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Financial Life Advisor
Childcare & College Savings
I have two children, one 6 and the other 16 months....what is the best way to save for college and how much should we consider for inflation? We currently have a 529 account for our son but heard that it was not a good idea to have two accounts but just allow both to use the same account. So based on this information what type of account would you recommend we use to save for our children's college fund? The second part of this question would be is there an account that we could use that for example: as long as we had (x) amount of dollars in there by the time he was 13 it would have enough time to compound to the dollar amount we would need to have as a sufficient amount of money to use? I do not want to feel that I will need to save an extra mortgage amount each month until they are both 18 and in college. Help me budget for my kid’s college.....Thanks!
One kid is in kindergarten and we do not have to pay for daycare and the other child will be in daycare for 3 1/2 more years at roughly $900-$1100 per month. We are having trouble putting away a set amount each month due to paying for the childcare to where we are afraid we are going to be behind on our college savings if we can't add to our 529 account for the next three to four years like we would like. We are adding a little here and there but not sure if it is doing us any good. What do you recommend we do now or after our daughter starts public (free) education?
L.S. from Denton, TX L, you ask some provocative questions. Your questions have no doubt been asked by many concerned parents who are trying to prepare for the high cost of college education for their children. So let me address each one of your questions separately.
The best vehicle for most people to use when saving for college is the 529 plan. It provides a potentially tax free growth vehicle for saving. The way a 529 works is that parents, grandparents, friends or whomever can put money into the 529 for a named beneficiary. Inside the 529, you generally have a broad list of investment options in which to grow the account. When it comes time for college, the gains are free from federal income tax as long as they are spent on qualified higher education expenses. The 529 will outperform a simple brokerage account because of the tax free growth allowed by the 529 tax code.
If the money in the 529 ultimately is not needed for college, then it ends up being taxed and penalized upon withdrawal, the good news being that a beneficiary can be switched on a 529. Take, for instance, your 6 year old decides not to attend college. You can then switch the beneficiary to the 16 month old. This is probably why you have heard it is better to have one 529 plan instead of two. I would caution you, though, that from a practical perspective, if you have one account, there is a high potential for one sibling to feel treated unfairly. If the first child uses up too much of the account or if the market changes the value of the second sibling’s “share,” they could get upset. I would generally think that keeping separate accounts would be better to avoid some of those potential conflicts, but that would be based on your personal preference.
In a previous blog posting, I talked about how much one could expect to save for college expenses and what to consider for inflation calculations. I quoted the average rate of inflation from FinAid.org in that posting at 8%. You should also consider what type of college you want to prepare for financially. The cost difference between community college and a private school is quite large.
In consideration of inflation, there are a limited number of 529 plans which guarantee future tuition increases by allowing you the option of purchasing at current prices. These 529 plans are generally backed by the respective State, so no matter how high college tuition costs go, you have the ability to “pre-pay” for years of tuition. Not all States have this type of 529, but Texas does. You can find more information at www.TexasTuitionPromiseFund.com.
The first time Texas tried this program they ran into trouble quickly. The first attempt, known as the Texas Tomorrow Fund, ended up being much more expensive for Texas than anticipated. The program had to close to new participants only several years after launch. The new plan has more flexibility, but it is not backed by the full faith and credit of the State of Texas. Additionally, you should be careful of the restrictions of these guaranteed tuition plans. If you do not end up at a State university, then you typically do not get the most favorable rates of return if you can receive anything at all. These plans do help address the inflation and specific costs of planning to pay for college.
I would also recommend you read my blog posting on saving for college versus saving for retirement. I make the argument that it is probably better to save for retirement over college expenses if you cannot afford to do both. As far as choosing between childcare and college savings, it is probably better to defer college savings again. There are numerous ways to go to college without having enough saved to pay for it upfront. Childcare is an immediate need which allows you to work and earn more than $1,100 a month in childcare expenses ( I assume you are earning more than you pay in childcare).
It is nearly impossible to for most people to know exactly how much money will be needed to pay for all of college. There are just too many variables. Your children are lucky in that they have parents who really want them to go to college and are going to help them financially to make it a reality. Even if you are not able to save the full cost of college, what you have saved will go a long way to making the debt burden lower for your kids. It might even be beneficial for them to contribute to their education and keep “some skin in the game”. If you have any more questions, let me know.
Posted by Ben Gurwitz on 14th December, 2009 | Comments | Trackbacks
Tags: Financial Planning, College Savings, Dec 09
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