your retirement before setting money aside in 529 plans because retirement accounts aren’t included in college financial aid calculations and you can take out loans for college but you can’t for retirement.)

In the past, I’ve always said, “and the kids’ 529s are on track to pay for the school of their choice [by the time the graduate college].”  What I mean by that is that we’ve been putting away $750/month in the accounts, even in the summers when I don’t get paid.  (It used to be $500/month, but we increased it when we paid off the mortgage and stopped paying for daycare.)  But we haven’t *actually* put enough money to be able to cash flow the remainder of the cost of (a four-year private) college yet.  We’re just on track to.

Over the next 4 years before DC1 starts college, $750/mo works out to $36,000 (actually a little less than that since it’s November, but it’s an estimate).  Over the next 8 years before DC1 ends college, it would be $72,000.  (That’s a LOT of money!)

We could just put in $36K (instead of $9,000) over the course of this year and then either start contributing again once we know where DC1 is going to college or not based on the cost of hir chosen school.  (Given hir struggles in English, it is likely that HMC is out, but also out with HMC is its insanely high $72K/year tuition.  I told DC1 we could get hir a unicycle anyway.)

Doing it this way loses some dollar-cost averaging benefits, but it gains the benefits of a longer period of untaxed earnings.

There are some wrinkles to doing BIG 529 account transfers.

The first is that even though the account is a custody account and doesn’t actually belong to the child, it still is subject to the annual gift tax.  For 2019, the amount that can be given annually without tax is $15,000.  Each parent can give that amount, so a married couple can give $30,000 in one year.  $36K is more than $30K, but there’s a loophole with the 529.

This wrinkle has its own wrinkle:  An individual or couple can give a larger lump sum, so long as the total given in that five year period is still less than 5 times the annual exclusion.  So DH and I *could* give $150K this year so long as we didn’t contribute again for another 5 years.  (Of course, that’s a moot point because we don’t actually *have* $150K to give, but you get the idea.)  That means when DC1 actually gets into college, we should be able to continue to contribute to hir 529 without penalty.

So our plan is to do a lump sum of $36K this month to DC1’s account (this gets rid of all our excess cash and digs pretty deep into our emergency fund, but the emergency fund doesn’t actually have to be full until May since we can cash flow most emergencies when we’re both being paid).  Then we will stop contributions to hir account entirely.  We will continue as normal with DC2’s account (contributing $750/month) until we build up excess cash and I start to feel like forcing DH to buy all the Apple products again.  At that point we will re-evaluate and decide whether we want to do a lump sum to DC2’s account or if we just want to increase the monthly contribution.  I’m sure I will post about what we end up doing.

In ~4 years when we know where DC1 is going to college, then we’ll decide whether or not to start contributing to that 529 plan again, and we will have a better idea about how much DC2’s account can bear without going over.

Grumpy Nation, I don’t have a good question for this post.

21 Responses to “Should I put lump sums in the 529 instead of dollar cost averaging?”

  1. Miser Mom Says:

    There’s another slight wrinkle, probably not super likely in your case, but . . . for my sons, we saved a grand total of $15K into a 529 plan. That doesn’t sound like much, but it turned out to be too much anyway. Neither one is likely to do any post-secondary ed that actually costs us money.

    We ended up rolling the money over into a 529 for my granddaughter instead. I think there’s a good chance she’ll use the money in another decade & a half — or maybe even her mom will: K-daughter has an associate’s degree, paid for (with lots of debt) before she legally became our daughter. K-daughter keeps making noises about going back to school. Still, if we didn’t have so many other kids to push the money at, this 529 money for my sons might better have been put into an UGMA or a trust or some such.

    • nicoleandmaggie Says:

      Hopefully not an issue for us! I do wonder what we’ll do if DC1 decides that zie must go to a state school. All my wealthier colleagues say zie will want expensive graduate school to be a doctor or lawyer or MBA, but that’s not really something CS majors do. Still, a masters degree would put hir at getting out of school at 22, so maybe not so crazy. (And DC1 might change hir mind about professions. And DC2 is only 7, so lots of time.)

    • bogart Says:

      I have the impression that one can also re-assign the account to oneself (i.e. the custodial grown-up/parent) and then apply its contents to educational expenses incurred *by* oneself … which could involve going back to school for “real” reasons, or for “recreational” reasons. A quick Google search on “529 retirement” suggests that I am correct.

    • SP Says:

      I believe you can also take out the contributions any time, only the earnings are subject to the 10% penalty. But, it is very possible you may have to take out the money proportionally, i.e. you might not be a able to take out principle without also taking out earnings. Still, the 10% penalty isn’t as scary as it seems.

  2. Revanche @ A Gai Shan Life Says:

    I don’t remember what your projected estimates of an expensive private four year college was, could you refresh my memory?

    The possibility of saving more than JB will need has occurred to me more than a few times, hence our backing off on the 529 after we did a lot of big lump sum contributions earlier on. I should do a bit of research to see if we have any other options than rolling the money back to ourselves. (Though, if cheese mongering or say, learning how to cook or ride could be covered …??)

  3. First Gen American Says:

    I’ve been maxing my pre-tax contributions for my 401K a long time but am nowhere near maxing to the $57K limit of all contributions per year. (Pre, after tax and employer). So now I’m thinking to up my after tax and back door yearly to a Roth and use those instead of 529…and that way there is no risk of over-saving.

    Any reason you don’t go that route or are you just confident if you don’t use all the 529, then a niece or nephew can get the money. I am not at all sure about the amount I should save. Up here in MA, I could be paying 3x the cost of the state school if we go private.

    • nicoleandmaggie Says:

      I am maxing out all available retirement options including backdoor IRA Roth and 457 plans. Neither of us has access to a mega backdoor Roth. I could do a self employment account but that seems like a lot of work for something that could get a few hundred in a good year (honoraria are generally in the $50 range but occasionally I’ll get a few thousand for something).

      • First Gen American Says:

        It’s definitely a good problem to have. Okay…adjusting my 401K withholding as we speak. I guess I should take greater advantage then. This is the first year I feel flush enough to do so….finally after 24 years of working.

      • nicoleandmaggie Says:

        In fairness, DH’s options are limited—just the regular 401k and the backdoor IRA Roth. They’re better than they used to be though—they fixed the problem with sending money back to us each year from the 401k because not enough lower income people were contributing. (And of course our housing expenses are way lower than yours have been.)

        Yay retirement savings!

  4. Bardiac Says:

    What happens if you have more money in a 529 than a child uses? Can it be moved to some other function, or is it lost somehow?

    • nicoleandmaggie Says:

      If you take it out for noneducational purposes there’s a tax penalty. You can take an amount equal to any scholarships the child gets without penalty but you lose the tax advantage. You can move it to yourself or another child without penalty.

  5. Becca Says:

    Bogleheads left me pretty confused about the gift tax. There are threads there stating you don’t need to worry about it, except you need to report >30k (per married couple) and it counts against your 11.4 million dollar lifetime exemption. If you are thinking about leaving that kind of estate, I’m happy to help you find more charities.

    Given your specific situation (plenty of niblings), I wouldn’t worry much about oversaving in a 529.

  6. I guess I’m not going to front-load DC2’s 529? | Grumpy Rumblings (of the formerly untenured) Says:

    […] summer, paid for lots of summer travel and camps that probably won’t happen now, maybe it was front-loading DC1’s 529… probably that.  Bad market timing there, eh?  Shoulda kept dollar cost averaging!)  Since […]

  7. I guess I will front-load DC2’s 529 too? | Grumpy Rumblings (of the formerly untenured) Says:

    […] we decided to stop contributing monthly to DC1’s 529 and instead invest a lump sum equal to what we would have invested each month in the time before zie graduated high school.  […]

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