I just had twins! Now what? Of course...start saving for college.
Saving for college is not the first thing I want to think of right after having my sweet little babies. After all I just want to spend my time focusing on and enjoying this precious stage of their lives. Not to mention I still have baby related medical expenses and I feel like I should have majority ownership in Pampers through my stock of diapers. I'm not really thinking about 18 years in the future when they will officially attend their first frat party. In reality I did think about opening college savings accounts for the twins but it took me about a year to actually do so (to be precise: one week before their first birthday). It doesn't matter though...the point is better now than never. Just like with many investments, it is usually not too late to get started and the earlier I start the more my money has the potential to grow. In this article I will explain the reason behind saving for my kids' college expenses so early, my decision to open a 529 savings plan in comparison to other options, and some of the mechanics behind getting this started quickly.
1. Be Smarter than Some of the Smartest People
I have met many smart people who do not respect the value of saving today. Saving for college (equally applicable to retirement) is a long term game. I have always been shocked at why some really smart people don't save. Often times the psyche of smart, confident people says: I will be financially successful in the future so saving today is not important. I say there is little downside to both feeling that way AND also saving at the same time. I've heard smart people say: 'I will save tomorrow.' I have also heard that other smart people, like doctors, are notoriously bad with money, not having the discipline or long term vision needed to save today. So the first thing I do is outsmart the smartest people by saving today, even if it is just drops in the bucket every month.
Here is what helps me... I close my eyes and envision myself 18 years from today. My scion has selected his and her colleges and the good (but probably future unappreciated) parents that we have become are about to cut a check to university. I pat myself on the back knowing I have just dipped in to my kids college fund--anxiety free--and our years of saving have turned in to a huge achievement. As I congratulate myself I also think that this achievement is far superior than (i) taking a loan and being a slave to debt later in life, (ii) pulling from investments/retirement savings possibly incurring significant tax penalties or early withdrawal penalties, (iii) or being in a position where paying for college puts other plans I have at the time on the back burner.
2. Ignore Family and Social Pressures to Spend
I'll admit it, I've been called cheap, stingy, and tight with money. I don't care about the haters because I am confident of my financial abilities. I do what is best for my family. I am fiscally conservative, live within my means, and proud of it. I actually don't even think I am any of those things that I have been called. In reality, I both save and make big calculated purchases - the latter being the antithesis of an aversion to spending. I just try not to spend a little a lot which I can see why this causes perception issues. This is a tough place to be in our real time culture of disposability and materiality. Ughh, sounds boring right - I can hear the haters say, 'you can't take your money to heaven.' Again, trust me, I sure don't plan on it. The key for me is balance - to be able to enjoy both today and the future. That tipping point will be distinct for different people though.
Family and social norms related to the spending habits of those close to oneself can be a real influencer. Often inclusion means spending a lot of money and that can be in direct conflict with personal or family financial goals one sets. I overcome this by setting financial goals (in this case saving for college) and blocking out the noise. Sometimes it requires painful sacrifices but for me the goal achieved and resulting reward (whether it be a visceral experience, material item, release of debt, etc) is worth it. I've mentioned long term vision and discipline; these pressures, if not faced with determination, will kill both of those items pretty quickly.
3. Open a 529 College Savings Plan
I chose to save for the twins college by opening a 529 plan. Why not just put some money away in the bank? Because we are smarter than some of the smartest people. There are federal and generally state tax benefits to these plans which are real significant; this makes committing my money here worthwhile. While the 529 is my main focus right now, I am also thinking about putting additional college savings away in normal stocks, mutual funds, or other investments to supplement the 529. While this complementary method doesn't have the same tax advantages as a 529, the investment choices can be more aggressive, which can behoove any 1 yr old set on going to a more expensive out of state or private school. That is the point, it is so far away and most people don't know where their kids will go to college at this point so don't overthink it.
Let's get back on track talking about 529 plans. When it comes to 529s there are prepaid college plans and there are 529s which are savings plans. With a prepaid plan I basically pay now -- typically in installments -- for future coverage of the tuition fee in the future (and some other expenses depending on the plan) at certain schools. There are only a handful of states that actually offer prepaid 529s and there are often residency criteria. With a 529 savings plan, college expenses are not guaranteed but I have more control. For me and my situation the 529 savings plan makes the most sense...here is why:
- More growth potential. I am able to choose from different investment options in the 529 savings plan - for example, there is a fund which is aggressive now but chills as my children become teenagers (the opposite of what will happen with their behavior) and this helps reduce risks down the road should the market happen to be cruddy when I need to withdraw funds to pay for college. With a prepaid 529 plan if my child does not go to a school which is under the plan, I can still apply what I contributed to the prepaid plan towards other schools but most likely this will only provide partial tuition coverage. The positive is that in this case I still wouldn't lose funds contributed to a prepaid 529. However, the money contributed in over the years to the 529 prepaid plan will most likely have a lot lower rate of return than from a 529 savings plan. The 529 prepaid would be a great option if was more confident that my child will go to one of the participating state schools. With the 529 savings plan, I like that I can choose the investments and that the investments will have more growth potential. I may at some point also consider investing in both too.
- More tax free growth potential. The money that is contributed to the 529 savings plan grows tax free - so for example, I can switch investments without having to pay costly taxes on how much ever the investment appreciated. This is more an advantage over a non-529 investment, such as a regular mutual fund, which has tax implications. With the prepaid 529 you are not choosing investment options, rather you are basically just purchasing future tuition today so the tax free growth benefit of the 529 saving plan doesn't apply here. However, the 529 prepaid plan has the obvious benefit of locking down the cost of college but as per above when evaluating all of the facts, it is not my choice plan right now. Both the 529 prepaid and the 529 savings let you "withdraw" funds for the qualified expenses tax free.
- More qualified expense options. Unlike the 529 prepaid plan, the savings plan can be used for more than tuition. The 529 savings plan can be used for qualified education expenses such as books, room and board, and technology. The prepaid plan is typically for tuition and possibly administrative fees, depending on the specific state plan terms.
- Flexibility. The 529 savings plan can be used towards pretty much any school in any state. On the other hand, the 529 prepaid plan is designed to cover tuition at participating schools - typically state schools within the state of the plan. However, funds from a 529 prepaid plan can be used towards many schools that are not part of the plan either in-state or out-of-state. So what is the real difference here? As mentioned in the first bullet above, if my kid doesn't go to one of the participating state schools, I believe I will have more return on my investment to use toward college via the 529 savings plan.
- The economics behind it. I also did a little math and I am gambling a bit that state school tuition and inflation will not increase every year more than what I can ultimately contribute and grow in a 529 savings plan. Basically my model concludes that if I invest the same amount required for a 529 prepaid plan in to a 529 savings plan, I will have over-payed for the 529 prepaid plan. Putting that same money in the 529 savings plan would provide more growth, cover state school tuition, and also produce surplus funds to purchase other qualified expenses like books. However, my model is based around my own assumptions of what tuition will cost in the future. If I was pretty sure my kid would go to an in-state school that is part of a pre-paid plan, then I would still consider the 529 prepaid more. I that case, what I believe I would be overpaying I would look at as insurance against the risk of high future costs.
- I have options later. I believe later on I could transfer my funds between the savings and prepaid plan which could be interesting. For example, if my kid is planning to go to an in-state school which is participating in the pre-paid plan, I would evaluate the cost of buying in to the plan at that point. If it is less than what is in my 529 savings plan and obviously less than what I think the cost of tuition will be, I think it could make sense to transfer some of the funds to a prepaid plan from the savings fund to pay for college. Then with the balance remaining in the 529 savings plan, that could go towards higher education, another beneficiary, or other uses. I could also invest in both plans at some point without transferring funds between plans.
Here is some official IRS information about the plan and tax implications: https://www.irs.gov/newsroom/529-plans-questions-and-answers
4. Opening a 529 is Easy and Only Takes a Few Minutes
It is easy to put off opening up a plan and I am guilty of it too. After all, it sounds complex: plans to choose from, investment options, tax considerations, forms to fill out, etc. The reality is that it was really easy to open a 529 savings plan and there were no costs. Once I had my children's pertinent info readily available, like their social security numbers, it probably took me no more than 15 minutes to open up both accounts. I was provided with quick online forms and was able to sign electronically - no printing, faxing, mailing scanning, etc was needed. I opened the plans through my existing online brokerage firm which is great because I can see all of my family's investments, 529's and others, in a single location by account.
I could open a plan under any state's program and typically I would look at my own state's plan first because it may offer extra incentives like state tax breaks for residents. I live in Florida and since there is already no state income tax here, it didn't really matter which state's plan I joined. My current brokerage firm offered a plan through another state so my 529 savings plan is an out-of-state plan for me.
Just a quick note, when I opened my plan I had to choose (i) a single custodian, who will fully control the account, and (ii) a beneficiary, who will be the future student. A beneficiary can have multiple plans such as both 529 savings and prepaid plans or as another example, a 529 savings plan administered by a parent and a separate 529 plan administered by a grandparent. If the family is trusting of each other I think a single plan for the child with the parent (or most fiscally responsible person in the family) administering the plan makes the most sense. Plus withdrawals from a grandparent's plan can have more negative impact on obtaining student loans than from parent owned plans because the money is considered a parental asset vs student income. For me, it is easier to manage savings goals when I have a consolidated view and access to plans. Additionally, I can control when the funds are disbursed come college time. With this structure, relatives can still easily contribute to the plan.
5. A little Adds Up
Now that I've opened the accounts I don't want to delay funding them. A little adds up...I have heard this a million times already and it is so true. For example, let's say I contribute just $100 a month, less than a typical cable/internet bill, to a 529 for my son. The first few months I may look in to the account and see just a few hundred dollars there and get depressed. I know college is expensive. However, I stick with it and even soon forget that I'm contributing to the accounts because I am smart and setup automated contributions. I don't even miss the money because it's not that much every month and my new budget becomes my norm. Then something happens. At the end of the year, I see $1,200 or let's assume it grew a little and is at $1300. I say: hmm, not bad my son has over a thousand dollars saved up! But in the big picture it still seems like it is not a lot for college. Over the next few years I check on the account periodically to make sure the money is still invested in the right investment fund for my son's needs but I pay little attention to the amount.
Fast forward a few years. My son turns 5 and he tells me that he wants to be a doctor (he will really tell me he wants to be a professional soccer player and I will respond by saying doctor is also good) so that means he needs to get in to a good school to do a pre-med curriculum. I think to myself: 'this could be expensive,' so I log in to the 529 to see what is going on. Wow, he has $9,000 in there from our contributions, family gifts, and growth. It feels like I didn't even do anything and this is some real money.
By this time I am able to bump up our monthly contributions and when my son is 10 yrs old I do a little 5 year assessment of where he is at: $30,000. Holy schmolies! That is great but still a long way's off from the cost of college. I still have about 10 years left for contributions and growth (tax free growth and tax free withdrawal). Over this time my son's fund can grow to $60,000, $100,000, $200,000 conditional on how much gets contributed, the investments I choose, market performance, etc. Depending on which school he goes to this can cover all of the costs and then some, all of the costs, or not all of the costs. If it covers less than 100% I am still ahead of the game by a lot. If it covers more than 100% I can leverage the funds for graduate school or reassign beneficiaries.
The bottom line is that funding college expenses last minute without truly planning for it can really suck. Avoid that by dropping a measly $100/month in to a 529 - no biggie! Here is one last point to consider, starting to contribute earlier can help me reach my goals earlier because of compounding - or making money off of money that I've made. For example, let's call the following Situation (A): I contribute $100 every month only for the first 9 years of my kid's life and then assuming the market continues to grow from age 9 to 18, the money in the plan can continue to grow without additional contributions. In comparison let's call the following Situation (B): I start to contribute later like at my kid's age 6 and contribute the same amount every month as in Situation (A), $100/month, through age 18. In both cases I can hypothetically end up with the same total dollar amount in the plan. In Situation (A) though I have a shorter timeline of contributions, 9 yrs. vs. 12 yrs., which also means I am contributing less overall money! Just some food for thought.
Once the accounts were opened I actually didn't drop a check in them, rather I setup automated funding. The best method for me was to figure out how much I can afford to contribute monthly - as small or large as it is right now - and automate the contributions. Set and forget. Let's chant: set and forget, set and forget, set and forget! There are many ways to do this such as setting up recurring, automated checks from my bank's online bill pay feature to the 529 account. In this case I setup an automatic monthly recurring transfer of funds from my bank's checking account to the 529. I did this through a feature in my brokerage account that will pull funds on a recurring basis from an external account to my 529 accounts in my brokerage portfolio. It took me less than a few minutes to setup and was not technically difficult. It is pretty easy.
7. Birthdays and Other Events. Let Relatives Confidently Contribute
What better present to give a relative than the gift of education? On my kid's birthdays and other special events I will encourage my relatives to give towards the plan over buying toys or other disposable items. Of course toys, clothing, and other cool gifts are great too for many reasons; as with everything a balance is best. If my relatives decide that they want to have a direct part in funding the success of my kids' futures, now they have a formal vehicle to do so. Relatives feel better knowing that a specific college savings account has been setup for their grandkids, nieces/nephews, cousins, etc. Relatives will feel better contributing to a structured plan, knowing that it isn't going towards mom and dad's bar tab the following weekend. There is still some trust required here because as mentioned in one of the above sections, the account custodian can withdraw funds at a penalty and use for non-qualified educational expenses. Another advantage, assuming the custodian is more responsible than the beneficiary, is that the beneficiary (aka the person going to college) will not have control over the funds so Johnny can't blow the savings on a summer trip to Las Vegas between his junior and senior year of high school. This means the grandparents don't have to worry about writing a check directly to Johnny. Last, a relative's contribution to the 529 will be considered a gift and as we know from filling out our taxes there are annual gifting limit, which becomes taxable after those limits are reached. For the average birthday gift and non-eventful year though this ideally should not pose much of a concern.
8. Don't touch it
As mentioned above, custodians can withdraw from the plan with penalties for use other than for the beneficiary and I would discourage from doing so at all costs. Remember: 'set and forget.' The 'forget' is not just about making this easy and painless but also 'forget' means fa'get 'bot it, as in don't touch it. There are always extenuating circumstances but financing a new boat or even a business venture is not one of them. I look at this as my children's money and not mine to borrow no matter how confident I can make it back quickly.
So, set your savings goals, don't overthink the options, ignore the noise, open an account today, start contributing, and automate. Most importantly, don't wait. By the way there are other options out there too in addition to 529 plans and normal investments like mutual funds, ETFs, stock and bonds. Coverdell Education Savings Accounts (ESA), Uniform Gifts to Minors Act (UGMAs), and Uniform Transfers to Minors Act (UTMAs) account are other options to consider.