KJ: There are several ways this post could go with the primary focus being philosophical or it could strictly be an informational post on ways to fund your children’s education. We decided to mix the two as we discuss education funding, so you can see that it’s not necessarily an all or nothing proposition, yet still discuss some tools to use in how to get there.
Step one: should I pay?
Think (long and hard) about the following question: should I pay for my children’s education? Depending how passionately you answer this question will dictate how high of a priority this is for you and your family. Angela and I – as we have stated previously – have been very fortunate in this (and many other) regards. We weren’t saddled with student debt when we came out of college due to the sacrifices and decisions our parents made. I see so many individuals that are tens (or hundreds) of thousands of dollars in debt as they start their careers. It’s not an insurmountable task to pay them off, but it definitely requires tremendous effort, close budgeting, patience, and good long-term planning to slowly chip away at the mountain of debt. We (not infrequently) reflect on our blessings and the sacrifices made on our behalf to have a better life – and what a good life it is 🙂 – but we do come back to the question of if we had paid for our own schooling (in whole or in part) where would we be today? Would we be coming back from the trip of a lifetime, discussing our future trip to wine country in California, or reviewing our top priorities for changes to our new home? Maybe, but chances are that things would look different than they do now, so it’s with these great blessings that we carry the guilt for the sacrifices our parents made on our behalf.
Step two: how much?
Next, consider the question: what proportion would we like to pay for our children’s education? Do you pay for everything all the way, do you let the child pay for all of it, or is there a happy medium? There’s a certain ‘pride of ownership’ as you may say in paying for at least part of your schooling. At times, it can be a whole lot more stressful while in school, but it can teach you invaluable lessons of the value of a dollar and the true cost of your schooling…it’s not just a cost per credit hour, but it extends to housing/apartment prices, utilities, books, food, and more! Don’t wait until the day you send your child off to college to have the conversation of how and where the money may come from. Our culture is usually so closed off when it comes to money, but at what cost? How can our children care about our finances if we can’t share anything about ours with them and at least set expectations? Of course you can’t expect them to agree on everything (hey, they’re children), but at least you have a chance to start off on the right foot.
Step three: public or private?
This step is partially a continuation of step two above, but do you want private or public school for your children? Growing up in public schools (some of the best in Texas I might add…) I am averse to spending money on private education (primary, secondary, or higher education) for my children when that day may come. Discuss with your significant other your goals on what type of education you would like to provide as well, and this will go a long way in setting the expectations of what you may need to be saving to get there. It may be on your ‘must have’ list to send your children to private school, so if it is, evaluate the costs and potential sacrifices you may have to make in other areas of your life, and put a plan together on how you can actually achieve it.
Step four: what tools are available?
Phew…now we’re finally to HOW to get there! There really are a plethora of savings approaches that may help you get there, so below is an introduction to some of the methods for how you may be able to save tax-efficiently for education. This topic is quite broad, so we will have more on each of these account types later. Enjoy!
- Prepaid tuition 529 plans – you prepay now and ‘lock-in’ the cost of college education for the future. Oftentimes, if the child goes out of state, you can receive a credit for what the plan would have paid had the child stayed in-state. Few states offer these plans, and you have to carefully watch the assumptions of the plan since they can typically be quite restrictive.
529 savings plans – these are some of the most common types of education savings and it works similar to a Roth IRA from a tax standpoint. Basically, you open an account with a state (typically you don’t have to be a resident nor plan to attend school in the state that is sponsoring the plan), and you contribute funds for a beneficiary. The money you contribute is not Federally income tax deductible (it may be state tax deductible depending on the plan and your state of residence), but the account grows tax free provided it is used for higher education expenses. Qualified education expenses can include tuition, fees, books, room and board, and it is overall quite broad, but it must be used for higher education to count. The amounts contributed to the account are considered a gift to the child (or other relative), and contribution limits are usually very high. Again, this can get quite technical, so more on this to come in another post.
Coverdell Education Savings Accounts – these accounts can be setup with some banks or custodians. The contribution limits – $2,000 per year per beneficiary – are much lower than a 529 plan, but the expenses can be used for K-12 in addition to college expenses unlike a 529 that can only be used for higher education. Without going into too much detail, generally, with both a Coverdell and a 529 plan you can retain control of the accounts to determine how/when distributions are ultimately made. Also, a Coverdell ESA has some income limitations that may disqualify certain individuals/families from being able to contribute.
UTMAs/UGMAs – these accounts can be setup similar to a Coverdell Education Savings Account with a bank or custodian. There are not usually contribution limits (although there may be gift tax consequences of a very large gift), and the funds can be used for a much broader set of expenses than simply education (including K-12 and college). You typically have a parent that is named as the ‘custodian’ of the account to control the investments, contributions, distributions, etc. while the child/beneficiary is not at the age of majority (note: in some states the age of majority is 18 while in others it is 21). Once the child reaches that age, the account becomes his/hers, and they have unrestricted use to spend, invest, and distribute the account as they wish (including non-education related expenses), so this option typically affords parents with multiple children the least flexibility in potentially shifting funds around from one beneficiary to another to make sure education expenses are paid for all children.
With all the options available and the litany of details on each one, it’s no wonder that it’s so much trouble keeping up with it all. Hopefully this post has served to be a great introductory summary, and we hope to have more to come on each of these at a later date.
- What is your philosophy in funding your child(ren)’s education?
Are you familiar with any of these account types?
Have you had any success using these accounts in the past?
Tell us about why you chose to use (or not use) these accounts.
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