Imagine you have a two-year old at home—as I do—and you finally get her down for a nap. You plop down on the couch, even if just for a brief moment. You pick up a magazine to relax, but quickly come across a frightening number, one that jolts you back to reality: $432,000.
That’s one estimate for the cost of a four-year degree from a private school beginning in sixteen years. To provide the whole $432,000, you’ll need to put away over $1,100 at the beginning of each month, assuming an eight percent rate of return.
But don’t forget you may have another child. Then there’s graduate school, paying off your student loans, saving for your retirement, your upcoming mid-life crisis …
Stressed? Don’t be. Although saving 100 percent of the anticipated expenses for your child’s education will likely be difficult (or impossible), there are other options. First, financial aid can provide valuable assistance and doesn’t seem to be going away. Most students get some form of financial aid these days. Plus, your kid might not go to Harvard (gasp!) or another very expensive private school. They might go to a public school or a less expensive private school.
Rule One: You Come First
I know it’s difficult to accept, but—at least financially speaking—your future is more important than your child’s college education.
I know you love your kids, but if you ultimately have insufficient funds for your retirement, you’re on your own. You can’t get a low-interest rate loan for retirement. There’s no financial aid office at the country club and no one confuses Medicaid for a work-study program.
If your circumstances dictate you must choose between saving for retirement and saving for your child’s education, most of your emphasis has to go to your future. Again, there are other ways for your child to get through school—not so for your retirement.
Rule Two: Have Your Child Be a Part of the Process
No, I’m not talking about this afternoon with your two-year old. Trust me, I get it: a financial lesson in our house is teaching our daughter to save at least one of the bananas for tomorrow. But your child—mine too—grows up quickly and is learning all the time. It’s important for her to discover the value of a dollar long before college orientation. Have her save part of her allowance, the gift from Grandma, or whatever—just teach her to save something. She’s learning from you, so set an example. Show your child that the whole family saves.
Rule Three: Know What Not to Do
Sometimes it is just as important to know what not to do as it is to know what to do. For example, using annuities, loaded mutual funds, and whole life insurance policies as your primary college savings vehicles will expose you to significant and unnecessary fees.
While both Roth and regular IRAs are excellent vehicles for saving, they should be used primarily—if not exclusively—for your retirement. Ultimately, there are better ways to save for college.
Rule Four: Save the Right Way, 529 College Savings Plans
While everyone’s situation is different, when it comes to saving for college, most people should seriously consider 529 plans. The two different kinds of 529 plans are pre-paid tuition and savings. With both types,
- Your contributions, while not tax-deductible, grow tax-deferred (aren’t taxed each year)
- If the money is taken out for qualified educational expenses, the distributions are tax-free
The tax-free component is critical—you can save and invest money for your child’s education without future tax concerns, dramatically increasing the amount you have available for college expenses.
A 529 pre-paid plan, operated by states and private schools, features tax-free withdrawals when done appropriately. However, the pre-paid tuition plan may be restrictive if your kid doesn’t go to the “right” school. The money you saved won’t be wasted, but it might not go as far as you had planned in the scenario where your child does not go to the school you funded. Simply stated, it’s less flexible.
Operated only by states, a 529 savings plan has the most flexibility. You retain the ability to use the money at almost any college, yet retain the tax advantages listed above.
Choosing your own state’s plan can provide you with some state income tax advantages. It’s best to research that on your own. Just go to your favorite search engine and enter the name of your state followed by the term “529 plan.”
Rule Five: Invest Your Savings Appropriately
Once you put money in a 529 plan, you must invest it. With a two-year old, you have a long-term horizon, so much of the money should be invested relatively aggressively.
If you don’t want or don’t feel comfortable making investment decisions for your child’s education, there’s some good news: one of the advantages of many 529 plans is that the money can be invested appropriately for you. Simply tell them the age of the beneficiary (your child) and they invest accordingly. If your child is young, they invest it aggressively, then gradually less so as your child gets closer to beginning college.
While it may be some time before the cap and gown from your child’s high school graduation are tossed up in the air, those items come down from the sky much quicker than they go up. Will you be ready when they hit the ground, or will you be caught—napping?
Oh my gosh, she’s up already?!
Michael B. Rubin is the author of Beyond Paycheck to Paycheck: A Conversation About Income, Wealth, and the Steps in Between and is also the founder of Total Candor, a financial planning education company. He lives in Portsmouth, NH with his wife, daughter, and one on the way. Another child that is, not another wife.