College Plan? Undeclared.

Two days after Christmas, we closed on the sale of our second, and final, rental property. We got a full price offer, too. (Minus having to give the buyers a $2k credit towards closing).

It is hard to describe how good this feels.

Though I was a bit nervous right up until the day the check cleared. A previous buyer on this property backed out at the last second, even after we agreed to fix the major items in his inspection list. So I wasn't going to declare we were officially-and-forever out of the rental business until the papers were signed.
Once check was in hand, we put Baby AF to sleep, opened a bottle of wine, and then I did a damn cabbage patch in celebration.

We've sold three properties in the past two years. We made a little profit when we sold the first rental in Indianapolis. And when we sold our prior primary residence, the first home we ever bought, we started deploying that cash to accelerate our financial independence plans.

But now that Baby AF is in the picture, Mrs. Done by Forty and I thought we'd use this rare, cash-rich opportunity to create a college fund for the little one.

I should acknowledge that we are two lucky fuckers, as these home deals could have gone sideways in a dozen different ways. For each house, we put over $20k into flipping the property, putting in new kitchen cabinets and granite, laying new flooring, hoping to make the home desirable to a family rather than another investor, and maximizing our profit on the back end. But we could have ended up losing that money had things not broke our way.

We were also ridiculously fortunate to have purchased all three properties at a low price in the first place (roughly $80k and $90k for the rentals, and our primary residence for about $130k back when the Phoenix area was giving homes away in 2010). We were also lucky to have cash available to make the deals in the first place.

We've got privilege falling out of our butts over here.

The catch is that we don't really know the best way to save for college, since I am only masquerading as someone who knows how to manage money. Given our long time frame between now and Baby AF's first college class, and our weird ass FI plan, we don't really know whether we should lump sum invest or dollar cost average, or to use a 529 or not.

That's where you smart people come in. You use your smarts and tell us what to do, and then we do it. But we don't pay you anything for your advice because we are cheap, and you are nice people.

Guiding Principles:

• We are planning to invest $40k for Baby AF's college, and let it compound for 18 years. If we assume a 7% return each and every year (ha!) then this would grow to $135k. If we want to account for inflation and assume a 4% real return, then the $40k would grow to $81k in real terms. 
• This will almost assuredly not cover the cost of a four year degree, and we are pretty okay with that. Mrs. Done by Forty and I both were responsible for a large part of our bachelor's, and we want Full Grown AF to have some baby soft skin in the game. The amount we're giving will still be many times more than what we received. And, who knows? Maybe we can add to the account later.
• Lump sum investing is likely to have the best outcome, though with CAPE where it is, dollar-cost averaging sure is tempting. Still, our plan is to invest the $40k in VTSAX within a fairly short time frame.
• Over time, we'd like the account to become more conservative, so we'd have the dividends each quarter be directed to cash, and buy the Total Bond Index (VBTLX). Over eighteen years, the mix would become more bond heavy through these dividend payments.
• We plan to have a second little one sometime soon, so we'd want to replicate whatever plan we come up with for her.

The 529:

• A 529 Plan seems to be the option of choice for most financially savvy folks. It allows two main tax advantages: avoiding some state income tax each year you contribute, and tax free growth for all the years the account compounds. 
• Tax free growth is a pretty great benefit if you're going to invest all at once, since a majority of the final balance will likely be from gains 18 years down the line.
• But a 529 has a few tricky bits for us. For one, in Arizona you can only deduct $4,000 from your taxable income each year. At our marginal tax bracket (3.32% for AZ state income tax), we would avoid $132 in taxes each year that we contribute $4,000: in effect, getting an immediate 3.32% return on that four grand. 
• However, to maximize this tax benefit, we'd have to spread out the $40k in contributions over ten years! The opportunity costs for staying in a cash position for so long, plus the impacts of inflation, are pretty substantial.
• Additionally, there is an outside chance that Baby AF gets a free ride to school. Or maybe he'll decide not to go to college at all, since robots took all the jobs after the SkyNet incident of 2020, and universal basic income started taking care of all our financial needs in 2021 under President Crissy Teigen. In that case, if we wanted to withdraw the funds and give the money to Baby AF to, say, start a business or for a down payment on a home, the gains in the 529 would no longer be treated as capital gains. Instead, those withdrawals would be taxed as earned income. It's hard to know what our rates will be twenty years from now, but they tend to be less attractive than capital gains tax rates.
• There are thankfully no account maintenance fees in the Fidelity AZ 529 plan, and there are some good index options that mirror what we'd choose to invest in with Vanguard.

The Taxable Account:

• Jeremy at GoCurryCracker has a pretty convincing take on the 529: if he's going to handcuff himself with a bunch of rules in exchange for tax avoidance, the benefits have to be pretty substantial. For early retirees who aren't going to pay a lot of taxes anyway, what's the point?
• If we were not to use a 529, we'd invest in a boring old taxable account and try to keep the funds fairly tax efficient. 
• Additionally, the taxable account might not be quite as bad of an option in the event that we retire early. With no earned income, we'd potentially have a 0% or a very low tax rate on the dividends, and could even do some tax-gain harvesting at 0% capital gain rates, too, depending on what Congress does with future tax laws. 
• Which all goes to say, the benefit of tax free growth in a 529 matter less to an early retiree, who is probably paying very little in taxes on capital gains & dividends.
• A big advantage of this plan is being able to invest as much or little of that $40k as we want right off the bat, rather than having to put it in $4,000 per year chunks if we were trying to maximize the state income tax avoidance with the 529.
• Of course, even if we decide we want to go with the taxable account, we still have to choose between investing the $40k all at once, or dollar cost averaging over a year or three.

A Hybrid Approach:

• As a compromise, we could do a bit of both: put $4k a year into the 529, but invest the rest into a taxable account. 
• We hypothetically could move $4k from the taxable account into the 529 each year, but the capital gains we'd see while working (15% currently) could more than cancel out the state tax savings (only 3.32%). 

There are even more options we could consider, like throwing an Educational Savings Account in the mix, or even going with another state's 529. But this post is already running too long, and the last thing we need is to throw more options into the mix.

So here's where I put our child's education into the capable hands of my readers.

If you were in our situation, would you go with a 529, a taxable account, or a mix? And would you lump sum invest, or spread out the contributions over a year or two?

The commenter with the most convincing answer gets to pick Baby AF's major.

As always, thanks for reading.



*Undeclared photo is from Fan the Fire Magazine at Flickr Creative Commons.