Why I Will Fund My Grandchildren’s 529 Plans Even Though College Is A Scam

529 plans are college savings plans that have become the best avenue for building generational wealth and it is something all new parents should take advantage of. This is true even if your children will likely not go to college, actually it is truer if your children do not attend college.

College is an absolute scam.  For most graduates it stopped having a positive ROI over a quarter century ago. We pushed too hard for kids to go to college as the ONLY path to a successful life, and they listened. We also created a situation where no one had to pay for it in real time, so debt was accrued that was also made non dischargeable in bankruptcy.  These 2 factors led to rampant increases in costs for a degree because the colleges found they could charge any amount and still fill their seats.  An over supply of degrees flooding the market and at the same time boomers extended their working careers, resulting in far fewer opportunities for graduates.

Real Numbers:

The sticker price for 4 years at Michigan State University with Room and Board (no meal plan) is $140,000.  37% of public university students graduate at 4 years, and only 60% graduate at all. For most students this longer time to graduate will add another roughly $20,000 to the total cost to cover room and board and more tuition for classes that weren’t passed the first time.

After graduation the starting salary for a recent college graduate is Michigan is $43,401 per year.  This is $7,400 more than the pay my 18 year old earned his first year at Walmart.

So not only do people pay $140,000 for a degree, they also typically do it while NOT working a full time job, which means there are lost wages of roughly $35,000 per year for those 4 years, bringing the total cost to $280,000. $280,000 invested to only earn $7,500 more per year.  This is NOT a good deal.

To make matters worse, this is usually done with significant debt financing. What is the interest payment on $140,000 of student loan debt? Student loans run about 6.5%, so that would be $758/mo in interest expense alone. This is the amount someone would pay every month every year, forever and then be 60 and see they still owe $140,000.  This is no principal repayment.

Even if only half the degree is financed, this is still $70,000 of debt to payback with minimum interest payments of $379/mo.  To pay off this debt amount of debt in a 10 year time period would require paying $795/mo.  To pay it off in 15 years would be $609/mo and over 20 years would be $522/mo.

Without essentially full ride scholarships, early college while in High School, AND working while in school, buying college degrees does not make sense for most people.

OK so I don’t believe in 4 year college, why would I finance a 529 Plan?

The overall goal is to help our children build a large retirement account nest egg before they move out on their own.  When young adults move out they often are living on a low income and don’t have the means to save for retirement.  Most people don’t start saving for retirement in any meaningful way until their 30s. This takes away a lot of compounding growth work.  The money an individual has invested in the stock market has historically doubled about every 7 years.  If your child moves out at 20 and has $32,000 in invested assets, then it will likely grow as follows IF THEY NEVER ADD ANOTHER DIME;

• Age 20: $32,000
• Age 27: $64,000
• Age 34:$128,000
• Age 41: $256,000
• Age 48: $512,000
• Age 55: $1,024,000
• Age 62: $2,048,000

Compare that to the median American’s retirement savings

• <35: $18,800
• 35-44: $45,000
• 45-54: $115,000
• 55-64: $185,000

This is less than 10% of the value of the front loading system at 62.  Using a 5% withdrawal rate the early investor can withdrawal $100,000 a year, while the median American can only withdrawal $9,250.

With the Secure Act 2.0 which passed in 2023, 529 plans became the easiest way to invest for children with tax advantages. In certain circumstances up to $35,000 can be converted from your child’s 529 plan into their Roth IRA.  Here’s the alternatives and why the 529 conversion is the superior method for investing for your minor child:

Option A: UGMA Accounts:

These are accounts like Stockpile, where the money is gifted to the children and investible in assets, just like a normal taxable investment account.  UGMA accounts don’t have any tax advantages.  Selling any assets in them triggers paying capital gains taxes.  Withdrawals of money is taxed as well and there are no tax deductions for contributions.

This money could not be put into tax advantaged accounts until the child has a job and then assets could be sold in the UGMA account and then reinvested in the child’s Roth IRA, which would cause capital gains taxes to be owed in each year this occurs. This is still better than doing nothing, but not as good as using a tax advantaged account.  The real risk here is never actually converting the money.  The UGMA account becomes the child’s when they are 18 and they can cash it out or may leave it invested.  If left invested it would keep growing, but the long term tax bill would grow as well.

Option B: Employ them and contribute to Roth IRA:

I like this idea and did it for a couple years.  It is burdensome to make this work.  The kids have to be motivated enough to work and capable of producing actual value.  You can’t pay your children more than you would pay anyone else to do the same job and you have to pay them inside of an actual business, you can’t pay them for doing household chores and then contribute to a Roth IRA for them.  Just getting the paperwork sorted out to do this was like banging my head against a brick wall.  On the plus side, once they earn the money and it is in the account it is safe from future taxation.

Another option here is rather than employ them, help them find a real job.  One of my kids got his first real job at 14, but in general jobs for kids under 18, and especially those under 16 are very rare. (Child labor laws have ruined our country!) I am a big fan of graduating high school early in order to give your kids a path to work full time and invest like crazy in Roth IRAs/401Ks while still living at home.

This is the path for everyone who has kids who are older than 3 and have not already started a 529 plan.

Option C: 529 Plans:

Due to recent legislation, funds in 529 plans in specific circumstances can be converted into Roth IRAs. Here are the ground rules:

• The 529 plan must exist for 15 years before it can be converted.  This means the plan must be opened essentially at birth for this to work well.  It is too late for this strategy to work for my kids. Even if you have no money to put into it to begin with, get the account opened!
• Conversions can only occur on funds that have been in the account for at least 5 years. To match up with the 15 years prior to converting rule, we want the majority of the money we add to be in the account in the first 10 years.
• There is a maximum of $35,000 that can be converted. We want to plan for growth to line up to around this amount.  It is OK if we overshoot, any funds left over in the account can still be used with no penalty for education expenses. The funds can also be withdrawn but will have taxes owed and a 10% penalty on any gains.
• 529 conversions are limited to the Roth IRA contribution limit by year, currently $7,000.
• The beneficiary must also be the owner and must have earned income equal to or exceeding the conversion amount.

How to use 529 plans to build generational wealth:

• Contribute roughly $7,000 at birth to the 529 plan.  This should double roughly every 7 years with 10% annualized returns, growing to $28,000 in 14 years. If 7K at birth isn’t possible that is OK. $1,000 a year for 11 years, would have similar results. This is much easier for grandparents to contribute to than parents. When my kids were born I was dead broke, but when my grandkids will be born I will be in a good financial position.  529 plans can also receive contributions from several individuals, not just one.  Have parts of birthday presents and Christmas presents be 529 contributions instead of plastic junk from China.  ANYTHING is better than nothing.  Maybe some years are $500. This is not only for the wealthy, a great option would be to put $500-$1,000 a year from the child tax credit into their 529 account each year.
• With $35,000 being the maximum conversion and $7,000 per year being the limit, then conversions must take place over 5 years.  The earlier this can occur the better.  Due to child labor laws most kids 14 and under can not find work. The sweet spot for conversions is between age 15 and 19 while the child still lives at home.
• At age 15 the child starts working part time and earns at least $7,000 per year.  At $13 per hour this is a little over 500 hours a year or 10 hours per week. Your child saves 50% of their income as cash to build up an emergency fund and buy a car.  You transfer $7,000 from the 529 plan into their Roth IRA to max it for the year.
• At age 16 they start working at Walmart (Walmart has an age minimum of 16), which offers a Roth 401K upon hire and has matching at 1 year of service. This is really important. They need to get a job that gives them access to a Roth 401K so that their earnings can go into a Roth 401K and not affect the Roth IRA contribution limits. Your child saves 50% of their income in their Roth 401K and you transfer another $7,000 from the 529 plan into their Roth IRA to max it for the year.
• At 17 they stay the course and continue working the same job. They put 50% of their earnings into their Roth 401K.  You transfer another $7,000 from the 529 plan into their Roth IRA.
• For ages 18, and 19 they continue the same job and you transfer another $7,000 into their Roth IRA, at this point the 529 account should be close to empty and you will have exhausted the $35,000 that can be transferred into a Roth IRA.

This is the best case scenario. At a minimum we want the child to at least work enough to earn $7,000 a year so that the maximum allowable amount can be put into their Roth IRA.

Since the money will also be growing in these years, the $35,000 total transferred over 5 years should be worth $44,000 at 19.  This money will grow to be worth  $1,000,000 at 52 and $2,000,000 at 59.

This doesn’t include the money they put into their Roth 401K in these years.  If they earned $10,000 a year at 16 and 17 and $30,000 per year at 18 and 19, then their Roth 401K should have ANOTHER $44,000 invested for a total of invested assets of around $88,000 when they move out at 20. The Roth 401K and Roth IRA growth will look like this if they never add any more money:

• Age 20: $88,000
• Age 27: $176,000
• Age 34: $352,000
• Age 41: $704,000
• Age 48: $1,408,000
• Age 55: $2,816,000
• Age 62: $5,632,000

And all this money can be withdrawn tax free in the future.

Visual Of Following This Plan:

What About Inflation?:

Inflation always eats away wealth.  This is especially true when we are looking at investing over 50+ years. As time goes on it will make sense to invest more and likely the Roth IRA contribution limits as well as the 529 conversion limits will increase.  20 years ago the limit for Roth IRAs was $4,000.   If you don’t like these numbers because of inflation, then invest twice as much to make up for it. Instead of investing $1,000 a year for 11 years, invest $2,000 a year for 11 years.

It isn’t the actual numbers that matter as much as the concepts:

• Investing earlier is always better
• Investing tax free in Roth accounts is always better
• Working in high school is important for job skill development and wealth building.

Start a 529 at birth.  Contribute and Invest over time. Have teenagers work.  Convert 529 to Roth IRA as allowable.  Don’t touch the money!  Bonus: Have kids save 50% of their income with the majority going to Roth 401K investments.  It’s that simple, and no one does it.  The average retirement account for people under 25 has $6,264 in it.

Change in 529 Strategy:

Historically many parents have made one 529 plan and used it for the oldest child, then what is left in the account would get transferred to a younger child.  This is a poor strategy for the 529 conversion plan because the $35,000 limit is per account.  You want to build each account separately for each child.

Taxes:

529 plans are funded with after tax money and grow tax deferred with no taxes being paid on withdrawals for qualified college expenses or for 529 conversions.  Some states offer a tax deduction for contributions.

My home state of Michigan has a $5,000 deduction limit, so in any year I contribute to a 529 I can get a state tax deduction of 4.25% on the amount donated up to $5,000. If maxing this out, this would be a deduction of $212.50.

Neighboring Indiana has the most generous tax plan for 529s in the country.  Indiana gives a 20% tax credit on up to $7,500 per year, which would be a $1,500 tax credit maximum per year.  This credit is non-refundable, so it may make sense for Indiana residents to plan out contributions over multiple years to ensure they take full advantage of this.

What do you think about investing in 529 plans to build generational wealth?