Personal finance 101 – saving for your kids’ college
This is the sixth part in my series on Dave Ramsey’s Baby Steps, a proven personal financial plan. My goal is to explain a really solid money management plan in plain ol’ English, for intelligent yet financially “average” home managers.
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nce you start funding 15% of your income towards retirement, and once you’ve fully funded your Emergency Fund (and any other big purchases you’re saving for – like a Car Replacement Fund), it’s time to start funding your kids’ future education.
This does not mean you can now afford to save up for the most expensive private school out there, nor does it mean your chid doesn’t need to contribute personally towards his future. But it does mean you are financially free enough to provide at least some towards a college education – at least a start towards entering university life debt-free (and hopefully staying that way).
Here are the nuts and bolts of Baby Step #5 in Dave Ramsey’s plan – put money towards your children’s college fund.
Dave’s Rules for College
These are pretty straightforward:
1. Pay cash. The average college student today graduates with about $15,000 in student loan debt after spending 3-4 years in an apartment. What a heavy weight strapped to a graduate’s shoulders fresh out in the job market! If you’re able to help your child avoid that burden, then do so.
2. And If you have the cash or the scholarship, go. As in, to college.
Student loans are so normal these days; there’s a prevailing myth that you can’t possibly go to a university without them. But they’re just not worth it. Even with the low interest rate most federal student loans have, you just never know what the future holds. I know I’d hate to corner my kids into having to pay for their education after they’ve received it. What if they’re offered some really great opportunity after graduation that pays very little (or not at all), yet is invaluable to their career or overall well-being? What if they want to settle down and become a wife and mom right away? These things would be so much harder to do with student loan debt.
Dave says this:
“If you’ve planned your savings goals and don’t have much room in the budget for college, don’t panic. Knowledge is just part of the formula to success. With what you are able to save, those precious kids can probably get a good degree if they will suffer through lifestyle adjustments and get a job while in school. Work is good for them.”
I wholeheartedly agree. I worked part-time all through college, and while I hated it at the time, I can look back and see the enormous life and business lessons I learned from those long shifts waiting tables. These life lessons are just as much a gift as the money you contribute to your kiddo’s education. Consider giving them that valuable experience.
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Where to Save the Money
Dave recommends putting college tuition funds in either an Educational Savings Account (ESA) or a 529, which are state plans and therefore different depending on your state of residence. College tuition goes up faster than regular inflation – 7 percent for college versus 4 percent for most everything else. This means that in order to keep up with tuition rates, you’ll need to earn at least 7 percent per year to keep up with the tuition increases.
With an ESA funded in a growth-stock mutual fund, your money will grow tax-free when it’s used for higher education. You can currently invest $2,000 per year, per child in an ESA (if you make under $200K a year) – and if that ESA averages 12 percent, you’ll have $126,000 in tax-free education funds by the time they’re ready for college.
If you make more than $200,000, or for some reason you want to contribute more than $2,000 a year (possibly the case if your kids are older than 8), then 529s are for you. There are lots of different 529 types out there, but Dave only recommends a “flexible” plan. He says you could pick from virtually any mutual fund in the American Funds Group or Vanguard or Fidelity and probably be okay.
How this applies to you depends on your circumstances.
• If you don’t have kids, it doesn’t apply to you at all because you can’t open ESAs or 529s for people who don’t exist. But seeing as this is Simple Mom, I’m guessing most of my readers are parents.
• If you you’re not debt-free (Baby Step #2), you don’t have three to six month’s of expenses in savings (Baby Step #3), and you haven’t started contributing towards your retirement (Baby Step #4), then you’re not ready to start saving for your kids’ college. Under Dave Ramsey’s plan, you’d hold off contributing to your kids’ college fund until you completed the previous Baby Steps.
This makes sense – why would you save for your kids’ education and not your retirement? In doing so, you’re strapping your kids down with having to take care of their parents down the road. I’d rather not do that and have them work for part of their college funding.
• If you are at the stage of saving for your kids’ college, then Dave recommends sticking to mutual funds through an ESA or 529. And do what you can afford without feeling guilty if you can’t fully fund their education. That’s never been part of the definition of a good parent.
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Our Personal Plan
As of now, our plan when we’re at Baby Step #5 is to provide a “matching promise” for our kids – we’ll match whatever they’re able to save, up to what an ESA allows at the time. And if they don’t have enough saved by the time they’re ready for college, we will highly encourage them to not take out student loans. They’re just not worth it.
I’ll end with another quote from Dave:
“Regardless of how you save for college, do it. Saving for college ensures that a legacy of debt is not passed down your family tree. Sadly, most people graduating from college right now are deeply in debt before they start. If you start early or save aggressively, your child will not be one of them”
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