This is the sixth article in Frugal Dad’s week-long series, The 7-Day Turnaround: One Week to Change Your Family’s Financial Destiny. Each day brings a new step to implement and help you get control of your finances.
One of the most valuable gifts we can give our children is the gift of education. Used properly our kids can lead successful lives long after we are gone. I am not one of those that believes a college degree is an automatic way to wealth. What you do with your education is far more important than the degree hanging on your wall. Having said that, if you are in the position to help your children complete their education it will help them immensely because they won’t owe Sallie Mae two years of their first salary earned out of school. Too many new graduates are saddled with huge student loan debt, stifling their financial productivity in those precious early years after graduation.
Start early. Like any type of investing, the key is to start early. College tuition continues to rise at a staggering rate, and by the time your newborn heads off to school it may costs as much as your mortgage, in today’s dollars. The only way to beat that pace, other than hitting the lottery, is to get an early start and take advantage of 18 years of compounding growth.
Take advantage of tax-free savings vehicles. The government has made the job a little easier these days by offering two outstanding tax-free savings plans for college savings. Education Savings Accounts (ESAs), sometimes referred to as an Education IRA, may be opened at nearly all brokerages. Unfortunately, you can only contribute up to $2,000 a year for junior, but the earnings do grow tax free. So if that $36,000 in contributions from birth to age eighteen grows to $100,000 you can withdraw 100% of the account balance tax free, as long as it is used for educational expenses.
Education Savings Accounts may provide adequate savings for your child, but in case they get accepted to attend an ivy league school it might also be a good idea to invest in a 529 College Savings Plan. 529 plans are sponsored at the state level, and many states offer tax deductions for contributions made to your in-state plan. If your state’s plan is lousy, don’t invest just for the tax deduction. You are able to invest in plans managed in other states, you just simply don’t get a tax deduction on your state income taxes. Saving for College has a good 529 plan overview that lists all the state plans.
Financial aid is still available. Neither type of college savings plan are considered student assets in the eyes of federal financial aid providers, and therefore will not significantly reduce your child’s eligibility to receive federal financial aid. However, since most needs-based scholarships are offered at the individual school level the schools may have different rules on how assets are treated. Also, take a look at the scholarships that I provide and feel free to taken advantage.
Chart your own course. Regardless of savings vehicle you choose be sure to select your own investments. Some of the best 529 plans offer a wide range of investment options in top mutual fund brokerages such as Vanguard or TIAA-Cref. Others offer only “managed allocation” options based on when your child plans to attend college. The plan administrator may not have the same tolerance for risk as you, and move your child’s savings balance to more conservative options too early.
What if my son or daughter decides to take a different path? If your child decides not to attend college you may assign another family member as beneficiary, which could be a nice gift for a brother, sister, or favorite niece or nephew. If you have a small family with no other beneficiaries available you can always cash out the savings and pay a 10% penalty, in addition to your ordinary income tax rate.