Question

Your 40-year clients, who have a 12-year old child, plan to retire at the age of 62. Assume 360-day year and 30-day month in your calculations.

They have a current salary at an annual rate of $144000, being paid equally at the end of each month. They expect a 3% raise in their salary every year until they retire. They deposit 12% of their monthly salary to their 401(k) account that generates an annual rate of return of 10%, compounded daily. In addition, their employer matches their contribution with 5% of their salary to the same 401(k) account.

Currently, annual college expenses are running at $30,000, and are expected to grow at an annual rate of 5%. Their child is expected to enter college when she turns 18, and complete the degree program in 5 years. Your clients expect their child to be responsible for 20% of college expenses via the work-study program. All annual college expenses are due at the beginning of each year. Your clients plan to tap into the 529 Plan account for paying their child’s college expenses. Is there sufficient funding in the 529 account for financing their child’s college expenses? If not, when will the funding run out of money? Support your answers numerically.

Answer 1

Answer:

Current annual college expenses = $30,000

College expenses during joining's time = Current expenses $30,000 * (1+Inflation rate 5%) ^{(18 years - Current age 12 years)}

College expenses during joining's time = $40,202.87

Parents contribution = College expenses at time of joining $40,202.87 * (1-Work study contribution 20%)

Parents contribution = $32,162.30

Value of 5-Year Parents contribution at time of joining = Present value of 5-Years of contribution

Note: Considered the discounting rate to be compounded yearly, the answer will vary based on the assumption of compounding

Assumptions:

• Since nothing is mentioned regarding the interest rates on 529 account and regarding the contribution, so assumed that there will be lump sum contribution made to this account at the beginning of the college.
• No withdrawls from 401(k) account in between 6 years of contribution

Since the amount of savings in 401(k) account $215,998.90 > Present Value of contribution required for college studies $133,492.54, hence there is sufficient funding in the 529 account for financing their child’s college expenses.