Drawing Down College Savings

[Closet_Gamer]

My older daughter heads off to college in the fall of 2018. Having spent 18 years assembling the financial artillery to pay for the college war, I now need to figure out how to draw it down.

I'm guessing others on this board have been through this and would welcome any insights on best approach.

Apologies for a long post but wanted to share all the facts.

Situation Facts:

2 kids -- one will leave in fall of 2018, the other in fall of 2021
$450k in college savings

$275k in 529s that grow at the rate of college inflation
$175k in a generic after tax brokerage

Our original plan was to get each kid through a private, four year degree with zero debt. Any grad school would be on them.

DD#1 is now pursuing a six year PharmD program...so the notion of four years and then she's paying goes out the window. We won't have access to need-based financial aid and net of merit aid, our estimated out-of-pocket to get thru the PharmD program is $300k accounting for inflation.

Assume DD#2 follows a similar path…accounting for inflation her estimated cost would be $350k.

Combined, we’re looking at a 9 year drawdown schedule where DD#1 enters in 2018 and DD#2 finishes in 2027 for total nominal outlays of $650k (we’ll expect them to pay back about $200K combined, but this question is about draw down.)

College Investment Facts

• The 529 program we use grows the money at college inflation rates and can be used for either kid. In my mind, this is “magic” money as its liability matched, tax deferred, and paying an effective rate of 3.5% on a pretty short maturity. Of course, it can only be used for college.
  
• Brokerage investments are just investments...but the short time horizon is a challenge. Equities create sequence of returns risk while interest rates won't keep up with college inflation.
  
• I have excellent free cash flow and could pay the costs out of cash flow if necessary.
  
• I will likely FIRE in Year 4 of the 9 years. So years 5-9 need to be confidently funded as I won't have income to cover any variance between college savings and college costs.

The quandary is how to balance three funding sources (cash from income, after tax brokerage assets, and inflation protected 529 assets) to confidently pay out the costs over 9 years recognizing that Years 4-6 are the peak burn rate with both of them in school.

Year 1-3: Pay cash from income (~$150K)
Year 4: Pay cash from income (~$100K)
Years 5-6: Clean out the brokerage and some of the 529s (~$225k)
Years 7-9: Burn down the inflation matched 529s (~$175k)

In essence I will cover the gap between $650K nominal and $450K saved by fronting the first few years in cash and then use the saved $$$ in the later years.

Questions:

1. What do people think of this approach?
2. Do people agree that the inflation protected 529 money should best spent last even though its “single purpose” college $$$?
3. What AA would you suggest for the brokerage $$$ that needs to be tapped in ~6 years from today?
4. What else am I missing?

Thanks!

 

[ivinsfan]

Pharm D is not a walk in the park and your daughter is not even in school yet. Not sure why you feel obligated to pay every cent of 6 years worth.If she gets a pharmacy degree loan payments should be no burden on her

 

[USGrant1962]

I would suggest consuming the 529s earlier - you don't really want to be left with funds subject to a 10% tax penalty on withdrawal. Say, for example DD#2 gets more merit aid and goes to a less expensive school than you expect - you could be left with a good chunk in the 529.

I know! DS#2 went Air Force ROTC at a GATech while Grammy and I had fully funded a 4-year private school in his 529. Having money left over is a good problem, but paying extra taxes is not.

Other thoughts:

• College inflation seems to be slowing down, so that is good
• If you seem to be overfunded in a 529 don't forget that you can withdraw amounts equal to scholarships without the 10% penalty
• In your example, I would target spending down the 529s around year 7, pending a better view of the cost of DD#2
• In the end if there is money left in the 529 it can always be used for grandchildren or yourself (tax free), or as an emergency fund (taxable)

 

[euro]

I would suggest consuming the 529s earlier - you don't really want to be left with funds subject to a 10% tax penalty on withdrawal. Say, for example DD#2 gets more merit aid and goes to a less expensive school than you expect - you could be left with a good chunk in the 529.

I know! DS#2 went Air Force ROTC at a GATech while Grammy and I had fully funded a 4-year private school in his 529. Having money left over is a good problem, but paying extra taxes is not.

Other thoughts:

• College inflation seems to be slowing down, so that is good
• If you seem to be overfunded in a 529 don't forget that you can withdraw amounts equal to scholarships without the 10% penalty
• In your example, I would target spending down the 529s around year 7, pending a better view of the cost of DD#2
• In the end if there is money left in the 529 it can always be used for grandchildren or yourself (tax free), or as an emergency fund (taxable)

Agree - spend down 529 sooner. Of course, you know your kids better than any of us, but just based on MY experience with my two kids, you really can't assume that your 15 year-old will enter the same doctoral program. She may, but then again, may not. Or may not even go to college. May want to start a business and you may want to help with that (529 money no good for that). Many, many uncertainties. DD1 may discover she doesn't like pharmacology after all and bails out with a BS. Who knows?
They both may have grandkids and then you can roll the 529 balance over to them - or they don't and you have to pay the 10% penalty plus tax on gain.

I'd hedge my bets and plan on drawing down the 529 somewhere along the lines, NOT wait until the end.

 

[Closet_Gamer]

Pharm D is not a walk in the park and your daughter is not even in school yet. Not sure why you feel obligated to pay every cent of 6 years worth.If she gets a pharmacy degree loan payments should be no burden on her

From my post:
>>(we’ll expect them to pay back about $200K combined, but this question is about draw down.)

I'm not planning on paying it all for her -- my intent is to pay what I originally planned and have her (and DD#2) pay back the difference. Given our financial circumstances, I do not expect her to qualify for any subsidized student loans and I see no reason to pay interest in conventional loans. Figuring I'll need to figure out how make the cash flow work and then have her pay it back (or pay what she's able as she goes thru.)

I'm not too versed on student debt/qualification for the graduate portion of the PharmD...so perhaps she could draw subsidized loans directly for that part? That would be helpful.

You're correct that PharmD isn't a walk in the park. Given her scores/GPA/"resume" coming out of high school, all signs are she'll be admitted to a few of her target schools for a 6 year PharmD tho.

Thanks.

 

[Closet_Gamer]

I would suggest consuming the 529s earlier - you don't really want to be left with funds subject to a 10% tax penalty on withdrawal. Say, for example DD#2 gets more merit aid and goes to a less expensive school than you expect - you could be left with a good chunk in the 529.

I know! DS#2 went Air Force ROTC at a GATech while Grammy and I had fully funded a 4-year private school in his 529. Having money left over is a good problem, but paying extra taxes is not.

Other thoughts:

• College inflation seems to be slowing down, so that is good
• If you seem to be overfunded in a 529 don't forget that you can withdraw amounts equal to scholarships without the 10% penalty
• In your example, I would target spending down the 529s around year 7, pending a better view of the cost of DD#2
• In the end if there is money left in the 529 it can always be used for grandchildren or yourself (tax free), or as an emergency fund (taxable)

The point on DD2 & the 529s is very well taken. Who knows what road she'll walk? I anticipate it involving college/grad work but life is uncertain. Modeling DD2 the same as DD1 had more to do with being prepared to deliver the same support to both as with knowing what she'll actually do.

Great point on pulling that forward in the plan. In principle that would allow me to have the brokerage in a more aggressive AA as the first "draw" date would be further out.

The grandchildren are on their own

Thanks!

 

[Closet_Gamer]

Agree - spend down 529 sooner. Of course, you know your kids better than any of us, but just based on MY experience with my two kids, you really can't assume that your 15 year-old will enter the same doctoral program. She may, but then again, may not. Or may not even go to college. May want to start a business and you may want to help with that (529 money no good for that). Many, many uncertainties. DD1 may discover she doesn't like pharmacology after all and bails out with a BS. Who knows?
They both may have grandkids and then you can roll the 529 balance over to them - or they don't and you have to pay the 10% penalty plus tax on gain.

I'd hedge my bets and plan on drawing down the 529 somewhere along the lines, NOT wait until the end.

I think its a hugely valid point. The notion of DD2 taking on a 6 year path had more to do with modeling giving them equal support...but silly to let the model interfere with good execution. I should look at moving the 529s up in the plan.

Thanks!

 

[HillCountry]

Agreed with all the opinions spending down 529 first.

There are too many variables. Kids might not like the path you planned. They might not get admitted. They may change their majors in college.

You have a good problem to start with, i.e. 275k in 529. I only have 70k today, and it is good for one year. My kids will leave for college in 21 and 23.

 

[SecondCor521]

I would echo spending the 529s down first.

Two other things:

1. You *may* qualify for financial aid during the years that both are in school - if they go to expensive schools and if you cut back your income to part time as a way to ease into retirement.

2. Graduate students are automatically considered independent and thus qualify for financial aid based on their income and assets. Your DD#1 might qualify for aid since she will likely have relatively low income and assets.

FWIW, my 15 year old DD changes her mind daily on what she wants to do in life. I'm just targeting 4 years of undergrad now and will adjust as things become clearer.

Good luck!

 

[joeprintz]

I think it is just a different point of view. Our family has always felt if one has the ability to "fund" our kids education- what a blessing to allow them to enter the adult world debt free. I guess it is just how one feels about education. That being said I don't think parents should spend what they can't fit into a reasonable financial plan- just because kids are entitled to something.

 

[45th Birthday]

I'm going to put myself in the minority here and say hold onto those 529s as long as you can. The time horizon you are facing is fairly long, and the potential to put tax-free dollars to work down the road could be big. I'm going to guess your marginal rate now is pretty high, so paying out of current income could be costly.

That said, the uncertainty of the path they will take means you can't go all in on one strategy. I would construct several models based on the outcomes that might occur and optimize your withdrawal strategy for each. Then, when the path is known, pull the trigger on the appropriate plan.

As for asset allocation, I think the taxable college savings accounts should have a similar AA as the rest of your portfolio. In other words, model all spending including college and the lumpiness of the timing along with your other spending, especially since FIRE is involved along the way. Choose the best AA for your overall plan. The taxable college savings accounts (unless I'm missing something) probably have the same tax structure as any other accounts you own.

Final advice: if you live in a state where you get a deduction for contributions to a 529 plan, and are coming out of pocket (or out of a non-529 account) to pay college costs, and you are not maximizing the 529 deduction for your state, remember to launder the balance of the deduction limit through your 529 plan. I did this for several years, took money from taxable accounts, contributed up to the deduction limit, put the funds in a money market investment, and withdrew them as soon as I could. Just be sure total 529 withdrawals for the year do not exceed allowed expenses. Free, legal money.


P.S. I specifically avoided the topic of whether you should fund their college costs, and to what degree, because that wasn't the question you were asking here.

 

[rodi]

I am looking at my DS1 starting college fall 2019, and DS2 starting college fall 2021... so not too far behind you. I also have money set aside in 529's (about 200k total) and money outside the 529's.

The difference is that I'm not working anymore. So cashflowing everything is not as easy. But here is what I suggest for you.

Start off both kids with the 529's. All of the reasons stated above are valid - you get the tax break ONLY if they're used for qualified expenses.

If you want to set aside an equivalent amount to what you're drawing from the 529, while you're still working - do it. Nothing says you can't be stockpiling for the backend while you're still working.

My understanding is that grad school scholarships/work study are more easily obtainable than for undergrad... so that might work in your favor.

Like you're original plan - we've said we'll help them through their undergrad degree debt free (although we're budgeting for public schools.).

 

[RetireAge50]

We used up the education funds first. Felt good to get rid of those accounts. Now paying from savings or income. Moved any money needed within 2 years to cash otherwise 75/25 stock bond mix.

 

[Blue Collar Guy]

ill answer part 4 of your question

i think its an obscene amount of money to spend for a job that pays 120k,

 

[Shanky]

Just used bonus income for college bills after 529's were spent. We never had more than two in school at the same time. Grad school was on them.

 

[Closet_Gamer]

I would echo spending the 529s down first.

Two other things:

1. You *may* qualify for financial aid during the years that both are in school - if they go to expensive schools and if you cut back your income to part time as a way to ease into retirement.

2. Graduate students are automatically considered independent and thus qualify for financial aid based on their income and assets. Your DD#1 might qualify for aid since she will likely have relatively low income and assets.

FWIW, my 15 year old DD changes her mind daily on what she wants to do in life. I'm just targeting 4 years of undergrad now and will adjust as things become clearer.

Good luck!

Wow. Huge insight on the graduate students being treated as independent. Will need to go deep on that one. Thanks!

I will be going full tilt at work until Year 5 of the plan, but my income will drop a lot starting in year 5 so maybe the financial aid will change. Let's hope.

LOL on the 15 year old. My 17 year old is pretty locked on pharmacy at this point...but it hasn't occurred to my 14 year old that it's unlikely she can be a chef, a cognitive psychologist, an engineer and a physical therapist all at once. (Though if she did find a way to combine those, she'd have carved out a niche for herself!)

Thanks!

 

[Closet_Gamer]

I am looking at my DS1 starting college fall 2019, and DS2 starting college fall 2021... so not too far behind you. I also have money set aside in 529's (about 200k total) and money outside the 529's.

The difference is that I'm not working anymore. So cashflowing everything is not as easy. But here is what I suggest for you.

Start off both kids with the 529's. All of the reasons stated above are valid - you get the tax break ONLY if they're used for qualified expenses.

If you want to set aside an equivalent amount to what you're drawing from the 529, while you're still working - do it. Nothing says you can't be stockpiling for the backend while you're still working.

My understanding is that grad school scholarships/work study are more easily obtainable than for undergrad... so that might work in your favor.

Like you're original plan - we've said we'll help them through their undergrad degree debt free (although we're budgeting for public schools.).

Yep, very similar situation. I hadn't thought of burning the 529s and then "restocking" the war chest by setting aside income on the early years. Need to consider how to cover college inflation costs during that horizon w/o too much risk. Thanks for the idea.

 

[Closet_Gamer]

We used up the education funds first. Felt good to get rid of those accounts. Now paying from savings or income. Moved any money needed within 2 years to cash otherwise 75/25 stock bond mix.

Thanks. How did you think about sequence of return risk on the 75% in stocks? 2 years seems like a short horizon?

 

[Closet_Gamer]

i think its an obscene amount of money to spend for a job that pays 120k,

It's a job that can start at $100k+ and go from there. The payback is actually pretty fast vs. many other options. It also and has to do with using ones talents (chemistry and disciplined planning/execution) along with following ones desires to help people.

But I understand your point and appreciate you taking the time to respond to the post. It takes all kinds and there are many paths.

Thx

 

[Closet_Gamer]

Just used bonus income for college bills after 529's were spent. We never had more than two in school at the same time. Grad school was on them.

Thanks. The part where I FIRE in the middle eliminates the ability to fund the later years out of bonuses but to another suggestion that came in, I could stack bonus dollars while I'm still working.

 

[Closet_Gamer]

I'm not trying to close down the thread -- pls keep the ideas coming! -- but do want to take a second to say thank you for the excellent responses.

This is why this board is great. One could (literally) spend $1000 with a financial advisor to get the same insights/concepts about funding strategies, 529 approaches, AA and financial aid.

Thanks.

 

[ivinsfan]

It's a job that can start at $100k+ and go from there. The payback is actually pretty fast vs. many other options. It also and has to do with using ones talents (chemistry and disciplined planning/execution) along with following ones desires to help people.

But I understand your point and appreciate you taking the time to respond to the post. It takes all kinds and there are many paths.

Thx

If you research a little you will find out the majority of pharm D people start out with a decent wage, but unless they want to work extra shifts the income doesn't really go up much...unless you get into a very lucrative field like research, years of experience don't add much to your bottom line.

 

[euro]

i think its an obscene amount of money to spend for a job that pays 120k,

That really depends on what the young woman ultimately does with the degree. There is huge upside potential for someone with a Pharm.D so I'd look at it as an strong investment. That said, obviously, the investment would be even stronger if the cost were lower.
I would rather spend 300K all in on a Pharm.D. than 150k on a BS in art-history or comparative religion. Nothing against those either, but it is MUCH harder to recover your investment in one of those fields - purely on a financial level, that is. If someone's passion is in comparative religion, then by all means go for it, but it is a much harder row to hoe.

 

[MichaelB]

What's the value of the tax deferred income over the 9 year period? In other words, how much tax are you avoiding with this account by using those funds last, vs first? There's something to be said for having the savings in a regular taxable account. You have maximum options, in case there is a change of plans, family finances, or other circumstances.

One option to keep in mind is to borrow some money. If some loans can be obtained with favorable terms, that cash that would have been used can stay invested for a few more years and be used to pay down the loans later.

 

[ivinsfan]

That really depends on what the young woman ultimately does with the degree. There is huge upside potential for someone with a Pharm.D so I'd look at it as an strong investment. That said, obviously, the investment would be even stronger if the cost were lower.
I would rather spend 300K all in on a Pharm.D. than 150k on a BS in art-history or comparative religion. Nothing against those either, but it is MUCH harder to recover your investment in one of those fields - purely on a financial level, that is. If someone's passion is in comparative religion, then by all means go for it, but it is a much harder row to how.

When you say huge upside potential what are your referring to,my DD's in-law family have 6 pharm Ds between and I don't find your statement to agree with what I know about their jobs/wages.