If you have a young child, then you are probably thinking about future college costs, and your participation and guidance to help your child get enrolled and graduate from college- and possibly graduate school. I have thought a lot about the future costs of college for my child, and I am also concerned about the quickly rising college costs that occurred in the last several decades.
I attended college during the Reagan years, at that time, the cost of a highly ranked public university was basically insignificant compared to today. My college friends and I worked during school and did extra jobs in the summers to finish college mostly debt free.
529 College Savings Plan
In the state of California, we have access to a college savings plan 529. This plan provides very good tax-exempt advantages. Your money goes in post-tax, but it grows and can be withdrawn for college expenses completely state and Federal tax free. It's not the triple tax benefit as provided in a Health Savings Account (https://financialsombrero.com/core-income), but a 529 college savings plan is a pretty good double tax benefit in California.
Put Money Away Early:
So new parents need to make college financing decisions early on in their child's life. Start putting money away early, the earlier the better and allow it to grow tax free. Some people I've talked to avoid saving anything for college- they rely on future assets, such as home equity loans, 401k loans, family generosity, or they find a way to fund college using their monthly income (their expectation is that their income will be higher in the later stages of their career).
Important Costly Example
My specific decision to participate early in a 529 college savings plan was prompted by a colleague who self-funded his three kid's private school education. This colleague basically paid the schools what he could during the overlapping eight period of college costs for his three kids, and then his kids took out parent plus federal subsidized student loans for the majority of their college expenses.
Till Death Do You Part:
Because this friend saved zero dollars before the college experience started, the private college cost was very impactful to him and his family for nearly eight years. Additionally he will be forced to repay the parent plus loans for his kids until, well basically until his death if his kids cannot repay the loans themselves.
I therefore started participating in a college 529 plan for my child early on, and I setup automatic deductions from my checking account to fund this plan. As with any investment, I started with really small amounts and increased them slowly, or occasionally added lump sum funds when I could.
Violin, Travel Soccer or College Savings:
You may also need to make tough budget decisions for other child care expenses. For instance, does it make sense to pay thousands of dollars per year for travel sports fee's, or expensive violin lessons, advanced tutoring and summer camps if you are not putting enough into some type of college savings. Of course the one exception is the rare student who gets the full sports, academic or music scholarship. Yes, this is a very nice situation to experience, but is it realistic for your child.
What if you save into a 529 plan and your child does something other than college.
-You could use the money yourself to expand your education, or the education of other eligible family members.
-A recent change to the 529 plan allows for funds to go to elementary, middle school and high school costs up to $10,000 dollars per year.
-You could pull non-qualified withdrawals, but you will be subject to a 10% federal and potentially a 2.5% state tax.
The kid doesn't go, or gets a full scholarship.
I definitely want to mitigate the tax implications of paying the 10% federal and 2.5% state taxes. Saving money diligently for eighteen years only to be hit with an unplanned taxable situation is not the scenario I want. My partial flexible solution helps, but does not solve the tax implications.
My Flexible Solution:
What I do Is maintain enough college savings in the 529 plan to cover 50% of the college costs, the remaining 50% I keep in CD's or online savings accounts, depending on who offers the best rates. This way, If I need to take out the non-qualified withdrawals, I can limit the withdrawals to only 50% of the total college savings.
I also maintain the other 50% of the college costs in a purely liquid account. Yes, I am limiting the overall tax savings if my child does indeed need all of the funds I have saved, but I also sleep better knowing that I could free up 50% of the college costs if the situation arises.
Lastly, I understand that everyone wants to setup and fund a college savings plan for their kids, but they feel they cannot contribute to these plans. My advice, any savings created early on, no matter how small will assist you down the road.
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Note that I am not a financial or legal professional, nor am I licensed to sell securities, or any other financial instruments. Given this statement, I strongly recommend that you consider this blog as entertainment value. Although, I sincerely hope that I can motivate you to learn to build your own financial knowledge and wealth.
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