The following is a guest post from Sandy L over at First Gen American. I personally really enjoy the emotion she puts into her writing, so I highly suggest checking out her blog when you get a chance!
Today I’d like to offer an alternative point of view on how people prioritize their savings goals. You see, when I read about most people’s plans, they look something like this:
- Pay off Consumer Debt
- Build an Emergency Fund
- Pay off Student Loans
- Save for Kid’s Education
- Save for Retirement
- Pay off House
I mean even Dave Ramsey says you should save for your kid’s education before you pay off your house, so what gives? Although it is logical to organize your savings goals in chronological order, I hope to convince a few people to move #4 down to the bottom of the list.
My first bit of advice if you have children of any age, is to learn about FAFSA. This is the federal financial aid form. Its purpose is to calculate out a person’s eligibility to receive need based financial aid.
The FINAID site goes into all the nitty gritty details on income limits, scholarships, ownership rules, etc. The two things that everyone should be aware of before saving a dime for college is whose name to put the asset in and what the federal government considers an eligible asset or liability. I won’t touch on all of them in this post but there are 4 big ones that I think everyone should be aware of:
- 401K and IRA plans – are not considered eligible assets in your need based calculation. (The exceptions are the contributions that occur during the year of the FAFSA application). The good news is the federal government doesn’t expect your 70 year old arthritic self to eat cat food in order to pay for junior’s education today.
- Your Primary Residence - is not considered an eligible asset...even if it’s 100% paid for. Again, Uncle Sam doesn’t want you to go homeless to pay for Jr’s education.
- Your consumer Debts – are not considered eligible liabilities. So if you make $100K/year, but have thousands a month in credit card payments and car loans, the federal government doesn’t count those as eligible liabilities. Your income on the other hand does count. Uncle Sam isn’t going to reward you for being a dumb a$$.
- Certain Durable Goods – like cars, computers, etc are not considered eligible assets.
So what’s my current plan for my kid’s education (ages 1 and 5)? Well, they do both have 529 plans, but they usually only get contributed to during birthday or Xmas time when family members throw them a few bucks. I do plan on eventually contributing, but not until after I max out our retirement plans and pay off our mortgage.
Oh, I guess I do one other thing. Our emergency fund is in savings bonds in our name (better than if in Jr’s name). If we’re lucky enough not to have to tap that til college time, we can cash those in tax free come tuition time.
What’s your plan? Has your mind been changed at all?
It’s also very important to shop around for 529 plans. When my wife and I selected the New York plan, it was on the basis of a very low load (which, by the way, goes even lower depending on participation), good website, and excellent, diverse investment offerings.
To give you an idea, the New York plan has about a 0.5% load, whereas the worst plans had about a 3.5% load. Using http://www.savingforcollege.com/college-savings-calculator/ shows that to be a nightmarish difference in return, especially in a down year where the load comes out anyway.
Some of the plans I researched had nothing but stacked stock/bond funds in them, which were also performing terribly. Why would I put my money in a 2-star fund that’s got a 15-year average return of 2.5% on stocks? (To quote Troy McClure from the Simpsons: “Two Minus Three is Negative Fun!”)
Also, don’t be afraid to put money into 529 plans. Even if your recipient doesn’t decide to go to college, you can change the beneficiary fairly easily. In the best case scenario, if your recipient gets a scholarship, they (or you, wink-wink) can pull money out of the 529 on a dollar-for-dollar basis.
While we’re not putting a lot of money in now, it’s important to start a 529 plan for several reasons:
1. you need to do the calculations, just once, so you KNOW the details. As your kids get older, you are prepared to be able to discuss education costs intelligently, rather than with a handwave. Model the financial preparedness you want them to have.
2. if you don’t, you’ll always have a nagging fear about it. Nagging fears drag down the whole planning effort.
3. it protects you from absorbing the kids’ gift windfalls into the household budget.
4. I’ve found that the more financially-prepared you are to receive gifts, the more they seem to arrive, and the farther they go when you get them.
5. As long as you’re starting plans for your kids, consider starting a plan for a young niece or nephew. What better way to demonstrate compound interest?
It is unlikely that we will qualify for need-based aid. Maxing out our retirement would be putting away 76K/year. I’m fairly sure our mortgage will be paid off before our first (?) child goes to college, unless we move.
So we do some of everything. No debt, healthy emergency fund, student loans long gone, money for retirement every month, money for the 529 every month, extra for the mortgage. With the mortgage vs. retirement I like to think of it as a form of diversification. I don’t want to lose out on potentially huge stock market gains, but the house is a sure return.
We’re in the Utah 529. When we started it was easily the best plan. Now there are other plans that are equally good.
We also put money in a 529 for DH’s cousin’s kids. But they’re getting close to college and it has done a very poor job of demonstrating compound interest. A great job of showing stock market risk…
That’s interesting to know that retirement plans and your primary residences aren’t considered for financial aid. That’s probably where the majority of people’s net worth is at, so that could be very beneficial.
My plan has kind of gone like this so far though:
1. Pay off consumer debt
2. Build an emergency fund
3. Pay off student loan
4. Rebuild an emergency fund
5. Save for retirement, pay off house, and help to pay for kid’s education as he goes.
6. Build wealth
I am like Nicole, I put a little toward everything.
My oldest will be a junior this year in high school, so my college costs are looming fast. I don’t have nearly enough saved to cover his college by any means. I doubt we will qualify for aid period, so my son is going to have to pursue independent scholarships and such.
If I had any consumer debt, I would be working 4 jobs to get it paid off. I cannot stand one dime going to interest (outside of my mortgage, I have accepted I cannot pay that off anytime soon, and I am not going to give up living to get that paid off. I do contribute extra every month though.)
Like NicoleandMaggie, I did a little of everything. We paid off our house (at much higher rate than available today), figuring that the monthly cost could be diverted to tuition. We had a 529 for each child. We funded it to around $40,000 each and put it in the guaranteed option, which turned out to be a good thing.
As it happens, the money is still there. We will have our kids either use for grad school, or give it to them as a “dowry” over a few years to get them started in life.
PS Spouse and I are teachers in the humanities, so please don’t think the savings are impossible for average income people.
T. Derscheid — I’ll have to show DH your site. Our kid played his first board-game this weekend. He started with crokinole.
Are 529 plans based on the state where you live? What about if your child goes to school out of state?
Jenna– You can use the 529 money for any school, anywhere. (There may be some limits on professional training, but you can use it for some for-profit educational training.) Some states give you tax breaks on state taxes if you use their plan. If your state doesn’t, then there’s no reason not to use a plan like Utah’s or another state with good diversification and low fees.
My husband and I had this same delimna. We will pay off our house first. Our logic is that we will pay cash for the kids education as it is happening (we have some $ currently saved). Currently our expenses are lower then our income.
I want my overhead to be as low as possible NOW and so getting rid of the house payment contributes heavily to that goal.
I’m also a big advocate of the kids helping out with the costs of their education. Even if I have the cash to foot the entire bill I won’t!
I always advise people to make saving for college a low priority. I believe that a person should be completely out of debt, and comfortably saving for retirement before worrying about their kids’ college costs.
Let that be the job of grand & godparents, other family and friends. Instead of all the expensive gifts that the kids won’t use much anyway, just ask them to put the money in a 529 account instead.
Get those kids some education and get them to apply as many scholarships as possible.
What if the child is eligible for major scholarships in both undergrad and graduate school? Can he/she still have the 529 $ for uses other than education expenses?
agreed with Lop, specifically local scholarships such as the rotary club. since those are limited to kids within the city, sometimes even a specific school, i consider it low hanging fruit your kid will have a good chance of snatching. i was awarded one of these in the amount of $6k over a 4 year period providing i maintained a 3.2
I agree that college savings should go towards the bottom of the list. My husband and I put a little (250/child/month) in our two daughters’ 529s. We are already maxing out retirement and have no debt other than the mortgage. I plan to have the mortgage paid off within the next 10 years. Since our 2 are 23 months and 4 months old, I think we will be ok. After we pay off the mortgage, I plan to put about 1K/month per child into their 529s. That should chop off a decent amount of their college costs.
Oh! Almost forgot. There is a snowball’s chance in hell that we will get financial aid. Our children might get merit based scholarships, but never financial-based ones.
Great comments by everyone. The FAFSA’s purpose is to calculate what the parent’s and child’s contributions should be. Everything else gets covered by loans and financial aid. My experience with scholarships is as follows: When I received a scholarship from an outside organization, then a need based one was removed of equal value. (The parent’s contributions don’t change).
I think the same about financial aid that many of the commenters do(that my kids won’t qualify). However, when I was in school, I had friend who’s mom was a nurse and dad was a sheriff and he received financial aid. His parents earned more than some other people who received no need based aid. It has alot to do with how their assets were distributed. The students that got nothing had cash accounts specifically in their name. Childern’s assets get weighted more heavily than the parent’s assets.
I think this topic needs a few more posts. There’s so much to cover.
Holly,
There is a 10% penalty for distribution for non qualified college expenses.
If the beneficiary receives a scholarship, the 10% tax penalty is waived on distributions up to the amount of the scholarship. The other thing you can do is transfer ownership to another family member (up to first cousin) with no penalty. The penalty is also waived if the beneficiary dies or becomes permanently disabled.
T. Derscheid
Good point about the loads on 529′s. I haven’t looked closely at mine, although I know they’ve performed pretty poorly since I’ve had mine.
Consumer debt free? Wow one hell of a goal. I really hope you pull it off. Budgeting is a very good way to get there
Sandy L, kudos to you for doing your homework!
Of the list of 6 above, I put the most money to the following in this order:
6. Pay off House
5. Save for Retirement
4. Save for Kid’s Education
1, 2 and 3 doesn’t apply to me because I have no debt and enough money saved in investments and my Roth IRA, so that I don’t need a real emergency fund (hopefully).
Great work researching the effects on finaid eligibility vs college saving plans!!!
Sandy L: “When I received a scholarship from an outside organization, then a need based one was removed of equal value.” This is generally true. My college made a really big deal about how they only removed half of the need based scholarship (something I appreciated!). If your parents aren’t well-off and you’re going to a well-endowed school there’s often not much point in getting outside scholarships.
You’re also right that many people are wrong about their eligibility for need-based aid and don’t apply even when they’re eligible. I’m hoping that by the time our children are in college that we’ll be well-over the cutoffs for any need based aid on income alone. We’ll readjust our 529 contributions if that turns out to be wrong. It’s still a long ways off for us.
BTW– The FAFSA got a major overhaul and redesign this year so it should be a LOT easier to fill out than what we all did back in the day.
This is one reason why I hope to work at an university- reduced tuition for dependents.
I don’t have kids yet, but I would say that saving for a future child’s college is a low priority to me. If and when I have kids, if I can pay for some or all of their education, then great. If not, I’ll help them fill out a FAFSA and then help little Smitty manage his/her student loans by devising a plan to pay them off; a much better approach in some ways. They can learn about budgeting and personal finance, and build a credit score to boot.
I couldn’t agree more with this. As much as I hate debt, kids can always get some loans for school. You can’t do that for your retirement, unless your house is paid off and you get a reverse mortgage. But I’ve never heard anything good about those!
Oh and Crystal, not that I want to give you a hard time about the lawn mowing, but does Mr. BFS hate mowing as much as you do? You should just get him to do it if not…
One advantage of not mowing your lawn though – no need to buy and store a mower!
@Rob, oh yes, Mr. BFS and I discussed mowing the lawn before we even started looking at houses – we both think it sucks since it only needs to be done during the hell-like hot months here in Houston…it was a cost we budgeted in to the whole home ownership thing…
I received some merit based scholarships to attend college, and what wasn’t covered my parents paid for the rest. I left college with zero student loans. I am so grateful that my parents helped me with my college bills. I’m now 25, and since I had zero debt, I was able to purchase my first home by myself, putting 20% for down-payment. I would not be where I am without the help my parents gave me. And I know that when I have children that I will pay for their college education, what isn’t covered by scholarships, so that they don’t have to dig themselves out of debt.
@Mary, I might do the same, but my kids will totally be told that some scholarships are expected. I know too many kids that blew off the work of applying for scholarships since they knew their parents would cover everything anyway….
College savings plans generally permit an account holder to establish an account for a student for the purpose of paying his or her eligible college expenses. investing in a 529 plan will generally reduce a student’s eligibility to participate in need-based financial aid. Good job for the posting be continue please
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